Persistent inflation means higher rates are coming our way

Equity markets took a beating yesterday on comments made by Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen.  Omicron had the market spooked out of the gate, but things got spookier as the Fed Chair hinted at speeding up the bond buying taper and the Treasury Secretary warned of default.

N O T E W O R T H Y

Triple threat.  Yesterday marked the final day of the Atlantic hurricane season, but if you were on Capitol Hill or in the hallowed New York Stock Exchange, you would have thought that we were at its height.  Markets… all of them… stocks, bonds, currencies, and commodities were all hit by a trio of powerful storms yesterday.  Let us begin with the first:  Hurricane Omicron.

We need to get one thing straight… we are still in the midst of a pandemic and rapidly approaching “the colder months” which usually means closer contact and more indoor activity… unless you are blessed to live in a milder climate location.  Vaccine strength has been on the decline as a large chunk of the population has been fully vaccinated for over 6 months.  We have the Delta-variant being passed around which is more transmissible than its predecessors and is apparently able to infect even fully vaccinated folks.  From a health perspective, that is far from upbeat.  From a market perspective… well, it is already factored in.  Enter: Hurricane Omicron, a new variant that has been identified overseas.  It appears to be some sort of mutation from an earlier strain of the virus, but a far more complicated mutation.  Notice that I used the word appears in the last sentence.  Go ahead, search Google for information on it.  You will find many hits, but few facts.  You will see statements like “may be more transmissible,” “appears to have milder symptoms,” “not clear whether it will increase hospitalizations,” or “scientists are baffled as to its origins.”  Yeah, pretty non-decisive.  But wait, we have vaccines now.  There is even a pill from Merck, which was just narrowly recommended to FDA for emergency use last night WHILE YOU SLEPT, though it is not as effective as hoped and can cause birth defects.  As you may have noticed, there has been a recent public health push for the unvaccinated to get vaccinated and the fully vaccinated to get boosted.  Ok, so that should help with this new elusive Omicron-variant, right?  Well, as of Sunday night, bosses at the leading vaccine providers, Pfizer and Moderna were publicly confident that their jabs would cover us against Omicron while newly formulated Omicron-targeted ones would be available in short order.  Ah, finally some knowns in a sea of unknowns.  Markets like knowing, so they rallied on the news on Monday.  But wait, on Monday night WHILE WE SLEPT, something changed.  Officials at both Pfizer and Moderna suddenly became less confident that their vaccines had the stuff to block Omicron.  What’s worse is that “new vaccines soon”  became “new vaccines some time in 2022.”  What this all means is that we know very little about Omicron and what impact it may have on not only our health system, but ultimately the economy and the capital markets.  Hurricane Omicron made landfall Tuesday prior to the market open.

Next came a duo of tempests.  On the docket for the day on Capitol Hill was Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen… unarguably two of the most influential people in global markets.  Their narratives leading up to yesterday was clear and calming. Powell: we are a calm, numbers driven Fed, we have a solid plan, we are confident that inflation is temporary, and we will only raise interest rates when we are at full employment… a long, long time from now.  Calming indeed.  Markets have been predicting a rate hike sometime next May or June after bond purchase tapering ends.  That timeline was being actively questioned yesterday morning as Hurricane Omicron struck.  While not devastating, the new variant could have hampered the recovery and labor markets.  We would have expected Powell to back all of that up… somewhat positive for the markets which have already factored in next year’s hikes.  On the forecast for Powell’s testimony, slightly overcast with the possibility of a passing shower.  Secretary Yellen has been touting a slightly different narrative recently.  She is confident that inflation will dissipate next year and said so on numerous occasions in many ways.  She should know, as she is an acclaimed economist and was the Fed Head before Powell… oh and her husband, George Akerlof is a Nobel Prize winning economist.  Not sure what dinner conversations are like at the Yellen-Akerlofs, but I am sure that the topic of inflation comes up now and again, and the dynamic duo thinks that it will dissipate next year.  Ok, I am good with that… and so was the market.  On a sourer note, Yellen’s job is to manage the country’s check book and things have been getting dicey with it since we approached a previously set debt limit.  Congress decided to kick the can forward earlier in the year, and that can has landed somewhere between mid-December and mid-January.  Yellen would appreciate it if Congress would raise or remove that limit so she can pay the bills… and avoid a default for the country.  Now, her message is ominous, but the markets have already factored those in.  The Yellen forecast:  dark and angry clouds with no precipitation expected.  All right, so let’s hang tight, buy some extra batteries, water, pasta… and cookies and hunker down with some Netflix until Omicron passes, which should be relatively quick, based on past ones.  But, alas, even the most confident weather forecasters can be wrong.

Somewhere around 10:00 AM EDT weathervanes started to rattle, and skies began to darken.  Leaves swirled about and traffic lights began to swing to and fro.  Did the forecasters get this wrong?  All at once Hurricane Powell and Hurricane Yellen made landfall simultaneously.  Yellen was a category 2 but Powell was a category 5.  In Powell’s testimony, he decided to retire the word: Transitory once and for all.  OK, so if you have been paying attention and reading my notes regularly, you know that inflation, whether transitory or not,  is not and has not been good for us.  However, hearing the creator of the second most overused word in the financial markets (unprecedented, being the first) remove it from his narrative is somewhat shocking.  But not nearly as shocking as his admission that it would be appropriate for the Fed to consider speeding up its tapering… to make way for sooner rate hikes.  That discussion will happen later this month at the next FOMC with fresh employment data in hand (that comes out this Friday).  With three storms running amok in the financial markets, confusion and selling were abound.

Today, in the wake of those three formidable gales, investors will have to decide the way forward… clean up the damage.  Will the Fed raise rates more quickly than expected?  Will the Fed even raise rates at all?  Will Omicron cause enough damage to shut down the economy once again and drive the US and others into recessions?  Will the US default?  Let us check on the markets this morning and see if we can get some clues and answer these questions.  Fed futures are predicting a small chance of a rate hike next May, with a strong probability of at least two rate hikes by the fourth quarter… same as last week… answer to question 1: Yes, but already known.   The Treasury yield curve between 2 and 10-year maturities flattened yesterday by -13 basis points, largely due to an uncharacteristic +8 basis point jump in 2-year note yields (which are highly influenced by Fed policy)… answer to question 2: Yes, but kind-of expected.  Stock futures are higher this morning along with Crude oil, up by around +4.76%.  Early morning gains are seen in Occidental Petroleum, Carnival Corp, Norwegian Cruise Lines, and Expedia Group to name but a few but the winners are mostly in energy and travel.  The answer to question 3: probably not, Omicron affects may be transient.  Regarding the final question of default.  Short maturity Treasury yields are slightly higher but mostly stable.  The Treasury has endured these political fights in the past and we have even suffered government shutdowns, but ultimately, default was avoided.  The answer to the final question is: possible but not probable.  Let’s see if these answers persists through the session.  Hurricane season appears to have ended… for now.

THE MARKETS

Stocks sold off precipitously in yesterday’s session on Omicron fears and following hawkish testimony by Fed Chair Jerome Powell.  The S&P500 fell by -1.90%, the Dow Jones Industrial Average dropped by -1.86, the Nasdaq Composite Index traded off by -1.55%, the Russell 2000 gave up -1.92%, and the S&P500 ESG Index sold off by -1.68%.  Bonds traded higher and 10-year Treasury Yields fell by -5 basis points to 1.44%.  Cryptos rose by +2.17% and Bitcoin fell by -2.02%.

NXT UP

• ADP Employment Change (Nov) is expected to show +525k new jobs created compared to last month’s +571k.
• ISM Manufacturing (Nov) may have risen to 61.2 from 60.8.
• Fed Beige Book will be released this afternoon.
• Powell and Yellen will be back on Capitol Hill today.  Pay attention this time.
• Earnings announcements after the close are expected from Snowflake, Okta, Synopsys, C3.ai, Crowdstrike, Splunk, and Five Below.