Fed: Hawkish – Bonds: Dovish


Like clockwork, as soon as the Fed gave in to constant market and media pressure to tighten, announced an acceleration of the QE “cone” and showed much more hawkish “points” (the graphical plot of the views of the FOMC members on where the federal funds will be in 2022, 23 and 24), the markets have changed their tone. Bond gurus are now seeing a slowdown in the economy (which we’ve been seeing for some time – see below) and a moderate Fed tightening cycle. At the same time, the stock markets seem unable to understand what could happen next and have become volatile and somewhat schizophrenic.

Truth be told, a stealth sell-off of stocks has now been in place since the end of the summer. The Nasdaq

is made up of more than 3000 tickers; 1300 (over 43%) are in correction territory, that is, down more than 10% from their peaks. The S&P 500 hit an all-time high on December 9 and the second-highest all-time high on December 14. The media have boasted that the S&P has risen by more than 25% since the start of the year. Yet 210 of the 500+ companies in the S&P 500 (42%) were also walking in correctional ground.

Why markets are volatile

While the Fed’s dot-plots call for a terminal Fed Funds rate of 2.125% in 2024, the futures markets, via real money bets, have reduced their point of view to 1.24%. In his post-meeting press conference, Fed Chairman Powell painted a brilliant picture of the state of the US economy; surely the “kiss of death!” Certainly, some of his optimistic rhetoric can be seen as political. After all, the Fed and the members of the FOMC are all appointed by the executive branch. Meanwhile, the models of Wall Street economists like David Rosenberg, and clearly rate movements in fixed income markets, say that a Fed Funds rate above 1% will lead to a recession.

Incoming data

So far, the incoming data supports the “softening” view:

  • We have voiced our opinion on several blogs that the “shortage” story, which is always talked about in the daily media, is driving holiday shopping forward. The National Retail Federation’s November survey found that 60% of vacation shoppers started vacation shopping early. Thus, the surge of + 1.8% of retail sales in October (Seasonally adjusted (SA)). Our view was that November retail sales would also be strong. (We were half right: + 0.3%). It should be noted that November department store sales fell -5.4% and contracted in two of the past three months. (And, it can’t be omicron, because it wasn’t even discovered until it appeared in South Africa on November 26, the day after Thanksgiving.) We still think December sales will be disappointing (on a South African basis), as will GDP. . [It appears that Q4 GDP will be positive, but significantly lower than the 6.9% growth the Fed has penciled in; and we aren’t alone in that thought process.]
  • Real weekly earnings are down -2% year on year (see chart above). The November reading was negative (-0.4%) and will likely stay that way until 2022, until inflation cools. This means consumers can buy -2% less physical items than a year earlier (unless they are dipping into their savings). Tax freebies are now in the rearview mirror with the latest (the cash “advance” on the Child Care Income Tax Credit for 2021 taxes) due to end this month.
  • In our last blog, we commented on the weakness in auto sales in November. The media attributed this to “shortages” of chips. But American auto factories have new product, and domestic chip companies have also increased production. Chip shortages may have dampened sales earlier in the year, but not anymore. The real reason for weak auto sales is satiety of demand, as shown by the University of Michigan consumer sentiment surveys, i.e. car buying intentions. at its lowest in 40 years.
  • The Philly and Kansas City Feds released their manufacturing surveys last week. Philly’s stock fell more than -60% (15.4 to 39.0) while Kansas City’s was flat at 24. In both surveys, prices paid and received were lower, as were arrears; symptoms of easing inflationary pressures at the manufacturing level. More interestingly, investment plans have increased dramatically over the past two months in both surveys; not a good sign for future growth.
  • Housing starts, on the other hand, surprised on the upside, but it was mainly multi-family housing (+ 13% M / M; + 37% Y / Y). While single-detached home starts rose (+ 12% M / M), they are still down -1% Y / Y. For those worried about the impact of rents on the CPI (30% weighting), just as the Fed prepares to hike rates in mid-2022, we should see disinflation in the market. rental by then, as the huge supply, currently in the pipeline, comes online.
  • And then there is China. The weakness is reflected in its real estate sector, much of the net worth of Chinese consumers. Thus, the “wealth effect” will probably be at play in the behavior of Chinese consumers. The attached graph shows both the fall of the MSCI China Index (a large and mid-cap index of Chinese stocks) and the renewable energy sector. Note the plunge of the two since the fiasco of Evergrande. The recent rapid drop in the prices of major commodities is directly linked to weakness in China, the largest consumer and importer of commodities.
  • Data from the Eurozone (especially Germany) is negative and the UK looks ripe for slipping back into recession.
  • Considering all of the above, especially slowing growth in China and globally, rapid domestic economic growth in 2022 seems like someone’s (Powell?) Pipe dream, perhaps politically motivated.

Labor markets

During his press conference, Powell also highlighted how well the US labor markets are doing. Perhaps he had yet to see the latest (questionable) data or thinks the SA data accurately describes the state of the markets (again the politics!).

We will start here by observing that the media seem less and less concerned about labor shortages, and more and more about inflation. Perhaps it is because companies are less and less concerned. For example, in the Kansas City Fed Manufacturing Survey, employment problems scored 18; they were 27 in November and 37 in October.

Also note that the right side of the attached graph shows a spike in recent Initial Unemployment Claims (CIs) in the first two weeks of December. CIs are a proxy for new layoffs.

Also noteworthy is the concomitant increase in Continuing Unemployment (CC) claims. As the graph shows, after dropping for much of the fall, they leapt upwards by leaps and bounds after Thanksgiving.

Our vision for 2022 economic growth

We expect economic growth to slow in 2022 with China leading, struggling Europe and the United States not far behind. Emerging countries will also feel the negative effects of falling commodity prices. In the United States, headline inflation will fall, but “core” inflation, driven by energy prices, will be more persistent than initially thought. This can be problematic for the Fed. The central banks of many small countries have already started to increase their rates. With recent rhetoric, the Fed has joined this crew (although it is still far from relaunching it). The notable exceptions are the ECB (European Central Bank) and the PBOC (Peoples Bank of China) which both remain fairly accommodating and accommodating.

While the current official Fed position is that the economy is quite strong and interest rates could rise by mid-2022, we believe that a weaker economy will moderate any rate hikes, and we would be surprised if the Fed Funds rate is well above 1%. this cycle (by 2024). Bond markets seem to share this point of view.

(Joshua Barone contributed to this blog.)


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