The Market Today
Fed Accelerates Taper, Ratchets Up Rate Hike Projections
by Craig Dismuke, Dudley Carter
Jobless Claims Show Still-Tight Labor Conditions: Initial jobless claims for the week ending December 11 rose from 188k to 206k, slightly larger than the expected increase. At 206k, initial claims remain well below the 4Q average and only two weeks have seen lower tallies during the ongoing recovery. They also remain below the 2020 pre-pandemic average of 212k per week. Continuing jobless claims for the week ending December 4 fell sharply, down 154k to 1.85mm, the lowest level of the pandemic and only 120k above the 2020 pre-pandemic average.
Housing Starts and Building Permits Beat Expectations in November: Housing starts jumped 11.8% last month, handily outpacing the 3.1% gain expected and pushing the pace of activity up to 1.679mm annualized units, the second strongest pace since 2006. Adding to the quality of the gain, single family and multi-family starts both jumped by more than 11%. Building permits rose 3.6% last month, better than the 0.5% increase expected. The 1.712mm annualized pace landed near the middle of the 12-month range which is well above trend activity prior to the pandemic. Single family permits rose 2.7% while multi-family activity increased 5.2%.
Philly Fed Index Volatility; Supply Chain and Inflation Metrics Ease Up: The Philadelphia Fed report on regional manufacturing activity in December fell from 39.0 to 15.4, but remained above the 10-year average of 12.8. Discouragingly, the new orders index plunged 33.7 points to 13.7. Also falling were the shipments and unfilled orders metrics. On a positive note, the employment index increased 6.7 points to 33.9, the highest since in records since 1968. On a positive note, the metrics tracking the supply chain and inflation issues remain elevated but both eased up. Similar to the results in the previously released New York Fed index, the delivery times index inched lower. Both the prices paid and prices received measures fell notably.
Later Today: At 8:15 a.m. CT, the Federal Reserve will release its Industrial Production report for November. Following at 8:45 a.m., Markit will publish preliminary PMI results for December which are expected to show a slightly stronger pace for manufacturing and services early in the month. Finally at 10 a.m., the Kansas City Fed will report on manufacturing activity in its District.
OTHER ECONOMIC NEWS
Fed Formalizes Hawkish Pivot in the Face of Decades-Fast Inflation: In line with expectations and “in light of inflation developments and the further improvement in the labor market,” the Fed voted to double the monthly tapering pace from $15 billion to $30 billion beginning in mid-January. The more expeditious pace will conclude net asset purchases in March instead of June. Elsewhere in the statement, the word “transitory” was retired and inflation was simply said to be at “elevated levels,” still impacted by “supply and demand imbalances…and the reopening of the economy.” Although “new variants of the virus” were added as an explicit risk to the economy, the broader tone remained optimistic and included an added statement that “the unemployment rate has declined substantially.” The altered narrative was supported by the updated forecasts which projected a quicker descent for unemployment below the Fed’s estimate of the longer run rate and a much higher level for inflation over the next two years. Triangulating the new forecasts with statement edits that implied officials were comfortable that the inflation tests for raising rates have been satisfied support explains wholesale revisions higher in the dot plot. The median projection for 2022, which in September reflected even odds of one rate increase, now sees three. After three additional rate increases, the median forecast expects the target rate to end 2023 at 1.625%, up from 1.00% in September. The median 2024 dot reflected a year-end rate of 2.125%, up from 1.75% in September but still below an unchanged longer run neutral rate of 2.50%. The results, collectively, imply the Fed is comfortable running a pressure-cooker economy through at least the end of 2024 with an unsustainably tight labor market, above-target inflation, and accommodative monetary policy. The new rate outlook is clearly more hawkish, but stopped short of a less measured quarterly pace for future rate hikes some had expected or feared.
Powell Describes the Pivot Process: In his press conference, Chair Powell noted rapid progress towards maximum employment evidenced by the substantial decline in unemployment and acknowledged that wages are rising at their fastest pace in many years. He admitted that it may take longer than anticipated for participation to recover more substantially and again said that inflation pressures have broadened out. When asked what drove his pivot to a “greater wariness around inflation,” Powell answered that the process began in September when it became clear that economic imbalances were lasting longer than expected. The transition in thinking was later accelerated by the stronger 3Q Employment Cost Index, solid hiring in October (and positive revisions) paired with a lack of labor supply improvement, and the hot October CPI report. Powell noted that officials began deeper discussions about the balance sheet but said no decisions were made as to what may happen after the taper ends. He noted that there is a lot of uncertainty about the potential effects of Omicron that will only be answered with time. Broadly, however, he believes the economy has become more resilient “wave upon wave” at learning to live with and operate through the virus.
Bank of England Raises Rates: Surprising many, the Bank of England became the first major central bank to raise rates in the post-pandemic era, voting 8 to 1 to increase its target rate from 0.10% to 0.25%. Speculation had grown Omicron’s rapid spread and implementation of new restrictions could delay a hike into early 2022, despite strong inflation. Near the end of a lengthy statement, the central bank summarized the rationale for hiking rates amid the greater level of uncertainty. “The labour market is tight and has continued to tighten, and there are some signs of greater persistence in domestic cost and price pressures,” the Statement read, noting, “Although the Omicron variant is likely to weigh on near-term activity, its impact on medium-term inflationary pressures is unclear at this stage.”
ECB Softens Wind Down of Emergency Asset Purchases with Boosted Buys Under Traditional Program: The ECB will taper asset purchases under its emergency program starting in January and conclude the program at the end of March. It did, however, say the purchases could be resumed if needed and extended the reinvestment period of maturities in the program by one year to the end of 2024. Neutralizing those effects somewhat, the ECB also announced that it will increase monthly purchases under its traditional program from 20 billion euros to 40 billion euros in the second quarter. The pace will fall back to 30 billion in the third quarter and return to the current 20 billion monthly pace in the fourth quarter, continuing at that rate “for as long as necessary” to achieve its policy mandate. “The Governing Council expects net purchases to end shortly before it starts raising the key ECB interest rates,” the statement noted.
Home Builder Confidence Inches Up As Expected: The NAHB’s Housing Market Index rose 1 point in December to 84, matching both expectations and the high mark for 2021. December’s print remains below the record high of 90 from November 2020 but well above readings from prior to the pandemic. Indexes tracking current sales and foot traffic of interested buyers both rose 1 point while a gauge of future sales expectations was steady from November. The NAHB called a lack of housing supply the “most pressing issue” and noted “building has increased but the industry faces constraints, namely cost/availability of materials, labor and lots.”
Initial Reaction to Fed’s Hawkish Pivot Faded: U.S. stocks drifted lower Wednesday in front of the Fed’s afternoon decision while Treasury yields hovered just above Tuesday’s closing levels. Yields had briefly dipped earlier in the day following weaker-than-expected retail spending figures for November. While consumer spending continued to run at historically high levels, momentum slowed more than expected after a strong October gain. Just ahead of the Fed’s announcement, the S&P 500 was 0.2% lower and the Treasury curve was flatter; the 2-year yield was 1.4 bps higher at 0.67% with the 10-year yield up 0.3 bps to 1.45%. Stocks’ losses deepened and the yield trends intensified in the knee-jerk response to the Fed’s hawkish pivot (more above). The 2-year yield jumped by as many as 5.9 bps to as high as 0.72%, a new cycle-high. With the 10-year yield responding with just a 3.2-bp increase, the spread between the two securities fell to as little as 73.7 bps, a new 2021 low. Gradually, however, stocks recovered and yields pulled back. A quicker liftoff and more aggressive pace of tightening projected for the next couple of years didn’t really change the Fed’s longer look for a target rate of around 2% in 2024. The S&P 500, led by the tech sector, rallied sharply beginning during Powell’s presser to close up 1.6% at session highs. Yields retreated and the curve steepening dissipated. The 2-year yield ended just 0.6 bps higher at 0.66% while the 10-year yield added 1.5 bps to 1.46%. The Dollar erased its gains to close near session lows.
Global stocks remain sanguine Thursday in the face of shifting central bank postures and continued uncertainty about the economic effects of Omicron. After yesterday’s post-Fed rally in the U.S., stocks closed higher across Asia and were rallying sharply across Europe. U.S. futures were up more than 0.5% at 6:30 a.m. CT. While Treasury yields remained subdued overnight, sovereign yield curves in Europe had moved up, again led by the U.K. The U.K. reported record cases yesterday and sharp drop in its composite PMI overnight amid new Omicron restrictions. Nonetheless, the Bank of England surprised by raising rates a couple of hours ago after data yesterday showed inflation running at its fastest rate in ten years. U.K. yields were up more than 7 bps across the curve. The Eurozone’s composite PMI also pulled back in December amid Omicron developments with Germany’s Services PMI actually falling below 50, the first contractionary reading since April. After the ECB’s announcement (more above), European yields and the common currency were near the highs of the day. Before and after the jobless claims data, the 2-year Treasury yield was roughly 1.6 bps lower while the 10-year yield had risen 1.4 bps.
Virus Developments: South Africa and the U.K. both reported new pandemic records for daily infections as Omicron spreads. The U.K.’s Chief Medical Officer said the new variant is “going to be a problem” and is concerned that “substantial numbers” will be hospitalized after the holidays. Greece will require a negative test for visitors from all countries. Canada warned citizens against non-essential international travel for the next four weeks. Ontario reduced the window for a booster shot to three months after a second dose and limited capacity at large sporting venues to 50%. Apple temporarily shut three retail stores because of the virus.
Vaccine Developments: J&J reported positive results related to its booster protecting against severe illness. Moderna tweeted Wednesday that “while individuals had detectable neutralizing titers against Omicron [after two doses}, neutralizing titers were significantly lower” than against the original strain, based on preliminary test results. However, a booster dose “significantly increased neutralizing #antibody titers against #Omicron.”