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Markets: Revisiting History for Inflation, Jobs

Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.

Week in Review

December 6-12

Let’s start this week’s review by hopping into the WayBack Machine. First stop: the early 1990s…

Back then (when some of us were still <ahem> in college,) the phrase “three shots” probably meant something quite different to you than it does today. But whatever memories that particular phrase might elicit for any of us, today it probably instead conjures images of vaccine cards, booster shots, rubbing alcohol and band-aids.

On the other hand, “three shots” also means a little freer access to many of the things that society has to offer (for example, at a New York City diner this weekend, our entire party had to show proof of vaccination before we could be seated.) Of course, the reason for that newly aggressive stance on vaccination has to do with uncertainty related to the Omicron variant of COVID-19 – the same variant that caused both equity market and interest rate volatility to spike since the new and improved bug first arrived on the scene during Thanksgiving break.

But this week, the news turned again as evidence began to suggest that although Omicron has shown an almost supernatural ability to spread, it also might produce somewhat less severe symptoms than earlier versions of the disease. And then on Wednesday, we got word that a third shot of the Pfizer/Moderna vaccine might provide approximately the same level of protection against Omicron as two shots used to provide against the old, “wild” strain of the virus.[1] Equity markets received both of those bits of news with open arms, mostly reversing the prior week’s declines and allowing volatility to settle back into a rut.  So, booster shots for everyone!

But the dial on our WayBack Machine is still set to the early 90s, and before we leave we should take a look around and soak in the ambiance, because we might need to get used to it. That’s because the last time core inflation at the consumer level was this high, the USSR was technically still a country and Nirvana was still producing new music. The consumer price index (CPI) excluding food and energy rose nearly 5% in November, the highest level since June of 1991[2].

Now let’s reset the controls on our WayBack Machine back by a decade, to the early 80s: Ronald Regan is in his first term and ET is getting ready for his Oscar run. But that’s also how far back you have to go to find a period when headline consumer inflation (that is, including all goods and services such as food and energy,) was as high as it was in November, when the CPI (all items) rose almost 6.9%.

Inflation is very much on the minds of consumers, too. On Friday, the University of Michigan released its mid-month look into consumer sentiment and found – perhaps unsurprisingly – that consumers now believe the biggest risk to their overall well-being is no longer unemployment, but inflation[3]. When asked to rank those two risks against each other, respondents said inflation was the bigger worry by a ratio of more than three to one. Perhaps even more relevant, the UofM’s survey-takers also noted that the broader improvement in sentiment – which bounced off last month’s bottom-basement reading to a slightly less pessimistic 70.4 – was driven entirely by consumers in the bottom third of the income distribution. Moreover, that improvement was driven by a sharp, 2.9% rise in income expectations for consumers in that income cohort, the biggest rebound since 1981.

Rising incomes and a rapid change-of-heart away from job insecurity and toward price insecurity as the chief bogeyman for everyday consumers could be relevant to capital markets for at least two reasons. First, while there may be lots to like about higher incomes among low-income earners on its own merits, the good professors at the UofM also see a more sinister trend at work deep in the data: as they wrote in last week’s release, “this (data) suggests an emerging wage-price spiral that could propel inflation higher in years to come.[4]” If that early warning were to develop into a full-blown (and self-reinforcing) cycle where higher prices produce higher wages, which in turn produces higher prices, which in turn…etc., etc., then inflation could remain top-of-mind for consumers – and therefore markets – well into 2022 and beyond.

Second, and of perhaps more immediate concern, it could also give the Federal Reserve some degree of air support among the general public if the Fed’s current thinking continues to shift away from COVID-era stimulus and toward normalization. Recall that the Fed’s so-called “dual mandate” requires it to conduct monetary policy in a way that fosters both full employment and low inflation. These two objectives are often at odds with one another, and the emphasis clearly seems to be shifting toward the latter goal of keeping prices tame. That means the Fed might feel even more emboldened to tighten policy by doing things like accelerating the taper of bond purchases and <gasp!> raising rates off the zero floor. If that’s the case, investors may have to get used to a new reality where the Fed is somewhat less-than-friendly to markets than it has been in recent years.

But with all this talk of Fed policy, consumer attitudes and cutting-edge virology, it’s easy to forget that there is still a real economy at work behind the headlines. And there is perhaps no other place that defines “real economy” quite so viscerally as the jobs market. And that, fellow time travelers, brings us to the last stop on our tour: let’s set the dial on our WayBack Machine to 1969, the waning days of the Vietnam era. That’s the last time that weekly jobless claims, which hit a mere 184,000 last week[5], were as low as they are today.

Just like improving income prospects for lower-income earners that we discussed above, it’s hard not to cheer for collapsing unemployment claims if for no other reason than it means the long-awaited healing in the job market is clearly underway (a message that received some reinforcement from last week’s JOLTS report as well, which showed job openings at a near-record again in October, but a “quits rate” that is beginning to return to normal[6].) But in a similar way, jobless numbers that collapse too fast might also stoke fears of continued inflation: while the relationship between record-high job openings, record-low unemployment claims and wages is complex and ambiguous, common sense would at least suggest some kind of link that might ultimately prove inflationary. (Hence the preference for progress – but not too much progress – on jobs as the economy continues to right itself.)

We’ve finally reached the end of our little history tour, and thanks, fellow time travelers, for tagging along. Before we go, though, it’s telling that our trip took us to the 1990s, the 1980s, and even into 1969, the year Woodstock happened and Jimi Hendrix became a household name. Why? Because having to reach so far back into history to find precedents for some of the economic data we’re seeing today reminds us exactly how exceptional these times truly are. Something certainly feels different about how markets and the economy are currently functioning, especially compared to the easy policy regime that has dominated in recent decades. Whether or not the post-COVID era will prove to be a watershed is of course a mystery known only to the future, and the dial on our WayBack Machine doesn’t include that setting.

But for now, it might be enough to note that the more things change, the more they stay the same – at least in terms of near-term performance. That means when you finally break things down to their most basic, you’ll find that the virus, the Fed and inflation are still driving the machine.

What to Watch This Week

December 13– 17

Notable economic events (December 13-17)

Monday: No major events planned

Tuesday: Producer price inflation (PPI,) NFIB small business sentiment

Wednesday: FOMC announcement, Retail sales, Empire State Mfgr., NAHB Housing Market index

Thursday: Weekly jobless claims, Philly Fed, Flash PMIs, housing starts/permits

Friday: Quadruple witching day

The week starts slow, with no planned economic releases scheduled for Monday. On Tuesday, though, the Federal Reserve’s Open Market Committee will begin its last scheduled meeting of 2021, with an announcement on rates taper expected, as always, on Wednesday afternoon. While the overwhelming consensus is that the FOMC will continue to hold rates at zero, there are now at least a few futures traders who are betting that the Fed is so freaked out about inflation that they might lift rates off the floor as soon as this week. That remains the longest of long shots, though, so expect commentary surrounding this week’s FOMC to focus on whether (and how much) the Fed will accelerate the pace of the tapering of its asset purchases. Recall that the last FOMC statement implied the Fed would be done buying bonds by June; odds are that recent inflation numbers (and the Fed’s acknowledgement of them,) will pull that timeline forward.

We’ll also get an opportunity to see whether producer prices are running as hot as consumer prices, illustrated by the CPI data that we spent so much time discussing above. Producer prices seemed to accelerate sooner and in more robust fashion than consumer prices during this cycle, and it seems logical given where pricing pressures have originated that the PPI will have to cool before the CPI relents. For now, though, economists don’t seem convinced: estimates seem to be looking for a steady increase in producer prices at best, and a material acceleration at worst. Either way, we’ll know more on Tuesday.

Tuesday’s FOMC and PPI data are clearly the most important things on this week’s calendar, but are by no means the only relevant data. In addition to our first two regional Fed manufacturing reports (Empire State on Wednesday and Philly Fed on Thursday,) we’ll also get our first look at purchasing manager data (the so-called PMIs) on Thursday. It’s easy to shove all three of these reports into the same mental space because they’ve been saying the same things for so long: demand is abnormally strong, but production is being restrained by continued labor market issues and historic cost pressures. Until that changes, I wouldn’t expect too much reaction from any of these releases unless they say something exceptional.

In that same vein, Tuesday’s small business sentiment report from the National Federation of Independent Businesses has been a great window into how some of these broad, macroeconomic trends have reached ground-level by way of their influence on the day-to-day operations of the country’s small businesses. Look for that report to include interesting color even if continues, like the PMIs and regional Feds, to paint a picture of robust demand constrained by a challenging supply environment.

We’ll also get our first helping of December’s housing market data, beginning with Wednesday’s builder sentiment report from the National Association of Homebuilders and continuing with starts and permits on Thursday. The housing market has shown signs of improvement after a modest cooling through the autumn months, and this week should show whether or not that trend remains intact.

Finally, the most interesting standalone report could be November’s retail sales report, scheduled for Wednesday. Spending around the holiday season is always closely watched by analysts and economists as a view into how consumers are feeling – in some ways, a cross-check against what they’re telling pollsters like those at the University of Michigan and the Conference Board. This year’s numbers are likely to be distorted by the waning impacts of the stimulus as well as all kinds of social and psychological fallout from months and months of COVID restraint, but will nonetheless be watched for clues about the environment for consumer spending in the year ahead.

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Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.

 

[1] https://www.pfizer.com/news/press-release/press-release-detail/pfizer-and-biontech-provide-update-omicron-variant

[2] https://www.bls.gov/news.release/cpi.nr0.htm

[3] http://www.sca.isr.umich.edu/

[4] Ibid.

[5] https://www.dol.gov/ui/data.pdf

[6] https://www.bls.gov/news.release/jolts.nr0.htm

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