Back to All Posts

9 minutes

Key Points for the Week

  • Food and energy price increases helped push the Consumer Price Index up 0.8% last month, and annual inflation rate rose to 6.8%.
  • Job openings in the U.S. reversed the recent downward trend and increased to 11 million jobs available.
  • Omicron is still a concern for government officials but the concern has abated in the financial markets

When the Bureau of Labor Statistics released the Consumer Price Index (CPI) last week, it showed that inflation was at levels last seen in 1982. In November, prices were up 0.8 percent month-to-month and 6.8 percent year-to-year.

It was the blowout, superhot inflation number that everyone was expecting—and it was met with a shrug. The major indexes, for their part, rose a touch on Friday to finish what turned out to be a fantastic week: The S&P 500 gained 3.8% to hit a new high, while the Dow Jones Industrial Average rose 4.0% and the Nasdaq Composite gained 3.6%.

Ben Levisohn, Barron’s

The bond market’s response to the CPI was unexpected, as well.

Indeed, Treasury inflation-protected securities were saying price pressures in future years will be abating instead of getting worse.

Randall W. Forsyth, Barron’s.

Forsyth was referring to the breakeven rate, which is the difference in the yields of Treasuries and the yields of inflation-protected Treasuries with the same maturities. The breakeven rate is a measure of investors’ inflation expectations for the next five years. On Friday, the 5-year Breakeven Inflation Rate was 2.76 percent. That was below its November high of 3.17 percent.

The financial markets’ tepid response to the CPI sparked debate about whether inflation has peaked.

No matter which side of the argument you come down on:

The surge in inflation since the start of 2021 means that it is guaranteed to remain elevated in annual terms for a while to come. A relatively optimistic forecast would have inflation returning to its pre-pandemic norm only at the very end of 2022.

The Economist

This Week in the Markets

Consumer prices continued their rapid climb in the U.S. The Consumer Price Index surged 0.8% in November and is now 6.8% higher than one year ago. Big increases in food and energy prices accounted for nearly half the gains in the monthly and annual numbers. Core inflation, which excludes those more volatile elements, increased 0.5%. Even though the inflation rate was quite high, expectations for future inflation dropped slightly.

Inflation is also affecting the job market, and the number of openings surged based on October’s data. The Job Openings and Labor Turnover Survey (JOLTS) indicated openings climbed back above 11 million. The quit rate slowed slightly from 3% to 2.8%.

Stock prices reacted positively to the week’s data. The S&P 500 index gained last week and closed at record levels. The MSCI ACWI soared as well. The Bloomberg U.S. Aggregate Bond Index surrendered slightly as inflation pressure and concerns about higher rates pressured bonds. Bond prices move in the opposite direction of yields. The Federal Reserve’s meeting this week will be watched closely to determine if the Fed will taper its bond purchases more quickly and raise the possibility that interest rate increases could happen sooner than expected.

Prices Rise, Expectations Wane

U.S. consumer prices just keep climbing. The Consumer Price Index increased 0.8% last month and has risen 6.8% in the last 12 months. The 6.8% annual increase is the fastest rate since 1982, when inflation was falling from its peak during the Carter administration. Inflationary pressures are creating a challenging economic environment in which salaries have risen a rapid 4.8% but many workers are losing purchasing power because inflation is rising even more quickly than income.

Core inflation is also increasing but at a more moderate pace. Food and energy price increases accounted for roughly half the jump in headline CPI last month. Removing those two segments led to a smaller increase for core inflation. Price hikes for reopening items increased last month. New and used vehicles, airline fares, hotels, and shelter costs all rose more than the 0.5% increase in the core index.

The inflation data once again impacted interest rates as the yield curve steepened last week. The 10-year Treasury increased 0.14%, and the two-year climbed 0.07%. This puts it close to where it was in early November before the market saw a spike in equity volatility, which temporarily drove money into the safety of U.S. Treasuries.

Even though inflation keeps climbing, expected inflation is beginning to decline. The five-year breakeven inflation rate serves as a barometer for future inflation expectations. It calculates the difference in yield between a five-year Treasury and a five-year inflation-protected bond. It peaked last month at 3.17% but has since retreated to 2.76%. This indicates the market still expects inflation to run above the Fed’s 2% target but not as far above as expected just a few months ago.

It may surprise some that inflation expectations are already falling even as the monthly data remains so strong. There are likely a few reasons for the seeming paradox. First, the 12-month rolling inflation comparisons are about to get more difficult. Inflation was very low this time last year. Starting early in 2021, inflation began to spike, and price hikes aren’t likely to continue at the same torrid pace. Leading indicators also show improvement in shipping data and other transportation logjams, which indicate the inflationary pressures from trade and goods shortages are slowly abating.

The Fed’s meeting this week will provide the next big-effect decision point around inflation. The Fed seems likely to increase the pace of tapering its bond purchases. Buying fewer bonds isn’t likely to reduce inflationary pressures. It isn’t clear how much tapering makes a difference, particularly in a pandemic. More importantly, accelerated tapering means the Fed will be done with its special purchases sooner than expected, and that may clear the way for higher interest rates in the future.

Our expectation is for the inflation rate to moderate but still remain at 4-6% annually over the next several years.

Sentiment Round-Up

The University of Michigan’s Index of Consumer Sentiment showed an increase in optimism in early December.

The Consumer Sentiment Index was up (+4.5 percent) month-to-month, although it remained down year-to-year (-12.8 percent). Respondents were feeling a bit more positive about current economic conditions (+1.4 percent) and significantly more cheerful about the future (+6.8 percent) than they were in November.

When respondents were asked whether inflation or unemployment was a more serious problem in the United States, 76 percent chose inflation, 21 percent said unemployment, and the remainder couldn’t decide or thought both were problems.

AAII Investor Sentiment Survey showed that bullishness crept higher last week, but a larger percentage of investors are feeling bearish (30.5 percent) than bullish (29.7 percent). Almost 40 percent of those surveyed were neutral, meaning they were uncertain whether the stock market would move higher or lower over the next six months.

Some say this survey is a strong contrarian indicator, meaning the stock market may do the opposite of what survey respondents think will happen. In other words, if respondents were strongly bullish, the market might be expected to move lower over the next six months, and vice versa. The strong neutral reading indicates investors don’t know what to expect.

TIM Group Market Sentiment Survey reflects the real-time advice that investment bankers, corporate financial advisors, and other sell-side firms are providing to clients. Last week, survey respondents took a turn to the bearish. The survey’s sentiment reading was 43 percent, down from 46.8 percent two weeks ago. (A reading of zero is completely bearish and a reading of 100 is completely bullish.)

Build Back Better Act (BBBA) Tax Changes

The US House of Representatives has passed the Build Back Better Act (BBBA). The Bill has moved to the Senate, which is expected to make changes to the Bill. However, we have received inquiries as to what tax changes the Bill proposes:

  • Surtax on multi-millionaires: A new tax 5% when Adjusted Gross income is above $10,000,000. The surtax rises to 8% when Adjusted Gross Income is above $25,000,000. Please note that this is a tax on income as opposed to a tax based upon taxable income.
  • Expanding income subject to the ACA tax: The current tax law includes a 3.8% ACA tax on earned income and investment income. The mechanics for calculating this tax are different but there are certain types of income not subject to this tax. The list of excluded income will be reduced subjecting more income to this tax. For example, this tax will now affect business owners that are taxed as S-Corporations.
  • Corporate minimum tax: Companies have multiple acceptable methods of reporting income. Many public companies use one set of accounting standards to determine “book income” which tends to present the highest possible income and a different set of standards to report “taxable income”, which tends to report the lowest possible income. The difference is usually related to the timing of recognizing income and expenses. Th bill creates a new tax of 15% on “book income”.
  • Stock Buybacks: The Bill will now impose a 1% transaction tax on the value of any stock repurchased by publicly traded U.S Corporations.
  • Increase in the SALT limit: State and Local Income taxes are deductible as an itemized deduction. Under current law, this deduction is capped at $10,000. This cap would be raised to $80,000 and would be retroactive to 2021.
  • Limits on IRA and Roth IRA contributions: Taxpayers whose IRA and other retirement account values exceed $10,000, 000, would not be allowed to contribute to either an IRA or Roth IRA.
  • Conversions from traditional retirement accounts to Roth accounts will not be allowed for taxpayers whose adjusted gross income exceeds $400,000 (single or $450,000 (joint).
  • Pension Plan reporting: Pension plan administrators would now need to report to IRS the names and taxpayer identification numbers of any plan participant that has $2,500,000 or more in the plan.
  • A new IRA RMD: Currently taxpayers age 72 or older must tax a Required Minimum Distribution from their traditional IRA and some other retirement plans. This bill adds a new category of taxpayers that would be subject to required distributions and a new calculation for those taxpayers. If the year-end value of the IRA and other defined contribution plans exceed $10,000,000 then the following year’s required distribution would be 50% by which this value exceeds $10,000,000. If the value of these accounts exceeds $20,000,000 then the Required Distribution would need to come from the Roth IRA first.
  • Renewable Credits: New and expanded credits for Electric Vehicles and hybrids.
  • Foreign Tax Credit: New formulas for calculating and changing the credit from an aggregate to a per country credit. This would lower the potential credit by not allowing high tax countries to be offset by low tax countries.
  • Eliminates a tax provision that allows for after tax rollovers from qualified Plans in certain circumstances

Did you Know? This Week in History

December 14, 1911: Ronald Amundsen Becomes First Explorer to Reach the South Pole

On December 14, 1911, Norwegian Roald Amundsen became the first explorer to reach the South Pole, beating his British rival, Robert Falcon Scott.

Amundsen, born in Borge, near Oslo, in 1872, was one of the great figures in polar exploration. In 1897, he was first mate on a Belgian expedition that was the first ever to winter in the Antarctic. In 1903, he guided the 47-ton sloop Gjöa through the Northwest Passage and around the Canadian coast. Amundsen planned to be the first man to the North Pole, and he was about to embark in 1909 when he learned that the American Robert Peary had achieved the feat.

Amundsen completed his preparations and in June 1910 sailed instead for Antarctica, where the English explorer Robert F. Scott was also headed with the aim of reaching the South Pole. In early 1911, Amundsen sailed his ship into Antarctica’s Bay of Whales and set up base camp 60 miles closer to the pole than Scott. In October, both explorers set off, Amundsen using sleigh dogs, and Scott employing Siberian motor sledges, Siberian ponies, and dogs. On December 14, 1911, Amundsen’s expedition won the race to the Pole and returned safely to base camp in late January.

Weekly Focus

The truth is, most of us discover where we are headed when we arrive.

Bill Watterson, Cartoonist

Children are apt to live up to what you believe of them.

Lady Bird Johnson, Former First Lady of the United States