Omicron soft patch
Inflation spiking while job growth and consumer spending have slowed.
The omicron variant, which is more transmissible but less virulent than Covid’s delta variant, has surged over the past two months, creating a near-term soft patch for the economy. The labor market, consumer spending, manufacturing, and business and consumer confidence have all struggled over the past few months, while inflation has sustainably soared, resurrecting ugly stagflation comparisons between the Biden and Carter administrations. At the same time, the Federal Reserve has finally found religion on executing a more hawkish withdrawal of monetary policy accommodation.
Consequently, the S&P 500 has plunged by 8% in a difficult start to the new year, from a fully valued 4,818 on Jan. 4, 2022 to today’s retest of the 200-day moving average at 4,400. The technology-laden NASDAQ composite and the small-cap Russell 2000 indices have both dropped by about 13% over this same period. Benchmark 10-year Treasury yields soared from an overbought 1.33% in early December to an oversold 1.88% earlier this week, and the volatility index (VIX) spiked from 16 to an overbought 28 so far this month. While we have been expecting an 8-12% correction in stocks with sharply increased volatility over the first nine months of this year, the speed with which this pullback has occurred suggests that we could be approaching capitulation.
Omicron peaking? Although omicron spread more quickly than delta, it seems less virulent. So hospitalizations are up, mortalities are down and the symptoms are generally milder. In fact, omicron appears to be peaking in the U.S. this month, following a similar trend in South Africa, the European Union and the U.K. in recent weeks. According to the CDC, Pfizer and Moderna vaccines and boosters are 90% effective in preventing serious illness, and we believe that 2022 will be the year in which Covid transitions from “pandemic” to “endemic.”
Inflation soaring Nominal retail inflation hit a 39-year high of 7.0% y/y in December, while the core Consumer Price Index (CPI) rose to a 30-year high of 5.5%. The core Personal Consumption Expenditure (PCE) index (the Fed’s preferred measure of inflation) hit a 32-year high of 4.7% y/y in November (more than double the Fed’s 2.0% target), a level that we expect will rise to 5% in coming months. Consequently, Federal Reserve Chair Jay Powell has finally thrown in the proverbial towel on “transitory” inflation. We expect the Fed to complete its bond-buying taper in March 2022, at which point they will launch a series of four quarter-point rate hikes in each of 2022 and 2023 and begin to shrink their nearly $9 trillion balance sheet later this year.
Economy softens Nominal nonfarm payrolls rose by much weaker-than-expected levels in each of November and December, and initial weekly jobless claims for January 2022’s survey week rose to 286,000, substantially higher than December’s cycle low of 188,000 claims. The personal savings rate has normalized from nearly 27% last March to 6.9% in November, while Michigan’s consumer sentiment index plumbed a 10-year low. In December, existing home sales fell for the first time in four months by 4.6%, and auto sales declined sequentially by 3.9%.
Tweaking our GDP estimates The equity, fixed-income and liquidity, investment professionals who comprise Federated Hermes’s macroeconomic policy committee met yesterday to discuss the impact that omicron is having on the economy:
- The Commerce Department revised third-quarter 2021 GDP up to a final gain of 2.3%, versus the robust second-quarter increase of 6.7%.
- Fourth-quarter 2021 GDP will be flashed on Jan. 21, 2022. Christmas spending has risen in October, November and December by a strong 17.1% y/y, versus 3.7% last year. So we ticked up our fourth-quarter 2021 GDP estimate from 4.8% to 4.9%. The Bloomberg consensus is now at 5.3%, and the Atlanta Fed’s GDPNow model has been halved from 9.7% in December to 5.0%. The Blue Chip consensus raised its estimate from 4.9% to 5.9% (within a range of 4.3% to 7.0%).
- Our full-year 2021 GDP estimate is unchanged at 5.5%. The Blue Chip raised its forecast from 5.5% to 5.6% (within a tight range of 5.3% to 5.6%).
- With the potential for slower economic growth in the first-quarter of 2022 from the omicron variant and brutal winter weather, we are reducing our GDP estimate from 3.7% to 3.5%. The Blue Chip consensus lowered its estimate from 4.4% to 3.3% (within a range of 1.7% to 4.9%).
- We expect strong “Mapril” spending as omicron fears fade, so we left unchanged our estimate of 4.0% in the second quarter of 2022. The Blue Chip consensus was also unchanged at 3.9% (in a range of 2.7% to 5.1%).
- As the Fed ends its taper, starts to hike interest rates, and begins to shrink its balance sheet, GDP growth could slow in the second half of 2022. So we are cutting our estimate from 3.8% to 3.0% in the third quarter of 2022. The Blue Chip consensus left unchanged its estimate at 3.3% (in a range of 2.5% to 4.2%).
- That trend should continue into year end, so we are reducing our GDP estimate in the fourth quarter of 2022 from 3.5% to 3.0%. The Blue Chip consensus left its estimate unchanged at 2.7% (in a range of 2.0% to 3.5%).
- We cut our full-year 2022 GDP estimate from 3.9% to 3.8%. The Blue Chip lowered its forecast from 4.0% to 3.9% (within a range of 3.1% to 4.8%).
- We increased our full-year forecast for core CPI inflation from 3.9% to 4.4% for 2022, and we also raised our full-year forecast for core PCE inflation from 3.4% to 3.8%.