17 January 2022 - Don't fight the FED




Equity markets fell for a second consecutive week this year as investors are starting to realize that the FED has indeed changed its tone and strategy with respect to interest rates and policy accommodation. A late Friday rally in Technology stocks saved somewhat the day for US markets, which outperformed Europe this time. The Swiss market slumped by 2%, as it is the most negatively correlated to increases of global yields/interest rates among its European peers. On the contrary, the UK’s FTSE100 posted minor weekly gains as the index has a big weight in Energy, Materials and Financials, which are sectors set to benefit from an environment of high inflation, high economic growth and higher rates. The US equity market is closed today (public holiday).


The FED’s President, Mr. Powell, was questioned in the Senate banking committee for his renomination and hinted again that the central bank is most probably raising rates in March. The FED’s Vice President, Mrs. Brainard, also in the same committee was even more hawkish speaking rather aggressively on the need to tackle high inflation. Of course, Mrs. Brainard is the personal pick of President Biden and wanted to leave up to his expectations. What worries markets is that we have quickly moved from a scenario of 1-2 interest rate increases in 2022, to a growing consensus for a minimum of 4. JPMorgan’s CEO mentioned that he would not be surprised with 6 or 7 interest rate hikes.


The December US inflation was announced at the highest level since 1982, but at 7% it was actually slightly better than expectations. December US Retail Sales slumped by 1.9%, vs expectations for zero growth. This figure gave some hope to investors in growth sectors, such as technology, which fare much better in an environment of slower economic growth that the economy might slow down and there will be less need for higher interest rates. One should point out, however, that consumers had done most of their holiday shopping already in November, as there were fears and warnings by companies that there will be shortages due to supply chain issues.


China’s 4th quarter GDP was announced at 4.0%, better than expected (3.3%), but still the lowest growth since 2020. More importantly the central bank cut one of its key medium-term interest rates by 10bps, in a sign that the authorities will engage in a looser monetary policy this year.


Government bond yields traded in tight ranges, but the bias on the upside remains, The US 10-year Treasury yield is close to 1.8%, while the German equivalent is making attempts to turn positive for the first time since 2019.


The USD sold-off, as investors are watching US inflation continue rising to 40-year highs. The EURUSD approached 1.1500 but settled towards 1.430 at the end of the week.


Gold managed to break above 1800$, but the move did not continue higher. The metal is trading close to 1820$. Oil prices however are continuing their rally higher, with Crude Oil approaching again the previous high at 85$, the highest since 2014.


The Q4 corporate earning season is under way. The first US major banks reported better than expected profits, but most of them provided guidance for 2022 which included higher wage expenses, which will “eatup” their profit margins. The market reacted with a drop of about 4-5% for their shares, as guidance for this year is fundamental for the current, rather stretched valuations.



Charts of the Week


What a difference the Omicron variant has made, and hopes are rising that this could be the end of the pandemic and potentially Covid19 becoming endemic. The blue line represents the global cases of the virus, which since the end of November have risen in almost a vertical line. This tsunami of the virus spread, however, has not led to any spike in deaths (red line), which on the contrary is falling to lows last seen one year ago. The South African experience showed that the Omicron variant has an explosive rate of contagion, which peaked after 3-4 weeks, but produces mild symptoms, and does not “flood” the hospitals. The UK is following a similar pattern, and most European countries as well as the US should find their own peak of cases within the next 7-10 days, if this pattern proves to be correct. The end of this explosive phase could be close.


The US inflation in December hit a new 40 year high. Admittedly, there are items in the inflation calculation which could start moving lower in price in the coming months: For example, oil prices as we are exiting the winter season and and used cars prices, as supply chain issues are being worked out and consumers finally can access new models. Still, however one can argue that the extended period of extra low inflation of the 2010-2020 period (see red dotted rectangle) could be a thing of the past and we could return to regimes of inflation ranging between 2-3%, as was the case in the previous 20 years or so. In that scenario, central banks will have to move fast away from zero or negative interest rates and employ monetary policies that are more aligned with such levels of inflation and above-average economic growth. Implications on asset classes can be profound.



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