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Weekly Update 3/18/2022: Fed Lifts Rates a Quarter Point as Expected

  • Boeing a 737 Max jet was flown to China this week for their first delivery in three years in positive sign for the company
  • Accenture announces earnings delivering stellar results and raises guidance; warns of potential adverse impact in conflict in Ukraine were to escalate
  • Dow raises their first quarter 2022 guidance

Interest Rate Insight and the Fed

The Federal Reserve raised interest rates by a quarter percentage point and signaled six more such hikes this year, launching a campaign to tackle the fastest inflation in four decades even as risks to economic growth mount. Policy makers led by Chair Jerome Powell voted 8-1 to lift their key rate to a target range of 0.25% to 0.5%, the first increase since 2018, after two years of holding borrowing costs near zero to cushion the economy from the pandemic. St. Louis Fed President James Bullard dissented in favor of a half-point hike, the first vote against a decision since September 2020. The hike is likely the first of several to come this year, as the Fed said it “anticipates that ongoing increases in the target range will be appropriate,” and Powell has pledged to be “nimble.” In the Fed’s so-called dot plot, officials’ median projection was for the benchmark rate to end 2022 at about 1.9% -- in line with traders’ bets but higher than previously anticipated -- and then rise to about 2.8% in 2023. They estimated a 2.8% rate in 2024, the final year of the forecasts, which are subject to even more uncertainty than usual given Russia’s invasion of Ukraine and new Covid-19 lockdowns in China are buffeting the global economy. “The invasion of Ukraine by Russia is causing tremendous human and economic hardship,” the Federal Open Market Committee said in a statement Wednesday following a two-day meeting in Washington, the first held in person -- rather than via videoconference -- since the pandemic began. “The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.” Two-year Treasury yields jumped and the curve flattened sharply following the decision. The S&P 500 index pared its gains and the dollar index saw little reaction. The Fed said it would begin allowing its $8.9 trillion balance sheet to shrink at a “coming meeting” without elaborating. The purchases of Treasuries and mortgage-backed securities, which concluded this month, were intended to provide support to the economy during the Covid-19 crisis and shrinking the balance sheet accelerates the removal of that aid.

Stocks bounced back after Federal Reserve Chair Jerome Powell struck a more positive tone on the prospects for economic growth amid policy tightening. Bonds pared losses. The S&P 500 pushed higher after briefly dropping when the Fed statement came out. Treasury two-year yields, which are more sensitive to imminent policy changes, spiked as much as 15 basis points before paring the increase. The dollar retreated. Powell said the U.S. economy can withstand Fed tightening, while adding that the probability of a recession is “not particularly elevated.” Overall, The meeting and press conference proceeded about as we expected. The Fed was aggressive in terms of their forecasts for rate hikes – that in and of itself brings longer term inflationary expectations down. Whether or not they actually do hike rates as many times as the “dot plot” implies remains to be seen. Inflation really took hold in the second half 2021 so when we get to the second half of 2022 the headline numbers on CPI and PPI will moderate and come down from current levels on an annualized basis because the comps will be coming from a higher base. Also they have a dual mandate – stable prices and full employment. Rates hikes are designed to slow demand in the economy to control inflation. In our view, the Fed will be data dependent – they will monitor both inflation figures and economic figures such as employment data. It is a balancing act for them. Overall Powell seems to have a good grasp of this and he articulated Fed policy and the strength of the U.S. economy well during his “presser” in our view.

As we have been writing, a good amount of the pain associated with the Fed embarking on a rate hiking cycle has been built into equity and fixed income prices. The fact that the Fed came out and finally said – we have lifted interest rates – is almost a relief after six months of waiting for it. The other point we would make is that the Fed’s dot plot came out and was almost identical to the path of interest rate hikes that traders were predicting in the futures markets. In other words, there were no major surprises and the Fed acted as was expected. If history is a guide as well, it is not unusual to experience high levels of volatility ahead of the rate hike cycle and then to stabilize when the process actually begins. Between June 2004 and June 2006, Fed officials raised rates 17 times! The S&P 500 during that period posted gains of about 12% during that time frame. The 2015-2018 monetary tightening period was even more positive for risk assets as the S&P 500 rose about 21% during that period. Given the sharp retrenchment in both stock and bond prices that has been experience this year prior to the Fed actually raising rates – we will see if this time history repeats itself.

Impactful International News

China was all over the headlines this week. It was positive to see the U.S. meeting with their Chinese counterparts on Monday to work towards helping to resolve the conflict in the Ukraine. China obviously has a good deal of influence on Russia. Traders are desperately seeking signals that progress is being made on talks between the Ukraine and Russia. Additionally, the Chinese economy is the second largest in the world and many U.S. companies do business there. So in other headline news related to China, China made a strong push to stabilize battered financial markets, promising to ease a regulatory crackdown, support property and technology companies and stimulate the economy. The government should “actively introduce policies that benefit markets,” according to a meeting of China’s top financial policy committee led by Vice Premier Liu He, the country’s top economic official. That vow to take investors interests into account comes after a sell-off in domestic shares due to fears over growth risks and tough regulation of real estate and internet companies. The meeting offered investors re-assurance that a sweeping crackdown on internet companies was nearing its end and that the government would prevent a disorderly collapse in the property market. China’s banking regulator said after the meeting that it would support insurance companies to increase investment in stock markets.

Stocks surged after the announcements. The Hang Seng China Enterprises Index jumped 13% at the close in Hong Kong, the most since 2008, recouping nearly half of this year’s losses. The CSI 300 Index of mainland shares climbed 4.3%. “The statement addressed so many issues on various fronts, which is really rare,” said Ding Shuang, chief economist for Greater China and North Asia at Standard Chartered Plc. “Selloffs tended to be self-fulfilling partly because of the lack of response from the government,” and one aim of the government is probably to break that inertia and stabilize market expectations, he said. The statement signals an adjustment after months in which Chinese capital markets were battered by government policies ranging from a squeeze on financing for property developers to a sweeping regulatory campaign aimed at internet giants like Alibaba Group Holding and Tencent Holdings. The sell-off deepened in recent days, as rising energy prices caused by Russia’s invasion of Ukraine and a surge in Chinese coronavirus cases called into question Beijing’s ability to meet its economic growth target. The Financial Stability and Development Committee meeting concluded there is a need to “boost the economy,” in the first quarter and promised investors relief on several regulatory fronts. Monetary policy will be proactive in this quarter and new loans will grow appropriately, it added.

In other related news, Shanghai ruled out imposing a broad lockdown for now, while urging workers in its main financial and business district to work from home as officials try to rein in a swelling Covid-19 outbreak in one of China’s biggest and most important cities. This is important because we already have pressures on our supply chain and big companies such as Apple for example do rely on production and assembly in China even though most companies have diversified their supply chain. So any disruption can have an impact on business at least in the short term. Part of the reason commodities such as oil came off their highs was concern over the economic impact of a shutdown in China due to Covid. Gu Honghui, deputy secretary general of the Shanghai government, told reporters Tuesday that “there’s no need to lock down the city” at the moment, with authorities keen to minimize the impact of virus mitigation efforts on businesses and people’s lives. Instead, the authority overseeing the Pudong district, home to China’s main stock exchange and the local headquarters of a bevy of financial firms, called for more flexible work arrangements in a statement on its official WeChat account. Battling its largest nationwide outbreak in two years, China locked down Langfang, a city near Beijing’s new airport Tuesday, following similar moves earlier this week in the southern tech hub of Shenzhen and the northeastern province of Jilin. That’s fueled concern the country’s financial gateway could be next, with virus cases in Shanghai on the rise and some buildings already locked down. Some tenants of the IFC, an office complex in the city’s financial area of Lujiazui, were notified Wednesday that the building might be placed under lockdown. China is stepping up its tactics to quell the virus, continuing to deploy the Covid Zero playbook that has left it isolated from the rest of the world in a bid to bring cases back to near zero. While it has been able to avoid more stringent measures like lockdowns in bigger cities in the past, the more contagious omicron variant is challenging that approach like never before. More than 100 international flights will be diverted away from Shanghai from March 21, to ease pressure on quarantine hotels and isolation facilities. China isolates all virus cases, regardless of their severity, as a way of halting spread.

We are closely monitoring this and any signs of an easing of the conflict in the Ukraine and progress on talks which would lead to a ceasefire and an agreement. We hope that does happen soon for the sake of the people of the Ukraine. Wednesday morning a proposal for Ukraine to become a neutral country but retain its own armed forces “could be viewed as a certain kind of compromise,” Kremlin spokesman Dmitry Peskov said, hinting at possible progress in peace negotiations. Ukrainian President Volodymyr Zelenskiy delivered an emotional address to the U.S. Congress, appealing for help from Americans to fend off the Russian invasion.

Domestic Economic News

In other domestic economic news, prices paid to U.S. producers rose strongly in February on higher costs of goods, underscoring inflationary pressures that set the stage for a Federal Reserve rate hike this week. The producer price index for final demand increased 10% from February of last year and 0.8% from the prior month, Labor Department data showed Tuesday. That followed an upwardly revised 1.2% monthly gain in January. The median forecasts in a Bloomberg survey of economists called for a 10% year-over-year increase and a 0.9% monthly advance. Excluding the volatile food and energy components, the so-called core PPI increased 0.2% from a month earlier and was up by a 8.4% from a year ago, both figures were better than the expected 0.6% and 8.7% expected. Even though the figures were high, the fact they came in better than expected for the most part helped lift sentiment in trading Tuesday. The data reflect the biggest monthly gain in the price of goods in data back to 2009, with two-thirds of the increase due to energy. It’s the latest indication of rapid inflation in the U.S., and prices are poised to accelerate further after Russia’s invasion of Ukraine sent prices of some raw materials to new highs. It should be noted that many of those commodity prices have come off their recent highs. While that bolsters the case for the Fed to be aggressive in tamping down inflation in the coming months, the central bank will have to balance curbing inflation without stifling economic growth. There were signs in other parts of the economy that inflationary pressures were cooling. Prices for final demand services were little changed from January, the first month without an increase since December 2020. An increase in transportation and warehousing services costs was offset by declines in portfolio management and apparel and accessories retailing. The report captures changes in prices paid to producers a well as margins received by wholesalers and retailers. A separate report Tuesday showed prices received by New York state manufacturers advanced to the highest in data back to 2001, while a measure of input costs stayed elevated.

Growth in U.S. retail sales slowed in February after surging a month earlier, suggesting that consumers tempered their spending in some categories as inflation limited purchasing power. The value of overall retail purchases increased 0.3%, after an upwardly revised 4.9% gain in January, Commerce Department figures showed Wednesday. The February advance was led by a 5.3% jump in spending for gasoline. Excluding gas stations, sales fell 0.2% last month. The figures aren’t adjusted for inflation. For Federal Reserve policy makers, the retail figures suggest only a modest change in consumer spending behavior against a backdrop of soaring inflation that may worsen in the months ahead. Russia’s invasion of Ukraine has sent gasoline prices to a record and is adding to cost pressures more broadly through soaring commodities. Even so, American households are on solid footing with the unemployment rate at 3.8% and disposable income rising throughout much of the pandemic. The median estimate in a Bloomberg survey called for a 0.4% gain in overall retail sales from the prior month. Inflation-adjusted consumer spending data for February that includes services will be released on March 31.

The day after Fed Chair Powell in his presser stated “the U.S. economy is strong” we received a bunch of positive economic data reinforcing that Thursday morning. Weekly jobless claims were better than expected falling 15,000 from the prior week and coming in at 214,000 versus the expected 220,000. New U.S. home construction rebounded in February to the strongest pace since 2006, suggesting builders had greater success navigating material and labor constraints in the month. Residential starts increased 6.8% last month to a 1.77 million annualized rate, according to government data released Thursday. Applications to build, a proxy for future construction, eased to an annualized 1.86 million units, though remained elevated. The median estimate in a Bloomberg survey of economists called for a 1.7 million pace of housing starts in February. The data point to a pickup in construction activity after weather and omicron-related worker absences tempered building in January. Still, builders are struggling to meet buyer demand in the face of snarled supply chains, high commodities prices and an ongoing struggle to attract skilled labor. Looking ahead, Russia’s invasion of Ukraine has roiled global supply chains and led to a surge in commodities prices. Data out Wednesday showed U.S. homebuilder confidence fell to a six-month low in March, as the outlook for sales dropped to the lowest since June 2020. Single-family starts advanced 5.7% in February to an annualized pace of 1.22 million units. Multifamily starts, which include apartment buildings and condominiums, increased to 554,000, the strongest pace since January 2020.

In other positive news, production at U.S. factories rose in February by the most in four months, indicating firmer momentum in a manufacturing sector still challenged by supply constraints and higher costs. The 1.2% increase followed a revised 0.1% gain in January, Federal Reserve data showed Thursday. Total industrial production, which also includes mining and utility output, rose 0.5% last month. Factories were also able to ramp up capacity after weathering omicron-related challenges in recent months. Capacity utilization at factories rose in February to 78%, the highest since 2018, from 77.1% a month earlier. A steady inflow of orders -- a reflection of steady demand from businesses and consumers -- remains a source of strength for domestic producers. At the same time, still-fragile global supply chains and soaring materials costs continue to complicate the industrial recovery. The pickup in manufacturing output was broad-based in February, save for a drop in production of motor vehicles and parts. The Fed said that the 3.5% decline reflected ongoing shortages of electronics components. Factory production last month was boosted by stronger output of mineral products, wood, aerospace equipment, apparel and furniture. The median estimate in a Bloomberg survey of economists called for a 1% monthly advance in factory output and a 0.5% increase in total industrial production. Total industrial capacity climbed to a an almost three-year high of 77.6%. The latest Institute for Supply Management figures showed stronger factory activity in February on firmer growth in orders and production. The report also highlighted lingering logistical challenges as average lead times for production materials, supplies and capital equipment set record highs. While these reports are always mixed in terms of the positives and the negatives, overall the tone was distinctly positive.

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