The year is closing out and there are two more notable calendar events left in 2021. On Tuesday we get the Producer Price Index (PPI), a read on raw goods inflation, and on Wednesday the Fed is expected to announce a change to their bond buying program. In essence, the market is trading around the interplay between inflation and Fed policy right now. Since the financial crisis of 2008, inflation has been benign which has given the Fed the flexibility to keep interest rates very low with a sizable balance sheet (quantitative easing). The historically low interest rates have fueled debt issuance and robbed savers of safe income for many years. However, the pandemic has changed the inflation paradigm as supply shortages are causing goods to become scarce which pushes prices higher.
For many years, the Fed has played a game with markets about tapering bond purchases or raising interest rates which has always caused headwinds for the stock market. In every case, the Fed backed off and reversed course – like in 2018. But in this environment, the Fed’s hand is being forced as the CPI number released on Friday (more below) shows prices rising at a 6.8% annualized rate. And with the 2Yr Treasury bond at 0.7%, that implies 3 rate hikes in the near future so the bond market is signaling 2022 will be a reversal for Fed policy after more than a dozen years. Fortunately, corporations are capturing high margins in this environment so that provides the Fed some cover but they are behind the curve with fighting inflation so it is possible to see a ‘catch-up’ period at some point in 2022.
The S&P has corrected twice since September so the changes in Fed policy are weighing on the stock market. The latest low was confirmed this past week and the S&P looks headed to new highs after consolidating for three sessions. This implies that the market will like what the Fed delivers on Wednesday but we will have to wait and see how Fed Chair Jerome Powell handles this situation.
However, I must point out that the stock market has been bifurcated for most of 2021 as the Russell 2000 has traded sideways for most of this year. In fact, this index tried to break out in October and rolled over in November. This is a rare occurrence as a failed breakout is rare with a major index. Unless this index turns around in the coming weeks, we may see leadership in the S&P/NASDAQ start to thin out and warn of a larger correction but that is a discussion for next year.
Chart of the Week!
Economic & Central Banking Snippets
- The CPI read for November rose by 0.8% headline and 0.5% core compared to October. Over the past year, prices are up 6.8% headline and 4.9% core – the highest since 1982. The drivers of these elevated prices include rapid economic growth, improving labor markets and strong consumer demand for autos, furniture, appliances and other goods.
- The December University of Michigan consumer confidence index rose 3 points this month from a 10Yr low read of 70.4. The UoM said “When directly asked whether inflation or unemployment was the more serious problem facing the nation, 76% selected inflation while just 21% selected unemployment.”
- Initial jobless claims fell to a 50-year low at +184k as a strong economic recovery and persistent labor shortages continue in this recovering economy. The steady drop in unemployment claims this year is an indication that employers are reluctant to lay off workers while jobs are plentiful, consumer demand is high and the pool of prospective workers remains lower than before the pandemic. (WSJ)
- Taiwanese exports rose in November by 30.6%, well more than the consensus of 22.8% and driven by the semiconductor sector.
- Spain and Italy both reported October industrial production figures that were light relative to expectations with supply bottlenecks the main reason.
Macro Snippets
- Chinese real estate developer, Evergrande, has defaulted on its debt, according to Fitch Ratings. The credit rating agency downgraded the company to “restricted default,” meaning the firm has failed to meet its financial obligations, reflecting its inability to pay interest due earlier this week. The company has over $300B in debt outstanding so this will leave a mark.
- American Airlines will reduce international flights because of delays of Boeing’s 737 Dreamliner jets. Boeing has suffered delays delivering the Dreamliner because of production problems that have prevented it from handing over the jets to airlines for more than a year. (WSJ)
- Tyson Foods is ramping up its automation efforts in meat plants. The poultry giant said it plans to spend $1.3 billion to automate its production lines over the next three years, as the company struggles with a nationwide labor shortage. (WSJ)
- Ford has stopped taking reservations for its F-150 Lightning electric pickup truck. CEO Jim Farley said that Ford is oversubscribed, forcing it to stop taking reservations after 200,000 orders for the truck.
- Company founders and leaders are unloading their stock at historic levels, with some selling shares in their businesses for the first time in years, amid soaring market valuations and ahead of possible changes in U.S. and some state tax laws.
That is all for now and thank you for being a subscriber!
Regards,
Paul J. McCarthy, III
President – Kisco Capital