The Rise of Timid Hawks
All major US stock indices closed the week with gains, but volatility continues to dominate financial markets. Outsized daily moves and large intraday swings are fast becoming a trend on Wall Street. This week, even some of the super-sized market cap monsters boarded the volatility roller coaster and traded like micro-caps. Meta Platforms, the behemoth formerly known as Facebook, collapsed 28% from their pre-earnings level to the closing bell on Friday. The now $1.6 trillion Amazon harnessed volatility in the other direction with a 14% surge after they reported earnings. Most commodities were notably higher, the US dollar tanked, and Treasury yields continued to break higher.
In addition to market volatility, US central bankers continued to grab headlines this week. In the face of the fastest consumer price increases in 40 years, Richmond Federal Reserve president Thomas Barkin said there was not enough information to determine how far the Fed might need to go to restrain the economy and tame inflation. According to Barkin, it is unclear whether inflation will drop on its own or become entrenched. With the Federal Reserve’s policy rate remaining near zero amid a rising wage-price spiral, surging energy prices that are bleeding into economy-wide input costs, and businesses increasingly needing to pass costs onto consumers, Barkin conceded that the Fed should raise rates.
Without providing a timeline, Barkin said he favored a policy approach that would raise the Fed funds rate back to pre-pandemic levels. That would presumably target a range of 1.5%–1.75%. The president of the Richmond Fed said that pre-pandemic rates would not restrain the economy. As a result, in his view, “Pre-pandemic levels are the place to reassess.” “Then we can look around and say, do you want to then start to move into the range…where we are starting to restrain?”
Mr. Barkin’s comments seemed to indicate that his primary concern would be that overly aggressive Fed action could restrain and hurt the economy. Fears that an overly passive Fed might facilitate an acceleration of the inflation problem seemed relegated to secondary concern status. “I’d like the Fed to get better positioned. I think we’ve got a good part of the year to get there, Mr. Barkin said. He then added, “I think how fast we go just depends on how the economy develops.” Importantly, what Mr. Barkin didn’t say is that how slow the Fed goes will, in itself, materially influence how the economy develops. Mr. Barkin’s comments add to the concerns of those worried the Fed has already fallen dangerously behind the curve.
San Francisco Fed president Mary Daly did even less to inspire confidence in a fully committed inflation-fighting Fed. When it comes to fighting inflation, Daly told a Reuters forum that the Fed is “not behind the curve at all.” Daly suggested that, given her view of the strength of the economy, it is now time to start easing the throttle on the central bank’s most accommodative monetary policy in history. Daly’s comments don’t seem to take the current 7% consumer price inflation, or the risk that price increases could become further entrenched, seriously at all.
Overall, the messaging from regional Fed governors this week seemed intent on easing market concerns over a Fed tightening cycle that might be aggressive enough to threaten the economy and markets. Those fears were inflamed by Fed Chairman Powell’s FOMC press conference last week. On balance, the various voices out of the Fed family in recent weeks suggest a dramatic hawkish pivot from where they were last fall, but significant questions remain as to the extent and exact emphasis of future action given their current bind. They remain firmly wedged between a serious inflation problem they can’t be seen to ignore and a fully inflated “superbubble” they must handle with kid gloves. Unless problematic levels of inflation dissolve on their own imminently, the Fed is moving toward a consequential policy quagmire that could slip out of their control.
Meanwhile, the push in the direction of tighter monetary policy progressed internationally this week in both England and continental Europe. On Thursday, Andrew Bailey’s Bank of England raised interest rates for a second time and began the process of quantitative tightening. This was the Bank of England’s first consecutive rate hike since 2004. In the face of escalating inflation projections, now expected to reach 7% this spring, the Bank’s Monetary Policy Committee voted unanimously for a 25 bps rate increase that will take the main bank rate to 0.5%.
Also on Thursday, European Central Bank president Christine Lagarde, by far the most dovish of the major central bank chiefs, finally acknowledged that eurozone inflation was surpassing expectations, and that the inflation risks were skewed to the upside. While there was no surprise that the ECB left policy rates unchanged at Thursday’s meeting, there was widespread market perception that an important acknowledgement of an inflation problem had been made. When asked if the ECB was “very unlikely” to raise rates in 2022, rather than outright agree, Lagarde said the bank would be data dependent and assess conditions very carefully. The acknowledgement of the inflation problem and unwillingness to rule out 2022 rate increases was interpreted by the market as a first step that will ultimately mark the start of the ECB’s own more hawkish policy pivot. The market reaction sent European bond yields surging higher.
The perception that Thursday’s ECB meeting was a sign the bank might begin to move toward the US Fed and the BOE in regard to a tighter monetary policy also had currency implications. As our very own Doug Noland says, “the dollar’s greatest asset remains, it has very unsound competitors.” The euro is no exception to his point, but if the ECB does provide any hawkish policy surprises, the euro will be seen as relatively less unsound than the dollar. That may not sound like much, but technically the currency markets are a potential powder keg at the moment. The dollar sold off hard this week and is showing a number of signs that its uptrend since the start of 2021 may be nearing an end. At the same time, the euro is primed for a rally, and is bullishly back-testing a major breakout through resistance dating back to 2008. It may not take more than the slightest hawkish creep from the ECB to send the euro into a significant rally and the dollar into a downtrend. Such a development would carry significant bullish implications for commodities, and in particular, the precious metals.
Returning stateside again, the two major job reports released this week offered a tale of two labor markets. The ADP National Employment Report on Wednesday indicated sharp and broad declines in private sector payrolls for the first time since December 2020. Private employment dropped by 301,000 in January, a reading much worse than the expectation of a 270,000 increase.
On the other hand, US Non-Farm Payrolls far exceeded expectations, increasing by 467,000 in January. Average analysts’ estimates were for 150,000. A number of estimates were even expecting a negative number. Previous months were also revised significantly higher. The January labor picture was significantly distorted by the Omicron Covid variant. Overall, in light of the Covid distortions and the two conflicting reports, the labor market news is likely to have no impact on Fed plans to tighten policy. In addition, the Bureau of Labor Statistics’ latest Job Openings and Labor Turnover Survey data out this week continued to indicate a historically tight labor market supportive of the case for Fed tightening.
Since the great financial crisis of 2008, the unprecedented interventions of governments and central banks have thwarted the free expression of markets. Liquidity injections of unfathomable size and near-zero interest rate policy have been the tools applied to direct markets away from free prices and ever more toward the designs of central policy. This has resulted in markets inundated by liquidity and artificially steered by that liquidity’s guided currents. As both a direct and indirect consequence, persistent high inflation has resulted and spread globally. The consumer, which is to say everyone everywhere, is noticing and feeling the pain. Consumer optimism and confidence in government economic policies is plummeting in inverse proportion to the degree inflation is surging. The pressure is now ratcheting up on governments and central banks to respond. The response function is complicated, however. Any policy response substantial enough to mute inflation also risks strangling economic growth and dramatically deflating financial markets.
Former Treasury Secretary William E. Simon reflected that, for a long time, our political trajectory has been toward “contrived government solutions to all the problems in the United States.” Even if well intentioned, the tools used to achieve these designs in the economic sphere are inherently inflationary. Their use may alleviate some problems in the short term, but in the longer term they exacerbate existing problems and give birth to new ones. History teaches that, in the longer run, use of the inflationary tool kit contributes to destabilizing boom-bust cycles, unsustainable debt, systemic currency fragility, and devastating consumer price inflation. The inflationary toolkit is a particularly dangerous temptation for activist policymakers. This is precisely because, as Secretary Simon observed, people “hate inflation, but love everything that causes it.” As a result, the political temptation is to claim short-term benefit by offering everything that causes inflation. As for the long-term consequences, well, as famed and all-too-influential British economist John Maynard Keynes said, “In the long run, we are all dead!”
After over a decade of inflationary policy, however, the long run has arrived—and we are not all dead. Now that inflation is here, the game is changing. We are seeing the hawkish Fed pivot in the United States, and now some possible inclination to follow suit in Europe with the Bank of England and the European Central Bank. Recent stock market volatility and bond market spasms are in response to central planners starting to change their tune, and, in the process, necessitating a sober reappraisal of the financial landscape by market participants.
However, as Bank of America’s Michael Hartnett was quoted as saying in last week’s HAI, central bankers are “hysterically behind the curve.” What Hartnett means is that inflation is a process with momentum. When inflationary policies are initiated, a “nimble” central bank can theoretically quickly readjust policy and tighten financial conditions just enough to nip the eruption of full-fledged problematic inflation in the bud. This is what former Federal Reserve Chairman William McChesney Martin was referring to when he famously said that, “the job of the Federal Reserve is to take away the punch bowl just as the party gets going.”
As much as Jerome Powell, Christine Lagarde, and Andrew Bailey try to appear responsible and responsive toward the threat of sharply rising prices, inflation has already been surging globally for a year. They are “hysterically” late. Rather than yanking the punch bowl just as the party gets going, they have arrived only after the inebriated partygoers have left their mess and moved on to the after-party. Unfortunately, at this point, the policy choices are likely to be two very difficult ones: either entrenched problematic inflation that guts the consumer or a more substantial policy response to subdue inflation that will severely undermine the economy and debilitate markets.
Unless central bankers can utilize their tools to flawlessly navigate a minefield that is largely of their own making, they may soon be taught a memorable lesson in economics. As F.A. Hayek said, “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”
Weekly performance: The S&P 500 was higher this week by 1.55%. Gold was up 1.19%, silver gained 0.81%, platinum was up 1.75%, and palladium shed 3.56% on the week. The HUI gold miners index was up by 2.54%. The IFRA iShares US Infrastructure ETF gained 0.78% for the week. Energy commodities were mixed. WTI Crude Oil continued its tear and gained 6.32%, while natural gas lost 1.47%. The CRB Commodity Index was up 3.34%, while copper gained 4.18%. The Dow Jones US Specialty Real Estate Investment Trust Index was down 0.61% on the week, while the Vanguard Utilities ETF (VPU) was modestly higher by 0.48%. The dollar was lower by 1.84% to close the week at 95.48. The yield on the 10-year Treasury closed the week notably higher by 15 bps to close at 1.93%.
Have a great weekend!
Chief Executive Officer