A New Variant a Markets Knee Jerk reaction

& Other Economic News for the

Week Ending 11-26-2021

Last week, the yield curve flattened as short-end yields held steady while yields on longer-term maturities fell. Yields rose across maturities through Wednesday, but the announcement of a new COVID variant mentioned earlier pushed bonds higher on the last day of the shortened trading week.  U.S. initial jobless claims of 199K were well below the 260K expected and the previous week’s 268K as claims continue to decline from the pandemic highs. President Biden announced a release of 50 million barrels of oil from the U.S. Strategic Reserve in efforts to combat any sense of strain at the pumps. The average price of gasoline in the U.S. is $3.70 per gallon, approximately $1.25 higher than one year ago. Lower trading volumes were expected on Black Friday, but again markets were forced to digest the news of new Covid-19 variant Omicron coming out of Botswana and South Africa. With so many opinions on what this new variant means to the economy we expect a lot more delays of life going back to normal.

The Yield Curve

It looks like bond investors expected President Biden to appoint Lael Brainard as Federal Reserve Chair. Ms. Brainard is considered quite “dovish” (i.e., would keep monetary policy ultra-easy). Powell’s reappointment appeared to partially ignite the yield curve upward spike with the end result being that three 25 basis point (.25 percentage points) increases in the Federal Funds rate (what banks pay to borrow from the Federal Reserve), beginning in mid-2022, got priced in. That was quite a change from the prior Friday view that there would only be one rate hike in late 2022.

Characterizing Powell as a “hawk” seems like a stretch. Over the last few months, he has resisted any forecasts of rate increases insisting that such increases are data dependent (i.e., based on the performance of the economy). 

Powell has set Q2 or Q3/2022 for the Fed’s evaluation on inflation. So, the Fed expects the “transient” period to be as long as another year. In Fedspeak, that should signal no rate action till at least Q3 if inflation is still elevated (This is hardly “hawkish”).

Brainard was appointed as Vice-Chair and Biden has three more FOMC vacancies to fill. Given his Administration’s policy actions to date, we expect those seats to be filled by people with a dovish bent. 

So in our view, markets were making unwarranted assumptions.

The Labor Market

Another issue impacting the bond market on Wednesday was the Weekly Initial Unemployment Claims (ICs) data for the week of November 20. It showed a modern-day record low of 199,000 ICs seasonally adjusted (SA). But as we have mentioned in the past, trying to seasonally adjust the impacts of a pandemic (that has been around for less than two years) is troublesome and could lead to unwarranted conclusions. In addition, the numbers are lower because so many people have left the workforce. Perhaps the pandemic has given families pause to think of the value of truly parenting and spending more time with their children

Retail Sales

Retail sales rose +1.7% M/M in October. The large rise was powered by a 4.0% M/M growth in non-store sales (“Amazon”). Even adjusting for inflation, the rise appears to be +0.8% in real terms. Black Friday was a success for retailers as stores and malls were filled with shoppers U.S. shoppers spent more time and money at bricks-and-mortar stores over the Thanksgiving holiday weekend than the same period last year, though foot traffic remained below pre-pandemic levels.

The rebound marks a reversal from 2020 when the pandemic accelerated a yearlong shift of holiday spending occurring online at the expense of in-store shopping. It also shows retailers were able to secure spending on the key Black Friday selling day, analysts say, even though discounts weren’t as prevalent this year and they spent weeks nudging customers to shop earlier in the season.

While we don’t have any hard survey data or GDP numbers, every household in our sphere of influence has begun their holiday shopping early because of the “shortages” narrative in the daily media. As a result of demand being “pulled forward,” the seasonal factors would bias the SA number upward. We suggest that December SA retail sales may not be as robust as markets now believe. One way or the other, those December sales will give us a clue to the strength of the economy in 2022 and whether (and when) there will be rate hikes by the Fed. That data is still 45 days away.

 Shortages

If you subscribe to any news outlet you cannot avoid the narrative of shortages we are facing. Some products like furniture are way behind. But most other items are not. Most stores have enough inventory but just lack personnel manufacturing is slower because of workforce issues needed to execute production. We feel that demand will begin to Wane and that prices will come back to earth and that by mid-2022 inventories will be unloaded to offset surpluses

How We Got This Inflation

The government shut-down the economy in 2020. This reduced output (i.e., “supply”). At the same time, the government sent out free money, making sure incomes didn’t fall. Thus, “demand” remained near pre-pandemic levels. A fall in supply with no fall in demand gives a textbook economic result: higher prices!

Add to this the idea that appears to have been adopted in Washington D.C. (called Modern Monetary Theory – the government can print as much money as it wants with no consequences) in the form of $5-$6 trillion of budget deficits. The resulting inflation we currently have appears to be mainly due to the federal government.

Meanwhile, in the background, The Fed has continued its QE (Quantitative Easing) policy. Remember, in the Great Recession, QE was an emergency measure taken to ensure smooth functioning of the financial markets. While the Fed has promised that this QE will end sometime next year, we observe that the financial system is awash in liquidity with excess bank reserves now above $1.5 trillion on a daily basis. An earlier end to this QE policy seems to be in order; perhaps we will see such an outcome from the upcoming December Fed FOMC meetings.

Is the Inflation Endemic?

Do you really think inflation is here to stay How long will it last? Here are some observations:

The Baltic Dry Index has fallen -55% from its peak over the last month and a half. This is the cost to ship bulk items (like iron ore) (though we observe that Amazon has partially solved its shipping issues by loading its containers on top of the bulk cargo in the holds of some of those vessels – the wonders of capitalism!!). The fall in the Baltic Dry Index may have a lot to do with China’s stuttering economy - nevertheless, this still has worldwide implications.

The University of Michigan’s latest consumer sentiment survey hit a low in November not seen in decades; this is usually a good leading indicator. Intentions to purchase autos and homes are at 50 year lows. Since much of the major purchases are home related, we see a drop of in demand if people are not buying homes

The Regional Fed Surveys are reporting that corporations are raising prices at a pace faster than their costs are rising. (Because of the ubiquitous “inflation” and “shortage” narratives, customers aren’t objecting to the outsized price hikes believing that they are lucky to get the shipment at all!) Since the metals indexes are now falling, it appears to be only a matter of time before input costs mellow. Corporations will come out with fatter margins, but the excuse to raise prices will not be there, and, if demand falters, we may even see some prices decline.

Rents have a 30% weight in the CPI, and they are rising significantly. Once again, we can trace much of this back to federal actions which included moratoriums on evictions and foreclosures. Now that these have been lifted, rents are rising. We note that home prices have skyrocketed in 2021. Once again, we refer to the University of Michigan’s Consumer Sentiment Index indicating 50 year lows on home purchase intentions, and observe that housing starts are now falling. That fall, however, is concentrated in single-family starts (-10.6% Y/Y (October data)). On the other hand, multi-family starts are up +37% Y/Y and are at a 47 year high. We believe those multi-family starts will mitigate the “rents” issue in the CPI by mid-2022. Source Bob Barone PhD Economist

The Week Ahead

Last week was a stark reminder that the economic recovery path is still largely dependent on progress against the pandemic and how quickly conditions can change. Central bank leaders will likely have to continue exercising extreme policy flexibility. Some economists just published expectations of a potential 8% surge in Q4 U.S. GDP, but it remains to be seen how this new variant threat may undermine that outlook. After last week’s shockingly strong unemployment claims number, investors will look for additional labor market clarity from Wednesday’s ADP and Friday’s NFP reports. This week also brings U.S. ISM manufacturing and services PMIs, along with the regional report from Chicago. On Thursday the OPEC-JMMC meetings may add to oil volatility after the IEA lashed out at OPEC for failing to bring prices down, which came on the heels of the coordinated release effort from the U.S. and other nations. On the international calendar, GDP updates from Canada and Australia will drop, along with China’s manufacturing PMI, German retail sales, and Canada’s employment situation

This article is provided by Gene Witt of  FourStar Wealth Advisors, LLC (“FourStar” or the “Firm”) for general informational purposes only. This information is not considered to be an offer to buy or sell any securities or investments. Investing involves the risk of loss and investors should be prepared to bear potential losses. Investments should only be made after thorough review with your investment advisor, considering all factors including personal goals, needs and risk tolerance. FourStar is a SEC registered investment adviser that maintains a principal place of business in the State of Illinois. The Firm may only transact business in those states in which it is notice filed or qualifies for a corresponding exemption from such requirements. For information about FourStar’s registration status and business operations, please consult the Firm’s Form ADV disclosure documents, the most recent versions of which are available on the SEC’s Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov/