Back to All Posts

8 minutes

Key Points for the Week

  • The Fed announced a hawkish policy shift as its inflation outlook increased, doubling the pace of reduction in bond purchases to $30 billion per month
  • The Fed has announced that it currently plans three 0.25% rate hikes in 2022.
  • Retail sales eased and missed projections but turned in the fourth consecutive monthly increase, primarily driven by fuel and food as families gathered for Thanksgiving.

Stock and bond markets diverged.

Last week, the Bank of England surprised markets with a rate hike, its first in three years, and the Bank of Mexico raised rates more than expected. Both cited persistent inflation as the reason for the increases, reported Carla Mozée of Markets Insider.

In the United States, the Federal Open Market Committee (FOMC), which is the group that decides how the U.S. central bank (the Federal Reserve or Fed) will manage monetary policy, met last week and decided to become less accommodating more quickly.

With inflation at high levels and employment at full capacity, the Fed will take steps “to prevent higher inflation from becoming entrenched,” announced Fed Chair Jerome Powell. FOMC median projections suggest the Fed funds rate will rise from its current range (zero to 0.25 percent) in 2021 to 0.90 percent in 2022, and 2.1 percent by 2024.

San Francisco Federal Reserve President Mary Daly told The Wall Street Journal, “If we see that the economy is delivering high inflation, even if we expect that inflation to not persist past the pandemic, and we see the labor market is extremely tight, even though we don't expect that to be true past the pandemic, then the policy action that would be appropriate is, after tapering, to raise the interest rate,” reported Ann Saphir and Howard Schneider of Reuters.

Major U.S. stock indices declined following the FOMC meeting, reported Ben Levisohn of Barron’s. The reason for the decline is unclear since research suggests that, historically, stock markets have moved higher following rate hikes. Anne Sraders of Fortune reported:

Analysts at Deutsche Bank identified 13 separate hiking cycles since 1955, which lasted an average of under two years. And according to their research, which examined the average price performance of the S&P 500, there tends to be solid growth in the first year of the hiking cycle, with an average return of +7.7% after 365 days…

Anne Sraders, Fortune

As stock markets declined, bond markets rallied. Yields on Treasuries of many maturities finished the week lower. That was surprising because the Fed raises the Fed funds rate to push interest rates higher. However, bond investors appeared to be more concerned about the spread of the Omicron variant of COVID-19, reported Yun Li and Vicky McKeever of CNBC.

The world will not see a re-run of the spring of 2020, with jaw-dropping drops in [economic growth]. Even so Omicron—or, in the future, Pi, Rho or Sigma—threatens to lower growth and raise inflation. The world has just received a rude reminder that the virus’s path to becoming an endemic disease will not be smooth.

The Economist

This Week in the Markets

The Federal Reserve announced last week it would reduce its bond purchases faster than expected and signaled it intended to raise interest rates up to three times next year. The purchases were previously supposed to decrease by $15 billion per month and will now decrease by $30 billion per month, and the program to support the economy will end in March. One Fed governor announced a rate increase is possible for March.

A survey of key Fed governors and officials now shows all officials expect at least one hike next year and the majority expect three hikes. Eight Fed meetings are scheduled in 2022, and it is unlikely the Fed will raise rates more than 0.25% each meeting or raise rates two meetings in a row.

U.S. retail sales rose just 0.3% in November. Strong October data indicated some Christmas shopping was moved up one month. For example, Black Friday sales posted their first ever decline compared to the prior year.

Stocks fell under the pressure of higher rates and the rapidly spreading Omicron variant. The S&P 500 index declined after reaching an all-time record the previous week, while the MSCI ACWI sagged. The Bloomberg U.S. Aggregate Bond Index added slightly as bonds reacted positively to a more hawkish Fed. Data releases will be relatively light in a holiday-shortened trading week. PCE inflation and personal income lead a short list of key data releases this week.

Pushing the Breaks Harder

The Fed isn’t just tapping the brakes. Lingering inflationary pressures have worked their way further into the economy, and the Federal Reserve is seeking to slow the economy down in order to reduce those pressures. The Fed lowered rates during the onset of the pandemic to help lower the cost of debt, making it cheaper to borrow and increasing economic investment and the purchase of large consumer items, such as homes and cars.

Combined with direct aid from the government, these efforts helped the economy to bounce back quickly from the COVID-19 contraction, and unemployment has fallen close to the Fed’s long-term targets. Increased purchases, combined with fewer people working, has created supply snags and shortages. Companies have responded by raising prices in order to balance supply and demand, thereby adding to inflationary pressures.

In response to the recent jump in inflation, the FOMC announced at its meeting last week that it would increase the speed of its tapering. Previously, the Fed said it would reduce purchases by $15 billion/month until it was no longer buying bonds, which would have put it on pace to end the program by June. The announcement last week doubled the speed of the reduction to $30 billion/month, which would end it three months sooner, in March. This, in turn, would open the door for the Fed to begin raising short-term interest rates sooner than what was expected. In fact, in only the past six months, expectations went from zero to three rate hikes in 2022.

What caused such a massive shift in policy? In the summer, it looked like inflation in the U.S. was starting to ease. However, inflation re-accelerated in the second half of the year, mostly due to further supply chain challenges from the continuing COVID pandemic and storms that affected many parts of the country. The Fed believes inflation in the U.S. may persist longer than expected, especially with the likelihood that the new Omicron variant may add to this year’s challenges. Also, while the U.S. labor market has not fully recovered it remains very strong, with the unemployment rate just 0.2% above the Fed’s own target of long-run unemployment.

The good news is the markets, particularly the bond market, took the news in stride. If anything, the Fed moved closer in its policy to what the market was expecting. There was a small uptick in short-term rates, but long-term rates actually fell over the course of the week as the market recognized the shift made sense: Given inflation, employment, and growth expectations, the Fed should remove its accommodations faster than initially planned to ensure higher levels of inflation do not become entrenched.

Second-Guessing the Fed is a Popular American Pastime

Americans have been speculating about the Federal Reserve’s monetary policy choices – raising rates, lowering rates, buying bonds, tapering bond buying, and so on – for a long time. Sometimes, they even second-guess themselves.

Paul Volcker (1979-1987) took over an economic quagmire known as The Great Inflation. When he took office, U.S. inflation was in the double digits, and the unemployment rate was 6 percent. Volcker raised the Fed funds rate from 11 percent in August 1979 to 20 percent in March 1980, reported Kimberly Amadeo of The Balance.

Farmers protested at the Federal Reserve’s headquarters, and car dealers, who were especially affected by high interest rates, sent coffins containing the car keys of unsold vehicles. Many people also wrote letters to Volcker telling him how they had saved for many years to purchase a home but were now unable to because of high rates.

Bill Medley, Federal Reserve Bank of Kansas City

Alan Greenspan (1987-2006) was in charge through two U.S. recessions, the Asian financial crisis, and the September 11 terrorist attacks. Regardless, he oversaw the country’s longest peacetime expansion. Time Magazine’s ‘25 people to Blame for the Financial Crisis,’ reported:

…the super-low interest rates Greenspan brought in the early 2000s and his long-standing disdain for regulation are now held up as leading causes of the mortgage crisis. The maestro admitted in an October congressional hearing that he had ‘made a mistake in presuming’ that financial firms could regulate themselves.

"25 people to Blame for the Financial Crisis," Time Magazine

Ben Bernanke (2006-2014) became Fed Chair just before the financial crisis of 2006-2010. He was at the helm as the Fed began to stimulate economic growth through quantitative easing (buying mortgage-backed securities and long-term treasuries).

In 2012, economist Paul Krugman wrote in the New York Times:

…while the Fed went to great lengths to rescue the financial system, it has done far less to rescue workers. The U.S. economy remains deeply depressed, with long-term unemployment in particular still disastrously high, a point Bernanke himself has recently emphasized. Yet the Fed isn’t taking strong action to rectify the situation.

Paul Krugman, The New York Times

It's awfully hard to evaluate the achievements and/or failures of a Fed Chair before the economic dust settles. Usually, that reckoning occurs long after they’ve left office.

Build Back Better Act (BBBA) Tax Changes

On Friday Senator Schumer announced that this Bill would not pass the Senate this year. That announcement was followed by Joe Manchin’s announcement on Sunday that he would not support the current Bill. We need to wait to next year to see if this Bill or parts of this Bill are resurrected.

Did you Know? This Week in History

December 20, 1957: Elvis Presley is Drafted

On December 20, 1957, while spending the Christmas holidays in his newly purchased Tennessee mansion at Graceland, rock-and-roll star Elvis Presley received his draft notice for the United States Army.

By this time, Presley had become a national icon, and the world’s first bona fide rock-and-roll star. As the Beatles’ John Lennon once famously remarked: “Before Elvis, there was nothing.” The following year, at the peak of his career, Presley received his draft notice for a two-year stint in the army. Fans sent tens of thousands of letters to the army asking for him to be spared, but Elvis would have none of it. He received one deferment, during which he finished working on his movie King Creole, before being sworn in as an army private in Memphis on March 24, 1958.

After basic training, which included an emergency leave to see his beloved mother, Gladys, before she died in August 1958, Presley sailed to Europe on the USS General Randall. For the next 18 months, he served in Company D, 32nd Tank Battalion, 3rd Armor Division in Friedberg, Germany, where he attained the rank of sergeant. For the rest of his service, he shared an off-base residence with his father, grandmother and some Memphis friends. After working during the day, Presley returned home at night to host frequent parties and impromptu jam sessions. At one of these, an army buddy of Presley’s introduced him to 14-year-old Priscilla Beaulieu, whom Elvis would marry some years later.

Meanwhile, Presley’s manager, Colonel Tom Parker, continued to release singles recorded before his departure, keeping the money rolling in and his most famous client fresh in the public’s mind.

Weekly Focus

Not forgiving is like drinking rat poison and then waiting for the rat to die.

Anne Lamott, Novelist

The problem with putting two and two together is that sometimes you get four, and sometimes you get 22.

Dashiell Hammett, Author