Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.
Week in Review
March 14– 20
Do you remember your 10th birthday party?
If it was anything like mine, your family probably made it into a much bigger deal than they should have. After all, we were all the same awkward and obnoxious kids at age 10 than we were when we were still 9, so there really wasn’t any reason to pull out all the stops the way parents usually do to celebrate the big 1-0.
But there’s just something sort of magical about reaching double-digits that makes us all sit up and take special notice. And maybe that’s how the Producer Price Index felt last week when it finally reached 10.0%: it really isn’t any less obnoxious or annoying than it was last month when it was still (just barely) wearing a nine-handle, but somehow hitting that milestone probably made it feel just a little more special.
That’s certainly how the Fed seems to be viewing it. Since abandoning the idea that inflation was transitory late last year, the Fed has re-dedicated itself to a singular task: putting the inflation genie back in the bottle. To do that it’s taking all the right steps (and in the right order). First, the Fed announced in November that it would begin to slow and eventually stop its massive bond-buying program (commonly referred to as the “taper”). Then, just a few weeks later, it accelerated the pace of that taper out of fear of being caught behind the curve, effectively pulling the end of its COVID-inspired round of quantitative easing forward by a month or two.
Next on the Tightening Timeline was “lift-off”: the date at which the Fed would stop holding the Fed funds rate at 0%. That happened on Wednesday, when the Fed did what just about anyone with a pulse and even a passing sense of the macro expected: it raised the lower bound of its most famous policy tool from zero to 0.25%.
That’s not to say that last week’s Fed statement wasn’t without a few surprises. St. Louis Fed President James Bullard – always on the lookout for opportunities to make good on his reputation as the FOMC’s leading hawk while defending the bank’s honor – dissented from the decision and urged the Committee to instead consider an increase of half a percent rather than a measly 0.25%. While not really shocking, Bullard’s dissent was nonetheless notable as the first time in a while that the FOMC’s decision wasn’t unanimous (and unanimously dovish to boot.)
And then there were the dots. It’s not exactly surprising that a 10-handle on PPI might inspire a little hand-wringing at the Fed, but the extent to which the various participants in the FOMC are concerned about inflation became a little more obvious on Wednesday, because last week’s statement also included an update of the so-called “dot plot.” For those who may not be familiar, the “dot-plot” is essentially the Fed’s own version of pin-the-tail-on-the-donkey, where each of the FOMC’s 16-or so participants are blindfolded and stick a pin in a graph where they think rates will be at the end of each of the next 3 calendar years.
As you can imagine, the dot-plot gets a lot of attention from investors because it represents the clearest, most unbiased view of where rates are most likely to move. More than that, the dot-plot comes straight from the horse’s (…err, donkey’s…) mouth, so it didn’t escape notice that the latest version was a little more aggressive than markets thought it would be. Last week’s dot plot now puts the Fed Funds rate at around 2% by year-end, implying a total of six or seven more quarter-point increases this year. That’s WAY more aggressive than the three or four increases that were implied by last December’s version of the chart.
Of course, with the taper and lift-off out of the way, the next step on the Tightening Timeline will be so-called Quantitative Tightening, or QT. That’s the day, at some point in the future, when the Fed stops re-investing the proceeds from maturing securities that it holds (or, heaven forbid, they actually start selling those bonds into the open market,) thereby permitting its balance sheet to actually shrink for a change. On that, the Fed was mum, admitting that they would have to allow some shrinkage at some point in the future, but refusing to provide a guess as to when that might actually be.
So the bottom line from last week’s Fed meeting is that the Fed is concerned enough about inflation to get a little more hawkish on rates than markets expected them to be. But they also refused to go all-in by pointedly not handing out a prediction about when they’ll start actually allowing their balance sheet to shrink.
One reason for the reluctance by the Committee to actually put a pin in the map with regard to QT probably has to do with recent choppiness in some of the more current economic indicators we’ve all had to digest recently. Last week’s best example came to us by way of New York, where the New York Fed’s monthly survey of regional manufacturers (the so-called “Empire State” survey,) absolutely collapsed. New manufacturing orders and shipments both plummeted, while prices remained uncomfortably high. In sum, respondents are becoming more and more despondent, with 35% saying business conditions worsened last month compared to 24% who say they improved, leaving that portion of the index well below zero. While not quite recessionary, last week’s Empire State survey didn’t exactly exude confidence or inspire much in the way of economic optimism.
But I used the phrase “choppy” instead of “depressing” when I described the tone of recent indicators above. That was deliberate, because not all signs are pointing down. For example, the Empire State survey’s close cousin from Philadelphia – the so-called Philly Fed – surprised in the other direction (although perhaps not quite as convincingly.) There, manufacturers are actually feeling a little better about how things are going, led by an unexpected surge in new orders that stands in stark contrast to the collapse registered by businesses just up the road in New York. That’s encouraging, sure, but I think the bigger point is this: with different signs pointing in different directions, the Fed (and just about everyone else, for that matter) can no longer count on universally strong growth to provide cover for its tightening agenda.
So let’s do the arithmetic: we have an aggressive Fed, the highest level of geopolitical stress since the end of the cold war and an ambiguously growing/shrinking economy. Why, then, did equity markets put up their best week of 2022 so far?
We suggested last week that it’s all about oil, and that still seems to be the case. US crude prices were more than $4.50 cheaper last Friday than they were a week ago, and markets seemed to think that was enough reason to cheer like a 10-year-old celebrating his birthday Chuck-E-Cheese’s.
What to Watch This Week
Monday: Chicago Fed CFNAI, Powell speech at NABE
Tuesday: Richmond Fed
Wednesday: New home sales
Thursday: Flash PMIs, durable goods orders, weekly jobless claims, KC Fed
Friday: UofM consumer sentiment, pending home sales
One of the best things about being a member of the Fed’s most glamorous decision-making committee is that you’ll always be able to find work on the speaking circuit. With the FOMC’s latest meeting out of the way, Jerome Powell and his friends will be making the rounds on the nation’s stages to explain themselves. In addition to James Bullard’s written defense of his dissent, other Fed luminaries will speak at forums around the country, with at least one notable Fed speech each day this week (including Powell himself, when he speaks on Monday in front of the National Association of Business Economists.) Each of these presentations is another opportunity to assess whether the Fed is feeling particularly Vocker-y now that PPI inflation has reached 10%.
Other notable events on the calendar include Thursday’s so-called Flash PMIs – mid-month updates of the purchasing managers’ surveys that function as perhaps one of the best forward-looking batches of data we get each month. The PMIs – like the Empire State and Philly Fed surveys – have been painting a far more ambiguous picture of the economy in recent months. This week’s flash PMIs, together with second-tier regional Feds from Richmond (on Tuesday) and Kansas City (Thursday,) are likely to only deepen that uncertainty.
Moving down the list of potential notables, we have Friday’s consumer sentiment release from the University of Michigan. Consumers are feeling worse about the economy than they did at any point during the pandemic, and with inflation still out of control and the war in Ukraine still raging, Friday’s UofM release is likely to hammer that point in a little deeper.
A few other odds-and-ends might vie for attention, including Thursday’s durable goods report and a handful of housing-related releases. Durable goods orders are a good indication of end-use demand (and recall that the first signs of trouble in the UofM and other consumer surveys appeared in consumers’ plans to pare back durable purchases,) but in the current environment are also important insofar as they might suggest whether or not all the COVID-related (now Ukraine-related) supply chain stresses are relenting.
And as for housing, well, I think we all know that story by now. With mortgage rates rising and prices still climbing, affordability is suffering in a big way. This week’s home sales data – new homes on Wednesday and pending home sales on Friday – will likely do nothing to change that view.
But naturally, what still seems to matter most right now is what happens in Europe, and what it means for oil prices. Ordinarily, it’s difficult to draw so direct a line from geopolitical events to market- and economic performance, but with the war in Ukraine hitting so precisely on the one factor most responsible for economic and financial market stress – namely, inflation – it’s hard to argue that geopolitics doesn’t matter. That might just be a fancy way of saying this time is different, but for now, it’s reality.
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Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.