Passing the Covid baton
The omicron variant is driving the markets now.
With the emergence of Covid’s omicron variant over the past fortnight, investors have decided to shoot first and ask questions later. The S&P 500 plunged 5% from an overbought intraday record high on Nov. 22 at about 4,744 to an oversold reading last Friday. Benchmark 10-year Treasury yields fell from an oversold 1.70% just before Thanksgiving to an overbought 1.33% on Friday in a massive flight-to-safety rally. The volatility index (VIX) spiked from 17 to an overbought 35.
We’ve seen this movie before, and we think we know how it ends. Markets got hit when the delta variant arrived. But as the uncertainty faded, the financial markets rallied. We believe omicron will follow that path and expect to end the year with a Santa Claus rally that takes the S&P to our long-standing 4,800 target.
New sheriff in town Omicron is thought to spread faster than delta. In less than two weeks, it has been identified in more than 40 countries and several U.S. states, with new cases sure to rise sharply in coming weeks. But the symptoms appear to be milder than delta. Pfizer and Moderna are furiously studying omicron’s genetic makeup and have said they are confident they could produce a reformulated booster in the next three months or so if needed. The potential market risks resulting from national vaccine and mask mandates and another shutdown appear unlikely.
Federal Reserve throws in the towel on ‘transitory’ The core Consumer Price Index (CPI) rose to a 30-year high of 4.6% year-over-year (y/y) in October, and the core Personal Consumption Expenditure (PCE) index (the Fed’s preferred measure of inflation) hit a 31-year high at 4.1% y/y in October, more than double it 2% target.
As a result, Fed Chair Powell told Congress last week that it’s time to retire “transitory” from their lexicon. With inflation rising at a pace well above what policymakers had expected, we believe they will double their monthly tapering schedule in the first quarter of 2022, completing it by March 2022. That could set the table for quarterly rate hikes through year-end 2023. This comes on the heels of President Biden nominating Powell to a second term.
Ignore November, the labor market is strong True, November’s nominal nonfarm payroll gain of only 210,000 jobs (versus 546,000 in October) was less than half consensus expectations. But the non-seasonally adjusted gain was a robust 778,000 jobs, which means that the Labor Department made a downward seasonal adjustment of 568,000 workers. That is much higher than the average seasonal adjustment in Novembers over the past 20 years (200,000 jobs).
This downward adjustment doesn’t make sense in the face of the overwhelming strength in the rest of the November payroll report. The household survey surged by more than 1.1 million jobs, and the unemployment and labor impairment rates plunged to cycle lows of 4.2% and 7.8%, respectively. The participation rate rose to 61.8%, and average hourly earnings have risen at an annualized rate of 5.6% over the past eight months.
Why the sharp improvement? In August, schools and child-care facilities began to reopen, the $300 weekly government unemployment bonus ended in September, the savings rate plunged to 7.3% in October (from 26.6% last March) and delta variant fears faded in November. These favorable labor-market trends should continue, as the JOLTS report lists 10.4 million open jobs in September. Also, the ADP private payroll survey added an average of 543,000 jobs over the past three months. Finally, initial weekly jobless claims fell to a cycle low of 194,000 two weeks ago (down 97% from their April 2020 peak).
Consumer should be strong this Christmas The Back-to-School season (retail spending from June through September) was very strong in 2021, up 16% y/y versus 2020, and 20% versus 2019. That compares with increases in those four months, ranging from 3.4% to 5.1% over the previous four years.
Due to the well-publicized supply-chain bottlenecks, many people began their holiday spending for Christmas and Hanukah in October. That month’s nominal retail sales surged a stronger-than-expected 1.7% month-over-month and 16.3% y/y. We expect Christmas spending (October through January) to be solid (perhaps up 10%), but there are additional headwinds, such as inventory availability, soaring energy prices, higher inflation, omicron concern, a declining savings rate and falling consumer confidence levels.
Tweaking our GDP estimates The liquidity, equity and fixed-income investment professionals who comprise Federated Hermes’ macroeconomic policy committee met last Wednesday to discuss the many economic crosscurrents:
- The Commerce Department revised third-quarter 2021 GDP up a tick to a relatively muted gain of 2.1%, versus the robust second-quarter increase of 6.7%.
- We’re still expecting a strong Christmas as sales got off to a powerful start in October. But we are watching the progress of the omicron variant, the ongoing supply-chain shortages and the West Coast port backlogs. On net, we raised our fourth-quarter 2021 GDP growth estimate from 4.5% to 4.8%. The Blue Chip consensus trimmed its estimate from 5.3% to 4.9% (within a range of 3.6% to 6.3%). The Atlanta Fed raised its GDPNow forecast from 8.6% to an even stronger 9.7%.
- For full-year 2021, we lowered our growth estimate down from 5.6% to 5.5%. The Blue Chip also reduced its from 5.7% to 5.5% (within a range of 5.3% to 5.6%).
- We raised our full-year forecast for core CPI from 4.7% to 4.8%. This metric is currently at 4.6% in October, a 31-year high (the consensus forecast is at 4.7%.) We also raised our full-year forecast for core PCE inflation from 4.2% to 4.3% in 2021 (consensus estimate is 4%).
- With the potential hinderances of the omicron variant and winter weather, we estimate growth of 3.7% in the first quarter of 2022, compared with the Blue Chip’s consensus forecast of 4.4% (in a range of 3.1% to 5.7%).
- We expect strong “Mapril” spending as omicron fears fade, so we are predicting 4% growth in the second quarter of 2022, compared with the Blue Chip’s consensus estimate for 3.9% (in a range of 2.7% to 5%).
- As the Fed starts to hike rates by midyear, growth could slow in the second half of 2022. So we are forecasting 3.8% in the third quarter of 2022, compared with the Blue Chip’s consensus estimate for 3.3% (in a range of 2.5% to 4.2%).
- That trend should continue into year-end, so we are looking for 3.5% growth in the fourth quarter of 2022, compared with the Blue Chip’s consensus estimate for 2.7% (in a range of 1.8% to 3.5%).
- We are concerned about the prospect for fiscal policy drag in 2022, as we now expect the Fed to complete its bond-buying taper by March 2022, with three quarterly rate hikes to follow through year end. So we cut our full-year 2022 GDP estimate from 4% to 3.9%. The Blue Chip lowered its forecast from 4.1% to 4% (within a range of 3.1% to 4.8%).
- We increased our 2022 forecast for core CPI from 3.7% to 3.9% and for core PCE from 3.2% to 3.4%.