Week ended December 17th, 2021
“People invest in stocks for two opposite reasons -- in hope and confidence in the future of an enterprise or in fear that the value of their capital will be lost through inflation.” – Bernard Baruch
Gyrations in financial asset prices this past week were mainly influenced by monetary policy decisions from the world’s major central banks, which came fast and furious starting mid-week. As a high level comment, I would say that financial markets reacted more or less as expected, aside from the rather bizarre rally on Wednesday in US stocks – which soon fizzled – following the Federal Reserve’s announcement suggesting a decisively more hawkish tilt. The spread of Omicron provided a bleak overlay to economic news, as the number of cases explodes, and countries scramble to react. News seems to suggest that the variant is the most transmissible yet but is fatal much less often. Still yet, the resurgence in cases and the still-low vaccination rates in many parts of the world is causing real concern especially in those countries (most of them) with nationalised healthcare and / or limited hospital beds. Government action is likely to side towards a more conservative approach, meaning economies will once again be negatively affected. It is fair to say that the country most in the spotlight at the moment is the UK, which rather unfortunately seems to be a leader in this undesired area but is no doubt simply an indication of what lies ahead for the US, the EU and other countries around the world.
Even with the pandemic overhang worsening, investors were firmly focused on the actions of the four central banks last week. Some economic data provided context to the actions of central banks, so let me mention that first. In the US, PPI for November (see BLS release here) of 9.6% (12-months running ended November) was the highest since the figure started being calculated in 2010. PPI serves as a leading indicator of the direction of CPI, so inflationary pressures remain intense in the US. Later in the week, first-time jobless claims increased (vis-à-vis the week before), coming in slightly higher than expected at 206,000, a data point which might suggest that the economic recovery could be more choppy as the US nears full employment (DOL press release here). In the UK and Eurozone, inflation figures also came in hot. UK CPI (excluding housing costs) was 5.1% for the 12-months ended November 2021 (ONS press release here), the highest CPI figure in the UK since late 2011. Inflation in the EU also remains significantly above the long term target, increasing to 5.2% in November, whilst inflation in the common currency bloc (i.e. the Eurozone) increased to 4.9% (Eurostat press release here). With the exception of Japan, the world’s major developed market economies are all facing a fight against rising inflation, and this is increasingly influential on central bank actions. So let’s turn to the central bank decisions from the past week.
The Federal Reserve was the first to announce its intentions, releasing minutes from its recent FOMC meeting on Wednesday (here), after which Chairman Powell held a press conference. The net result is that inflation has become a more significant concern as the Fed pursues its dual mandate (of 2% inflation and full employment), leading to an even-faster hawkish tilt. This means faster tapering and a more aggressive (and earlier) series of increases in the Fed Funds rate in 2022 (three) and 2023 (three). The Fed’s economic projections (here) released concurrently with the FOMC minutes has US GDP growth projected at 4.0% in 2022, unemployment of 3.5% by the end of next year, and inflation at 2.6% for 2022. With US economic projections revised upwards since the last set of projections in September, it is clear why the Fed has finally decided to act more aggressively to unwind its exceptional stimulus. The Bank of England is even being more aggressive in quelling inflation in the UK, announcing Thursday that it would increase the overnight bank borrowing rate (the Bank Rate) by 0.15%, from 0.10% to 0.25% (BoE press release here). This step comes against the rapid spread of Omicron in the UK. Some investors might have again been caught off-guard following the BoE’s failure to act in early November (pre-Omicron as an aside), although inflation data released a day before the moentary policy statement should have suggested with decent (albeit not perfect) confidence that the BoE would act since its sole mandate is to keep inflation in check. Across the Channel, the ECB would have nothing to do with the hawkish tilt by the UK and US in order to see off inflation, even though inflation is also surging in the EU. Some suggested that the ECB had a slight shift towards tightening as far as its tapper programme, but it appears to be nothing more than cosmetics to me. The ECB press release is here. As expected, the Bank of Japan announced (see here) that it would continue to wind down its pandemic relief (by March 2022) but otherwise its loose monetary policy will continue, including its QE programme, nil interest rate policy and yield curve control. To understand the BoJ’s “forever easy” approach, you need to keep in mind that – unlike in the US, the UK and the EU – inflation remains very subdued (as it has for years) in Japan, with the latest CPI figure (ex-food) coming in at 0%.
There were three other developments that influenced markets this past week. Firstly, in US politics, Congress and the President reached agreement on increasing the debt ceiling to take the country through to 4Q2022, although it was not without drama as it came down to the wire, and Congressional approval was along party lines. The US$1.75 trillion Build Back America Act also seems to be on a slow burner, and its approval will now not likely occur until early 2022. Secondly, the UK is embroiled in political turmoil as the Conservatives and its leader – PM Boris Johnson – seem to be losing their grip on power as Omicron casts a long and dark shadow over the UK. Lastly, the IEA released its Oil Market Report-December 2021 (here) projecting lower demand for oil in 2022 and increasing supply from non-OPEC producers, which is likely to mean that OPEC+ supply increases will remain as scheduled during the first part of 2022. Oil largely stabilised around $70/bbl (WTI) on this news although it suggests, at least to me, a downward bias in oil prices as we start 2022.
As far as global equity markets, there was a lot of red last week as you can see in the table below. In fact, the only index I track that was green last week was the Nikkei 225 (Japan), even though the Japanese equities lost a bit of ground Friday following the BoJ monetary policy release. The worst performing index of the week was the S&P 500, which (eventually) sagged mid-week as tech shares sold off on Thursday, following the release of the FOMC minutes the day before. Emerging markets also suffered, including Chinese equities, whilst European bourses were negative but not severely.
US equities endured another wild week although volatility (as measured by the VIX) remained much more in check than just after (US) Thanksgiving. The various indices shifted around all week, with tech shares surging on Wednesday and then collapsing on Thursday. By the end of the week as you can see below, it was the tech-heavy NASDAQ that took it most on the chin, although the DJIA and Russell 2000 also performed poorly. In fact, US equity markets felt much more volatile last week than the gyrations in the VIX suggested. As liquidity dissipates and investors lock-in 2021 gains, I see more downside from here as we enter the last two weeks of the year.
The US Treasury bond market also endured a week of sentiment shifts, with the final result being lower yields across the curve.
Although it might seem counter-intuitive given the Fed’s more hawkish shift, the yield curve flattened by 6bps. The yield on the 2-year Treasury, influenced much more by expected increases in the Fed Funds rate, decreased only 1bps. However, the yields on intermediate and longer maturity bonds decreased more significantly, as the Fed emphatically (finally) altered its policies to tackle inflation more aggressively. As I mentioned last week, there might be some flight-to-quality influence going on, too, as equities gyrate and we near year-end. Even as the Fed turned more hawkish, yields on inflation-protected UST securities remain negative across the curve, with the 10-year TIPS yielding -0.97%.
In the corporate bond market, yields and spreads were little changed on the week.
As far as safe haven assets other than US Treasuries, gold was slightly better bid on the week (+1.2% W-o-W), whilst the US Dollar strengthened on the Fed’s more aggressive shift towards tighter monetary policy. The Yen weakened, reflecting a combination of stable risk and ongoing easy monetary policy in Japan. The ECB’s ongoing accommodative monetary policy weighed on the Euro, which weakened vis-à-vis Sterling and the US Dollar.
Oil prices were slightly weaker last week, perhaps nearing what might be a floor of around $70/bbl for WTI crude. Cryptocurrencies continue to be under severe pressure due to contagion from volatility in other financial asset classes, approaching year end (as 2021 crypto gains have far outweighed gains in other asset classes), and looming threats of harmful crypto legislation in several places, including the US, the EU and China.
This coming week is holiday shortened, as equity and bond markets in the US and the UK will be closed on Friday in commemoration of Christmas Day (on Saturday Dec 25th). Most EU markets will operate on a half day basis on Dec 24th. The bond market in the US will close early on Thursday (Dec 23rd) in the lead-up to US stock and bond market closures on the 24th. Equity markets will be closed in the UK on Dec 27th for Boxing Day, whilst markets will be open in the US and most EU countries on Monday. There is a risk of greater volatility and more severe swings in asset prices (and sentiment) as liquidity decreases in the coming days. I suspect that investors will gladly lock-in gains and sit out the rest of the year as they celebrate another extraordinary year as far as appreciating financial asset prices. Omicron is likely to continue to cast a long shadow. The direction of the world’s leading central banks is no longer a secret, and at least investors can move forward for now with this uncertainty removed from their thoughts.