In this week’s Monday Market Insights, we discuss the most recent inflation report, the prospects for higher interest rates, and the implications of President Biden’s falling approval rating. In the Chart of the Week we highlight the likely path of the U.S. Dollar and what that might mean for markets. Finally, we break down our view of the labor market while making the case that inflation will subside as we move through 2022.
- January Inflation Hotter than Expected. The January Consumer Price Index was 7.5% year-over-year versus the 7.3% consensus forecast. After some speculation that inflation would come in under forecasts for January, this report pushed stocks lower and rates higher. We do not believe the Federal Reserve (Fed) will hike rates 50 bps in March (we think only 25 bps), but this inflation report may perpetuate the fear of a more aggressive increase while serving as a near-term headwind to further equity market gains. The January CPI reading does not change our view that inflation will begin to ease later in 2022 (see Commentary section below for more).
- Financial Stocks Lead Rates. The relative performance of financials versus the broad market has been a good leading indicator of major peaks in interest rates. Financials peaked 8 months before rates in 2018, they peaked about 6 months before rates topped in 2007, and they peaked 20 months prior to the top in rates in 2000. Last week financials made a new relative-high versus the S&P 500, not showing any signs of indicating a major top in bond yields. Heading into the year, we believed rates would drift higher in 2022 (especially in the first half), but upward momentum may wane later in the year. The relative performance of financial stocks is something we will be watching very closely for signs of a turning point in rates.
- Biden’s Approval Rating Hits New Low. As the mid-term elections slowly approach, the question is can President Biden (and Democrats overall) recover? Although the president is facing approval rating pressure across the board, polling shows that inflation is a primary driver. Current numbers are consistent with Democrats losing at least 30 seats in the House and at least a couple of Senate seats. We believe that should Democrats lose the House, legislation will grind to a halt. The universe of bipartisan agreement is very small, and if Biden does not seek reelection, the incentive to compromise falls even further. A lack of legislative movement is often good for stocks, especially given the recent call for higher corporate taxes.
|Russell 1000 Value||0.8||0.0||19.3||14.74||10.78||1.84|
|Russell 1000 Growth||(0.2)||(7.5)||12.6||26.67||22.14||0.69|
|MSCI EM (Emerging Markets)||2.2||0.7||(9.9)||8.98||8.85||2.47*|
|Fixed Income||Week||YTD||1-Year||3-Year||5-Year||Div Yield|
|Bloomberg Barclays US Aggregate||(1.2)||(3.2)||(3.8)||3.24||2.79||2.30|
|Bloomberg Barclays US High Yield – Corporate||(0.8)||(2.9)||1.0||6.10||5.27||5.37|
|Bloomberg Barclays Municipal Bond||(0.2)||(2.5)||(1.9)||3.49||3.43||1.71|
|Bloomberg Barclays Global Aggregate x US (Country)||(0.8)||(2.2)||(7.2)||1.75||2.47||1.39|
|Crude Oil WTI (NYM $/bbl) Continuous||1.6||19.2||53.6||19.4||11.1||89.7|
|Natural Gas (NYM $/mmbtu) Continuous||(27.1)||12.7||41.4||15.8||5.0||4.0|
|Gold NYMEX Near Term ($/ozt)||1.4||0.4||(0.0)||11.8||8.2||1,835.2|
|Copper Cash Official LME ($/mt)||0.0||2.0||21.3||16.8||11.0||9,881.0|
|Currencies||1 Week Ago||YTD||1-Year Ago||3-Years Ago||5-Years Ago||Current Level|
|U.S. Dollar per Euro||1.13||1.14||1.21||1.13||1.07||1.14|
|Japanese Yen per U.S. Dollar||114.40||115.16||104.59||109.73||112.98||115.47|
|U.S. Dollar per British Pounds||1.36||1.35||1.38||1.29||1.25||1.35|
Chart of the Week
Do Fed Rate Hikes Mean Peak Dollar?
- Historically, the dollar peaks just as the Fed starts hiking rates.
- We see some evidence of this lately, with the dollar being flat since November 2021.
- A weaker dollar can be associated with higher oil prices, higher profits for large U.S. multi-national companies (translating profits made in foreign currencies back to dollars), and better performance from emerging market economies that often rely on dollar-denominated debt.
- A falling dollar would be consistent with our preference for large-cap stocks in the second half of 2022.
Commentary: Will Rising Wages Lead to Even Higher Inflation?
Will inflation finally start to trend lower in 2022? That is the question of the day, with wide-ranging implications. Obviously, for consumers, higher prices can be a headwind for confidence and consumption. For financial markets, stubbornly high inflation could cause the Fed to raise interest rates at a speed that would be determinantal to both economic growth and financial asset prices.
In our view, the magnitude of wage growth going forward holds the key to answering this difficult question. Simply stated, wages are often the most significant part of a company’s cost structure. To protect profits, companies will pass on this higher cost to their customers leading to higher inflation.
The labor force appears very “tight”, meaning the supply of labor is falling short of demand. To attract necessary labor, companies have been forced to pay higher wages. However, we don’t believe the labor market is as tight as it appears. Incoming labor supply will be a headwind to additional wage gains, and higher productivity trends mean that a company’s cost to produce every unit of their product (“unit labor costs”) should remain in check.
According to Piper Sandler Macro Research (PSM), prime-age workers and workers between the ages of 16-24 may introduce an additional 3.5 million people into the labor force this year. If that is the case, pay may have overshot fundamentals. This additional labor supply would be more consistent with 3% wage growth, not the 5% we saw in Q4 of 2021. If PSM’s forecast for 2% productivity gains is accurate, 2% core inflation would be more consistent with labor market fundamentals.