Week in Review

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Week in Review: January 21, 2022

Repricing Risk: Speed of Fed Rate Hikes and Higher Inflation Concerns Drive Market Volatility

 

U.S. equities staged a third straight week of losses to start 2022. Markets continue to focus on higher inflation and the Federal Reserve’s response. Supply and labor shortages continue to be exacerbated by the Omicron variant keeping workers on the sidelines, adding to inflation concerns. While there is little evidence these shortages will abate in the near term, the labor market continues to tighten and demand for goods and services remains high. In addition to strong inflationary pressures in shelter and used car sales, we continue to see broad-based increases in many of the inflation subcomponents (apparel and electronics, to name a few). This week’s rally in oil prices also poses challenges to consumers and the Fed as they try to restrain inflation while supporting growth. We believe the broad-based nature of inflationary pressures will keep inflation elevated and prevent it from “peaking” in the near term.  

The tight labor market will continue to contribute to inflationary pressures, in our view. The demand for labor continues to remain red-hot as job openings continue to outpace the number of unemployed, according to data from the U.S. Bureau of Labor Statistics (see Figure 1). Initial jobless claims were higher than expected in the week ended January 15 as they increased to 286,000, their highest level since mid-October. We view the increase as temporary as the rise in initial jobless claims reflects both an increase in layoffs due to the surge in COVID cases as well as a large seasonal adjustment factor. A wave of early retirements, an aging working population and COVID workplace disruptions are further limiting supply in the labor market (see Figure 2). As employers raise wages to attract employees, they run the risk of margin compression for equities. However, those currently in the labor force are enjoying wage growth, and the U.S. still has the healthiest consumer balance sheets in 20 years.  

If demand remains undeterred by price increases, it will be met with persistent supply constraints, adding upward pressure to inflation. We expect used car and shelter prices to continue to move higher in the near term. In addition, we anticipate rising energy prices to keep inflation higher for longer as supply chain issues linger. Recent data suggests that the shortage of workers to transport freights is a meaningfully large contributor to goods inflation due to scarcity. With no fast resolution in view, higher transportation-sector wages may diminish some pressure by midyear.  
With supply issues poised to keep inflation higher in the upcoming months, the Fed remains on track to raise interest rates at least three times in 2022, in addition to quantitative tightening. One of the biggest risks to equities is if the Fed raises rates too quickly or continues smaller hikes all the way through 2024 in order to slow inflation. For fixed income, corporate credit spreads continued to drift wider in anticipation of pending Fed actions. Despite the supply constraints and rising prices, pent up consumer savings (over $2 trillion) and higher wages will support consumer spending and corporate profits in the near term.  

As markets continue to digest the inflationary data and pending Fed action, we expect U.S. equities and bond markets to endure volatility but remain on track for subtle gains in coming months. While the timing of Fed rate hikes continues to remain unknown, we take comfort in the hope that Fed Chairman Powell will continue to be methodical and transparent in the upcoming press conference this week. This open dialogue will likely help protect against market surprises after future Fed decisions. A March rate hike is almost fully priced into futures markets at this stage, with expectations for around four 25bp rate hikes for 2022 — slightly more than the three in the median rate projected by Fed officials last month. With higher for longer inflation expectations, we continue to favor U.S. and European equities over Emerging Markets, and in fixed income we favor short-duration positioning.

 

THE WEEK AHEAD

  • January’s consumer confidence is expected to decline to 110.5, released on Tuesday.
  • At the FOMC meeting on Wednesday, we expect the Fed to reiterate a liftoff in March and progress in the labor market recovery.
  • 2021 Q4 GDP is expected to decline to 5.8%, quarter over quarter, released on Thursday.
     

Figure 1: Ratio of job openings to unemployed persons

      ratio of job openings

Source: Bureau of Labor Statistics

 

Figure 2: U.S. labor participation rate

  labor participation rate
Source: Bureau of Labor Statistics
 

 

Market Returns (USD) as of 1/20/2022

1-Week

Quarter-to-Date

Year-to-Date

1-Year

Global Equities

MSCI All Country World

 
-2.8% -3.9% -3.9% 10.1%

S&P 500


-3.8% -5.9% -5.9% 18.0%

Dow Jones Industrial Average


-3.8% -4.4% -4.4% 13.4%

NASDAQ


-4.4% -9.5% -9.5% 5.9%

Russell 2000


-6.3% -9.8% -9.8% -5.4%

First Republic Founders Index

 
-6.6% -13.5% -13.5% -13.9%

Russell 1000 Equal Weighted


-4.1% -5.0% -5.0% 11.7%

MSCI EAFE

 
-1.7% -0.7% -0.7% 7.8%

MSCI Emerging Markets

 
-0.6% 2.0% 2.0% -8.4%

Fixed Income

ICE BofAML Municipals 1-10 Year A-AAA 

-0.3% -1.0% -1.0% -0.5%

Bloomberg Barclays Intermediate Government/Credit

-0.6% -1.4% -1.4% -2.5%

Bloomberg Barclays High Yield Bond

-0.6% -1.2% -1.2% 3.3%

Market Levels

Thursday

Week Ago

Year End

Year Ago

S&P 500


4482.73 4726.35 4766.18 3851.85

Dow Jones Industrial Average

 

34715.39 36290.32 36338.3 31188.38

10-Year U.S. Treasury Yield (Constant Maturity)

1.83% 1.72% 1.51% 1.09%

Gold ($/oz)


$1,839.40 $1,826.30 $1,821.90 $1,871.95

Crude Oil ($/barrel)


$85.55 $82.64 $75.21 $53.31

U.S. Dollar / Euro ($/)


1.13 1.15 1.14 1.21

U.S Dollar / British Pound ($/£)


1.37 1.37 1.35 1.36

Japanese Yen / U.S. Dollar (¥/$)


114 114.13 115.16 103.57

Bitcoin Futures ($/XBT)

 
$42,675.00 $43,825.00 $47,977.03 $35,035.00