The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Fourth-Quarter Outlook:
- U.S. economy: Stimulus wearing off but growth remains solid. More workers needed.
- Global economy: Slowing from its fastest pace in decades even as parts of Asia and the emerging markets are set to reopen.
- Policy watch: Policy is shifting from “extremely accommodative” to merely “quite accommodative.”
- Fixed income: Income generation remains a challenge as rates rise gently from very low levels.
- Equities: Valuations have come down but remain high relative to history; earnings growth will be key to returns.
- Asset allocation: Balance the risk of hotter inflation with that of slower growth.
Quote of the week:
“Meet the new boss, same as the old boss.” – The Who, “Won’t Get Fooled Again”
A short week — but big news at the Fed
Last Monday, November 22, President Biden announced he would reappoint Federal Reserve Chair Jerome Powell for a second four-year term and elevate current Governor Lael Brainard to the position of Vice Chair. The appointments continue next month, when Biden will announce nominees for three open seats among the Fed’s Board of Governors. (Governors are permanent voting members on the Federal Open Market Committee, which sets monetary policy.) All of these appointments will require approval from a majority of the U.S. Senate, and early indications are that both Powell and Brainard will be confirmed.
These two have been the clear front-runners for the Fed’s top job for months and were generally seen as having similar views on monetary policy that would maintain the economy’s momentum while not letting “the inflation genie out of the bottle.
Despite this like-mindedness, now that Powell is expected to remain as Fed Chair, bond investors have priced in a more hawkish path of interest-rate increases starting next year. In fact, based on fed funds futures as of last Wednesday, there’s a better-than-even chance that the Fed will hike three times in 2022.2 (Fed funds futures are used by traders to bet on the direction of interest rates.).
Meanwhile, U.S. Treasury yields jumped following Biden’s announcements. The yield on the 2-year note, which often rises in anticipation of tighter Fed policy, began the week at 0.51% and closed 13 basis points higher (to 0.64%) on November 24 — its highest level since March 2020.3 Longer-term rates leaped as well, with the yield on the bellwether 10-year note bouncing from 1.54% to 1.64%.4
Real (i.e., after inflation) yields rose sharply, too, offset only partially by small declines in inflation expectations. This conveyed a sense that with Powell at the helm, the Fed will be less tolerant of inflation above its 2% target next year and more likely to raise rates to keep it in check.
Equity markets, for their part, seemed to take comfort in the continuity at the Fed. The S&P 500 Index rose nearly 1% in Monday’s first hour of trading before selling off into the close to finish the day with a modest loss. For the first three days of the week, the index gained 0.1%, but economically sensitive sectors like energy and financials significantly outperformed.5 As we see it, this is a sign that equity investors remain unconcerned by the prospect of tighter monetary policy slamming the door on the powerful bull market that began in the spring of 2020.
What’s our take on the developments at the Fed? We believe Powell and Brainard, along with the three pending governor appointees, will form a core “dovish” contingent, which will be patient before hiking rates in 2022 especially if inflation is decelerating, perhaps due to a combination of reduced consumer demand for goods and the mending of supply chains. The Fed is currently winding down its $120 billion/month asset purchase program and will need time to assess the impact of this action before moving affirmatively to tighten monetary policy through higher policy rates.
The risk to our outlook — and to U.S. equity markets’ ability to continue rallying — is that tightness in the labor force could translate into a wage-driven inflationary spiral. This would be a separate — and non-transitory — form of inflation than the 2021 version, which was fueled by the unleashing of massive pent-up demand in the face of woefully inadequate supply.
Key to assessing the risk of a wage-price spiral will be careful study of the details of the U.S. employment reports over the next several months. Robust job creation and a rise in labor force participation should forestall any need to tighten policy, in our view. We’ll evaluate the November report in our next weekly update.
Heading into the holiday with a plethora of positive data
As Powell and Brainard await their confirmation hearings, the U.S. economy is reaccelerating after growth flagged in the third quarter, thanks primarily to supply-related factors. Anecdotally, at least, some of those supply jams seem to be loosening up. The price of oil, for example, has fallen over 7% from its October 26 peak on expectations that more production is on its way.6
More importantly, demand remains incredibly strong. Orders for capital goods rose by more than expected in October after an upwardly-revised September. Businesses are continuing to invest in themselves in an effort to raise worker productivity. And the U.S. trade deficit last month narrowed appreciably on rising exports, a sign the rest of the world is returning to some semblance of economic normal, as well.7
But the real news came from the personal income and spending report, which showed yet another strong month of spending in all areas. Both incomes (+0.5%) and spending (+1.3%) rose by more than expected, but spending rose by more, financed by a fall in the personal savings rate from 8.2% to 7.3%.8 Adjusting for inflation, which continues to be elevated on a monthly basis though still below its second-quarter rate, disposable income fell last month. Growth in employee compensation is more than keeping pace with rising prices, but the continued drag from expiring unemployment benefits and other fiscal aid is holding total income growth below the rate of inflation.9
What’s keeping consumers so strong? Well, for one thing, a growing number of them have jobs. Initial claims for unemployment insurance dipped below 200,000 for the week of November 20 for the first time since 1969.10 Much of the recent decline may be due to diminished eligibility for the benefits and seasonal distortions, but there is no doubt that jobs are plentiful at the moment. Most of the people who have left their jobs in recent months have done so voluntarily with the expectation that they will be able to find higher-paying work elsewhere.
The U.S. economy is on very solid footing heading into the end of the year. It’s possible some of the November and December data will fall short of expectations if a lot of consumers did their Christmas shopping in October for fear of delivery delays, but this is as strong a start to the quarter as we could have expected.