Each week, we present our featured topics in the context of the major themes listed below from Nuveen's 2022 Outlook: Nuveen's 2022 Outlook:
- U.S. economy: Slower growth and inflation compared to 2021, but still pretty fast.
- Global economy: Showing signs of heating up thanks to accelerating vaccination rates.
- Policy watch: No more stimulus, but the Fed isn’t likely to raise rates too quickly.
- Fixed income: Expect further challenges for rate-sensitive assets; consider assuming more credit risk.
- Equities: Our cyclical tilt includes U.S. small caps and non-U.S. developed market shares.
- Asset allocation: Although valuations appear relatively full across many segments, we’re leaning toward risk-on positioning.
Quote of the week:
“The probability that we may fail in the struggle ought not to deter us from the support of a cause we believe to be just.” – Abraham Lincoln
The U.S. employment report the economy needed
A banner U.S. jobs report like February’s (released this past Friday) would normally be cause for celebration. But while the good news was welcome, investors were focused on the Russia/Ukraine crisis, which overshadowed the week’s other notable developments.
Both the headline job numbers and the report’s details offered further evidence of the strength of the U.S. labor market. Highlights included:
- Nonfarm payrolls increased by 678,000 last month, easily topping expectations for 423,000. Additionally, gains for January and December were upwardly revised by a combined 92,000.5
- The unemployment rate fell from 4.0% in January to 3.8%, its lowest level since February 2020, even as 304,000 people joined the workforce, adding to the nearly 1.4 million who got off the sidelines and “into the office” in January.6 By contrast, during the first half of 2021, the labor force grew by an average of just 74,000 workers per month. That improved to a far-more-substantial 197,000 in the second half of the year, providing momentum heading into 2022.7 Regardless of the reason — rising inflation, declining COVID-19 fears or less savings — people are not only getting off the sidelines, they’re finding jobs quickly.
- Crucially, the employment-to-population ratio among prime age workers (25-54) climbed by 0.4% to 79.5%, just one percentage point below its peak from the prior cycle.8 (This ratio represents the portion of the population that is currently employed.)
Disappointingly, average hourly earnings (AHE) growth came in flat versus expectation of a 0.5% monthly increase. Among non-supervisory workers, AHE rose a respectable 0.3%, but that’s still just half the average from the second half of last year.9 It’s best to keep these numbers in perspective, though. First, it’s just one month of data, and the year-on-year rate of AHE growth is still quite high. Second, the labor-force compositional effects as a result of the Omicron variant could be skewing these results. That might be the case if many of the jobs created in February were low-wage positions.
This was exactly the kind of “Goldilocks” release the Federal Reserve wanted to see as it embarks on a gentle but steady hiking cycle later this month: one with strong job creation, a growing labor force and wage pressures firm but under control. Chair Jerome Powell has stated that a 25 basis point hike is forthcoming at the Fed’s next meeting on March 16. February’s jobs report, combined with the economic uncertainty brought on by Russia’s invasion of Ukraine, has effectively taken a larger rate increase (50 basis points) — which traders had been pricing in as of mid-February — off the table.
Assessing Russia/Ukraine risks and keeping them in perspective
The situation in Ukraine remains fluid, with events on the ground changing daily (even hourly) and the humanitarian crisis worsening. More than 1 million Ukrainians have fled the country, and thousands are living in the subways of Kyiv, the capital, to escape Russian aerial and ground attacks.
Russia’s military activity has been met with overwhelming condemnation from the West, including a wide range of punitive measures designed to deliver maximum financial pain to the Russian economy, President Vladimir Putin and those with close ties to the Kremlin.
Both the invasion itself and the penalties imposed on Russia in response to it create significant economic and market-based risks. We’ve identified three of these risks and list them below, in increasing order of their potential severity:
Western economic sanctions could severely damage Russia’s economy, with imports from and exports to the country likely to drop sharply. (For example, the U.S. and its allies enacted export control measures that will cut off more than half of Russia’s high-tech imports.) But because this volume of trade amounts to only a tiny percentage of output worldwide given Russia’s relatively small share of global production and consumption, the impact on overall global activity should be negligible.
Financial sanctions might affect global financial conditions. These sanctions include (1) freezing the assets held by Russia’s central bank in the U.S. or in U.S. dollars parked in foreign countries, (2) limiting Russia’s ability to transact in foreign currencies and (3) cutting off Russian banks from the SWIFT messaging system, a network that connects financial institutions worldwide.
Crippling Russia’s central bank has had an immediate impact. Doing so limited its ability to prop up the country’s currency, the ruble, which plunged to an all-time low versus the U.S. dollar early last week and made imports far more expensive for Russians. Also, the Russian stock market was closed all last week, and the largest Russian equity index fund traded on U.S. exchanges is down 77% over the past two weeks.10
Commodity prices may well continue to climb, acting as a tax on consumers. While the official sanctions have thus far steered clear of Russia’s energy exports, the cost of commodities such as oil (Russia’s a major exporter) and wheat (Russia and Ukraine are both significant producers) has risen sharply as many refiners and shippers have begun to voluntarily shun Russia’s products, perhaps in anticipation of eventual official action again them. Oil prices (as represented by Brent Crude, the international benchmark, had already increased substantially over the past 12 months, feeding through into hotter headline inflation and eroding real income growth, and it has jumped an additional 25%, to $115/barrel, since Russia’s invasion on February 23.11
Oil’s latest lurch higher threatens to keep inflation at elevated levels for longer than we anticipated at the start of 2022. But central banks aren’t likely to raise rates more quickly based on rising energy costs, especially if they result in lower levels of spending on other goods and services. Federal Reserve Chair Jerome Powell stated last week that he’d favor a rate hike of 25 basis points when the Fed meets on March 16, versus the 50 basis points that some traders had recently been betting on. This indicates that while the Fed still wishes to begin its hiking cycle, it wants to do so in a measured way given the geopolitical backdrop.
Despite the barrage of distressing headlines about the events unfolding in Eastern Europe, there has been good news on the economic front. Global data releases broadly continue to surpass expectations. The Omicron variant caused an enormous spike in COVID-19 cases but does not appear to have put a big dent in economic activity. In the U.S., consumer spending was strong in January, businesses continued to hire and invest, and construction activity has heated up.
Lastly, there’s the question of whether investors should consider adjusting their portfolios in response to the Russia/Ukraine crisis. Geopolitical risks are a wildcard in investing and nearly impossible to forecast. As we’ve stated many times in this forum, it’s best to remain focused on long-term objectives, stay diversified and stick to your financial plan. Although past performance is no guarantee of future results, this approach has served investors well over many market cycles.