Markets Are Spooked by Inflation. Cathie Wood and Elon Musk See a Bigger Issue

It’s no secret that investors are worried about runaway inflation. Cathie Wood and Elon Musk see deflation as the bigger threat.

It’s no secret that investors are worried about runaway prices for goods and services, with the stock market on track to post its worst weekly run since mid-June and also nearing its worst performance since the Covid-19 pandemic rolled across the U.S. more than two years ago.

This week’s consumer price index numbers showing inflation running at an astonishing 8.3% annual pace as of last month all but confirmed that Federal Reserve Chair Jerome Powell will likely continue on his war path of raising benchmark interest rates in a bid to stop consumers and businesses from borrowing and spending.

But not everyone agrees that runaway prices for everything from food to cars to microchips is a longer-term issue. In fact, some high-profile investors and high-profile social media users (and owners) are expressing concern that the opposite could be the bigger issue facing Wall Street and Main Street.

Star stock picker Cathie Wood of Ark Invest  (ARKK)  cautioned in a webinar with investors this week that the Fed’s push to raise interest rates “will prove a mistake,” and that she is more concerned about deflation, or prices actually falling.

Wood’s Contrarian Call

Wood has been warning about deflation since last year on the belief that disruptive innovation will push down the price of obsolete goods and artificial intelligence will help reduce production costs. She is now doubling down on her call as a number of leading indicators she watches are pointing to deflationary forces instead of inflationary.

Wood, however, said falling commodity and freight charges, as well as stable gold prices suggest the supply chain issues that pushed inflation to 40-year highs are moderating. At the same time, she said the U.S. economy is likely in recession, which will bring down price pressures.

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Markets are betting the central bank raises benchmark rates by at least 0.75 percentage points next week, which would take the fed funds rate to its highest level since early 2007. 

The Fed has raised interest rates four times this year for a total of 2.25 percentage points. That in turn has caused tumult in the bond markets, which by extension has pushed mortgage rates to above 6%.

Understanding why inflation is bad isn’t difficult: no one wants to pay more for goods and services when their wages and earnings are staying the same.

Deflation Is the Bigger Threat

Wrapping one’s head around why deflation is an issue is a bit more challenging. For one, when people expect falling prices, they become less willing to spend, and in particular less willing to borrow, which can slow the economy even more than when borrowing is more expensive.

More broadly, falling prices typically leads to slower consumer spending, which is a major component of economic growth. Companies respond to falling prices by slowing down their production, which leads to layoffs and salary reductions.

Wood has at least one high-profile supporter of her view that the big surprise coming to investors and the markets is that prices are going down.

“We are getting some loud voices now accompanying us on this deflation risk,” Wood said in her investor webcast, naming both Tesla founder and CEO Elon Musk and well-known bond investor Jeffrey Gundlach in her remarks.

Musk responded to a Twitter thread with Wood Wednesday that the central bank should “drop 0.25%,” with the Tesla  (TSLA)  CEO calling falling commodity prices “neither subtle nor secret” and tweeted to his 100 million followers that “a major Fed rate hike risks deflation.”

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