Week ended December 10th 2021
“It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." — George Soros
What a strange week. Recall that it was just the week before when the death knell was ringing loudly as equities were collapsing under the pressure of new variant Omicron and ever-growing signs of persistent inflation. However, this ominous mood proved once again to be short-lived as investors did an abrupt-about face in a flash of an eye and piled back into stocks, with their conviction growing as the week wore on. I suppose by this point we should be conditioned to expect these rapid recoveries because they happen time and time again. (In fact, it begs the question as to why we still have dips at all, but that is a topic for another day.) Investors increasingly seem oblivious – or perhaps numb – as far as COVID-19 news of any kind. They also seem resigned and are perhaps getting used to the more hawkish shift by the Federal Reserve which lies head. Even geopolitical noise, which ratcheted up this week on several fronts, did not derail growing investor optimism. All I can say is “Let the good times roll!”
The economic news this week was principally focused on US inflation data, released Friday (BLS release here). The data showed that inflation in the US is running at its highest level since 1982, with November CPI coming in at a scorching 6.8% on a running 12-months basis. Core inflation (ex-energy and ex-food) also moved higher, to 4.9%, an increase of 0.5% over October. Fortunately, as hot as this data shows inflation to be, CPI was more or less bang in line with expectations. Jobless claims released the day before were perhaps a harbinger of what was coming as far as CPI. Initial jobless claims were much lower than had been anticipated, coming in at a mere 184,000. This was the lowest level since 1969 (DoL release here). The Federal Reserve is obviously gearing up to address rising inflation pressures head on, and the bond market is signalling that it is expecting the Fed to move relatively quickly. This means that – at least so far –the Omicron variant has had no effect on the Fed’s outlook for the US economy.
This week, the Federal Reserve, Bank of England, ECB and Bank of Japan all release monetary statements / minutes from recent meetings, which will provide investors with the latest update on just how long the unusually accommodative policies of central banks might continue. The expectation is that the Fed will remain on its current course to tighten policy, whilst things could not be more different in most other large economies. Perhaps most surprising has been the rather abrupt change in expectations as far as an increase in the overnight borrowing rate in the UK. England (and the entire UK) is facing tighter government-imposed restrictions to limit the spread of Omicron, and this will inevitably cause a drag on UK economic activity, a fact not lost on the Bank of England. Staying put as far as the Bank Rate is by no means certain though, as inflation is continuing to increase in the UK and – as we learned in early November – the BoE is capable of surprises which investors discovered the hard way. Unlike the US and UK which are titling hawkish, there is no such threat of this in the Eurozone/EU (ECB) or Japan (BoJ). The ECB does not seem bothered by higher inflation in the common currency bloc. In fact (and although unsaid), higher-than-2% inflation might even be welcome by the central bank after many years of fighting off deflationary threats. The growing concerns about the spread of Omicron and its effect on growth in the EU cannot not be ignored, and the ECB will likely be most sympathetic to these effects more than inflation. As far as Japan, it’s simple – “why change now”? The BoJ has been on-and-off (mostly on) accommodative across the board now for 30 years in an attempt to fight sluggish growth and periodic threats of deflation. I don’t see a change coming anytime soon in Japan.
Since I am on the topic of central bank policies, I would be remiss not to mention that the Bank of China decreased the reserve ratio requirement for Chinese banks early last week (by 0.5%, to 8.4%), effectively an easing measure as the central government navigates to maintain the impressive growth of the world’s second largest economy. Largely telegraphed, this accommodative measure did occur though as a precursor to defaults on off-shore bonds of two large Chinese property companies – Evergrande and Kaisa – announced by Fitch on Thursday. Limiting collateral damage as the property sector deflates and curtailing contagion into the Chinese banking system will be major challenges of China’s central government in the days ahead.
Although it might not seem so robust on the surface, this cocktail of economic news nevertheless led to the mother-of-all rallies in global equities. It was a week to rejoice no matter which equity market you are invested in, because most were on fire. The US and European equity markets had particularly strong performance, with the S&P 500 index up 3.8% W-o-W, whilst both the FTSE 100 (+2.4%) and the STOXX 600 (+2.8%) delivered eye-watering returns, too. This is especially notable after a week in which equities cratered, but it was not to last. The S&P 500 is now back within 1% of its all-time closing high.
As far as US equities, all of the indices I track were solidly in the green last week. Large-cap global companies – as expressed in the more concentrated DJIA – outperformed the Russell 2000 and the NASDAQ Composite. The VIX, otherwise known as the “fear index”, closed the week back below 19 (18.69) having touched an intraday high of 35.32 one week ago. How quickly sentiment has shifted as investors have returned to equities en masse.
As good as the week was for stock investors, it was equally poor for investors in US Treasury bonds. Prices of USTs headed south as yields moved higher and the yield curve steepened. Inflationary concerns alongside strong economic data are persuading investors that there will be a faster tilt towards tighter monetary policy by the Federal Reserve. At shorter maturities, investors are signalling their expectations by dumping short bonds, bringing forward their expectation of an increase in the Federal Funds rate. At intermediate and longer maturities, higher yields suggest that better-than-expected economic growth is trumping concerns over the possible effects on business growth because of the Fed’s faster pivot. The 10-year yield widened back out to 1.48% (+13bps W-o-W) to close the week, whilst the yield on the 30-year bond gapped out to 1.88% (+19bps W-o-W) as the curve steepened. Some of the sell-off in US Treasuries could also be attributed to a return of risk-on sentiment in global financial markets.
The more bullish sentiment as far as risk assets also filtered into the corporate bond market, with the riskiest end of the credit spectrum – high yield bonds – rallying alongside equities. The picture was slightly more mixed in investment grade corporate bonds (USD), with spreads narrowing but yields increasing. Keep in mind that investment grade corporate bonds are more sensitive to underlying movements in UST (risk-free) yields, so sharp increases in UST yields often push yields higher in investment grade corporate bonds, too.
As far as safe haven assets aside from USTs, gold traded in a very narrow $12 range last week (using closing prices), although the price continues to drift lower as it has over the last four weeks. Gold has seemed to find support at $1,750/oz and encounter selling pressure at $1,850/oz or so since the summer. The Yen also lost ground having racked up solid gains the week before, with arguably both gold and the Yen suffering as risk-off sentiment subsided. Similarly, the US Dollar was also a touch weaker last week, but its ongoing ascendancy continues at a steady pace. USD foreign exchange is engaged in a tug-of-war between desire for Dollars to invest in faster-growing US financial assets and a fear of persistent inflation lasting longer than expected, which might cause the US Dollar to eventually devalue. However, the Fed is showing more backbone than most of the world’s other central banks at the moment, sending a message that it is serious about bringing down inflation in the US.
Oil prices finally stabilised last week following declines since late October. Having stabilised, oil prices then rebounded and closed up 8.6% W-o-W, with WTI crude ending Friday at $71.98/bbl. There have been concerns that the combination of scheduled supply increases by OPEC+ in January and slower economic growth caused by Omicron might cause further downward pressure on oil prices. However, I would expect OPEC+ to react (by deferring supply increases) if the current rebound in oil prices proves not to be sustainable otherwise. Cryptocurrencies endured another frightful week as far as volatility, but this seems perfectly normal in the world of cryptocurrencies as sharp moves for no specific reason often occur. After bouncing around in a broad range all week, Bitcoin ended the day Friday at $49,271 (5pm EST), down 9.9% W-o-W (and is slightly weaker Sat morning).
All eyes will be focused on the central banks this week, as they react to changes in the economic outlook in their country (or economic bloc). Apparently a G7 virtual discussion about global inflation (amongst other issues) is scheduled to take place Monday, which will precede various central bank policy statements that will occur throughout the week. I expect there to be no material policy shifts that are not already priced in the market. As I have said on many occasions, hold your nose end stay invested.