How Will Increased Tapering Impact Markets in 2022?

How Will Increased Tapering Impact Markets in 2022?

According to a Dec. 15 Federal Open Market Committee (FOMC) statement from the Federal Reserve, the federal funds target range will remain at 0 percent to 0.25 percent. Beginning in January, the FOMC will reduce its monthly purchase of assets to $40 billion in Treasury securities and $20 billion in mortgage-backed securities, with tapering expected to finish well before mid-2022. The FOMC also projects three rate hikes in 2022. These monetary policy adjustments are all subject to change based on the economic developments going forward, signifying uncertainty for markets in 2022.

What History Says

Looking back to the last “taper tantrum” in 2013 when Ben Bernanke was in charge of the Federal Reserve, equities lost 5.8 percent during June 2013 (similar to the decline in markets during September 2021). While many considered this a “market pullback,” the S&P 500 saw gains of 17.5 percent for the rest of 2013. Looking from WWII onward, there’s been 60 instances of the stock market falling initially by 5 percent to 6 percent, but the next month it was up 3.3 percent on average, and 92 percent being higher by year-end.

From the second half of December 2013 through October 2014, the S&P 500 advanced 11.5 percent, primarily because Wall Street was confident in the economy’s health in growing with the Fed’s bond-buying.

After the rallying months, markets have gained an average of 8.4 percent 100 days later. For the 2021-2022 cycle, the rally is expected to go through January 2022. However, historical S&P 500 trends suggest volatility and a drop of 5 percent or greater in February 2022. February is generally the second worst month of the year for market performance.

What’s Happening this Cycle

Fed Chair Powell clearly indicated that rates are to be raised soon and inflation is expected to stabilize. Inflation is expected to hit 6 percent in Q4 of 2021, and trading on Wall Street is expected to see bearish trends to start 2022.

Since the Fed has been crystal clear about tapering, such communication has likely resulted in a relatively smoother transition for the markets. According to the Board of Governors of the Federal Reserve System, quantitative easing (QE) began in 2008 due to the financial crisis, was rolled back at the end of 2018, but the Fed became more accommodative again during the COVID-19 crisis. As of October 2021, the Fed’s balance sheet was $8.5 trillion. This was double what the Fed’s balance sheet was in early 2020 and 10 times as large from mid-2007 levels of $870 billion.

With Powell yet to be reconfirmed for a second term, there is uncertainty, along with the 2022 mid-term elections and pressure from progressive politicians looking for a dovish Fed chair.

Powell’s comments at the recent FOMC meeting explained that once COVID-caused jams to the supply chain are resolved, inflation will subside. This perspective, paired with his continual observation of the economy and flexibility on raising rates, has become a tug-of-war between the Fed and Wall Street investors on market performance. The Fed also indicated that once the bond-buying is complete, it’s not an automatic trigger for interest rate hikes. However, depending on how inflation plays out, the market will have its own interpretation of how the Fed will react to unfolding inflation.

Putting the Fed’s Moves Into Perspective

QE and lowering the Fed funds rate both can be effective monetary policy. QE helps when the Fed increases its balance sheet by buying long-maturity bonds and mortgage-back securities to drive lower yields. Lower interest rates enable cheaper borrowing, which can help the economy grow employment and increase growth. If QE is rolled back, there will be uncertainty over whether the economy can stand on its own two feet.

The true question of the potential impact on markets is whether the Fed will taper only or also reduce its balance sheet holdings. Other ways the Fed can tighten monetary policy is by adjusting short-term interest rates via the discount window/federal funds rate. The Fed similarly can sell assets from its balance sheet via open market operations (OMO).

Fed Chair Nomination in 2022: How Will it Impact Markets?

Fed Chair Nomination in 2022: How Will it Impact Markets?

Fed Chair Nomination in 2022As the Board of Governors of the Federal Reserve System points out, Jerome Powell was appointed to a four-year term on Feb. 5, 2018. With the Fed Chair’s term expiring in February 2022, there has been much uncertainty as to whether he would be reappointed or replaced.

Powell’s first term as the Chair of the Fed began in 2018, after being nominated by President Trump in November 2017. If reappointed, Powell will serve another four years, where he will guide the nation’s short-term monetary policy and become the Federal Open Markets Committee’s (FOMC) chair.

During a Nov. 22 announcement, President Biden said that he’s renominating Powell for another term for the chair position of the Board of Governors of the Federal Reserve System. President Biden also announced that Lael Brainard has been nominated for the vice chair position of the Board of Governors of the Federal Reserve System. With the Fed vice chairman for supervision resigning at the end of 2021, these series of events are providing President Biden with additional nominations to promote his policies.

Understanding the Federal Reserve’s Influence on the Markets

Similar to a chief executive officer, the chair is entrusted to carry out the mandate of the Fed. The primary foci include influencing short- and long-term interest rates, maintaining price stability and encouraging a balance in employment.

The chair of the FOMC is the steward for the nation’s monetary policy by adjusting the federal funds rate, discount rate and buying/selling of government securities to support the economy in its role in fulfilling its economic goals.

How President Biden’s Decision is Expected to Impact Markets

With Brainard having a favorability for fintech and cryptocurrencies and the ability to curry favor with progressives due to her desire for strong bank regulations, her nomination will provide the market with greater stability in conjunction with Powell’s renomination. This is due to Powell’s past four years of steering the market through its challenges, especially with COVID-19. With Powell already communicating the timeline of tapering and when the Fed is likely to increase rates, it should provide greater certainty for the markets.

Additionally, the investment community believes the markets will perceive Brainard as more politically focused due to her contributions to Hillary Clinton’s presidential ambitions in 2016. With Brainard expected to consider and strongly influence the FOMC’s actions on the 2022 midterm elections, she’ll likely lobby the committee to raise interest rates deeper into 2022 after the “tapering” or bond purchasing schedule is complete, compared to the earlier path under Powell’s lead alone.

Political Implications

According to a Nov. 19 statement in support of a Fed Chair other than Jerome Powell and who is committed to addressing climate change, Rhode Island Sen. Sheldon Whitehouse and Oregon Sen. Jeff Merkley made their thoughts clear on how they want the nomination process to not go in favor of Powell.

While Powell has been renominated, he’ll certainly face Congressional pressure during confirmation hearings and beyond if he’s indeed confirmed for a second term. However if the Federal Reserve nomination process plays out for Biden, Powell and Brainard, the FOMC will certainly have its policy influenced by more than President Biden.

Will the Natural Gas Squeeze Derail the Recovery?

Will the Natural Gas Squeeze Derail the Recovery?

Natural Gas PriceEnergy is expected to increase in price as 2021 closes and 2022 begins, according to the Oct. 13, 2021 Short-Term Energy Outlook (STEO) from the U.S. Energy Information Administration (EIA).

Between October 2021 and March 2022, the U.S. benchmark, Henry Hub, is expected to average $5.67 million British thermal units (MMBtu). For 2022, the average price is expected to be $4.01/MMBtu. This is attributed to increased consumer need, a decline in domestic natural gas production, and sub-par inventories stockpiled as the weather becomes increasingly cold.

According to the EIA, the price of natural gas is influenced by a multitude of factors. These include supply and demand, production, storage levels, imports and exports, seasonality, the state of the economy and the availability of other fossil fuels.

For example, looking at hurricanes and seasonality in 2001, 25 percent of “dry natural gas” was produced in the Gulf of Mexico; however, only 2 percent was produced there in 2020. Cold weather also can impact prices due to slowing production – and if it’s coupled with increased demand, it can similarly increase natural gas prices.

Power generation creates additional need for air conditioning and power. With natural gas used for power generation, and if there’s increased demand coupled with limited inventories, trading on the cash market could see significantly higher prices than normal.

The Federal Reserve Bank of San Francisco (FRBSF) saw how higher prices of natural gas impacted individuals and businesses in its Federal District. The agricultural sector used it for greenhouse temperature control, using mechanical equipment to prepare crops for the market. It led to some farmers halting their operations due to unprofitability.

Consumers in the nation’s West use natural gas as their chief source for warming homes. During 1999 and 2000, the FRBSF explained that it wasn’t uncommon for the price to increase by 60 percent or even double.

Considerations for the Stock Market

With the price of natural gas projected to increase as the weather gets colder, it’ll impact businesses and consumers. Businesses will be forced to determine how much of their additional costs to absorb, impacting profit margins, and how much to pass on to consumers. For consumers, there are two considerations – they will be impacted by increases in prices of goods and services, and the likelihood of decreased consumer spending and confidence, both impacting the economy.

It’s important to understand how consumer confidence impacts spending and therefore is a good indicator of how publicly traded companies will perform on their quarterly earnings. According to the Organization for Economic Co-operation and Development (OECD), consumer confidence gives a good idea of how they’ll spend and save determined by a survey of their budget and their outlook on the overall economy. The higher the consumer’s confidence, the more likely they are to spend and save less.

With production low and supply availability uncertain globally, depending on how hard consumers are hit in the wallet, price fluctuations of natural gas will impact consumers accordingly – and in-turn, that of company earnings.

Does the Fed’s Beige Book Forecast Negative Market Headwinds?

Does the Fed’s Beige Book Forecast Negative Market Headwinds?

According to the Sept. 8, 2021, release of the Federal Reserve’s Beige Book, the U.S. economy is facing many headwinds.

The report found that restaurants and the travel sector saw a drop in activity. Home and auto sales were low because of fewer available houses on the market and a challenging supply of computer chips for auto makers. The same report found that although more people have found work, the level of newly created employment was mixed, despite a continuing need for more workers. Due to people quitting their jobs, people retiring, and those unable to find means of suitable childcare, the employment situation remains uncertain. With continued stressors on the economy, how will the stock market fare through the rest of 2021 and into 2022?

The Beige Book, officially known as the Summary of Commentary on Current Economic Conditions, comes out eight times throughout the year. Information collection begins six weeks before, and the report is released two weeks prior to Federal Open Market Committee (FOMC) meetings, providing an overview of the economic health of each of the 12 districts of the Federal Reserve Bank.

The Sept. 8, 2021, Beige Book Report found challenges in different sectors; however, some challenges, such as the semi-conductor shortage, were faced nationally. Based on past analysis, current sentiment reported by businesses and consumers will be confirmed or dispelled by forthcoming data.

As Northwestern University’s Medill School notes, the Beige Book is devoid of formulas, statistical analysis or industry jargon. Rather, it contains observational and comparative data derived from speaking with and sampling business owners and business analysts. In contrast to statistical data, it illuminates what business executives and consumers are worrying about.

It’s often referred to as a key gauge and is especially important because when the economy takes a downturn, the data deterioration often renders business statistics obsolete. It’s also relevant because the FOMC uses it to determine monetary policy chiefly via modifying the federal funds interest rate target. Similarly, when it comes to economic figures, it’s important to keep in mind the timeliness of such statistics because they are announced after they’ve been recorded.

During the coronavirus pandemic, especially when little was known in the beginning, the Beige Book offered Fed officials the ability to speak with industry insiders in the thick of it, especially when data was scant or unknown. Others observe that the Beige Book predicted the 2008/2009 housing crisis starting in October 2006 when mortgage delinquencies began appearing.

By viewing events in real-time, it offers anecdotal evidence compared to questionable forecasts. For example, the July 18, 2018, Beige Book Report found that well before the data confirmed manufacturers’ worries over the trade war with China and Trump’s tariffs, 10 districts reported “moderate economic growth.”

According to a 2003 study performed by Occidental College and the Federal Reserve Bank of Atlanta, the more confidence-inspiring news a Beige Book Report contains, the greater the correlation with higher interest rates, especially when it comes to long-term rates. It also expresses a bullish correlation with increases in stock prices when the economy is growing, but a deceleration during an economic slowdown. When banks set their lending rates, they directly or indirectly use long-term rates as reference. Policy makers also use this as an indicator for inflation expectations in the financial markets.

While no one has a crystal ball to predict how the economy and stock markets will perform going forward, the Beige Book is an important tool the Fed and those in the government factor in when attempting to steer economic growth.

Are Retail Reports a Sign of a Slowing Recovery?

Are Retail Reports a Sign of a Slowing Recovery?

Are Retail Reports a Sign of a Slowing Recovery?As the U.S. Census Bureau reported on Aug. 17, retail sales fell by 1.1 percent during July compared to the revised June retail sales figures. This is in contrast to an increase of 20.6 percent between May and July and a 15.8 percent increase for the year-over-year comparison to 2020 for the month of July alone.

The National Bureau of Statistics of China released retail sales figures for July on a year-over-year basis. The agency reported an increase of 8.5 percent for the month, missing the 11.5 percent growth target that many predicted, and lower than the 12.1 percent growth in June. The decrease was attributed to the resurgence of COVID-19.

According to the Centers for Disease Control and Prevention, as of Aug. 22, 73 percent of adults in America have received at least one dose of a COVID-19 vaccination (62.4 percent or 170.8 million adults are fully vaccinated). However, the distribution is uneven, portending the increase in infections, hospitalizations, and loss of life due to COVID-19, especially the Delta variant that is infecting both the unvaccinated and a low percent of the vaccinated. The Kaiser Family Foundation notes that African Americans and Hispanics who are 18 and older make up a significant portion (41 percent) of individuals who are unvaccinated but contemplating whether or not to get the vaccine.

A recent McKinsey & Company study found that if 195 million Americans age 12 and older got the COVID-19 vaccine, which would bring the vaccinated level to 70 percent, this would increase the chances for a more robust economic recovery. The study observed that a successful, broad-based COVID-19 immunization push for the public would speed the recovery by three to six months. This would bring the economy to 2019 levels and generate an additional $800 billion to $1.1 trillion in economic growth.

According to an Aug. 3 publication from The National Retail Federation, the economy’s continued recovery is contingent upon combating increasing COVID-19 infections as retail buyers are concerned about new variants. Even though the Delta variant hasn’t changed individual and retail buyer habits yet, it is negatively impacting their outlook going forward. While inflation is expected to moderate over the next 12 months, a June 2021 University of Michigan survey found that retail shoppers see inflation rising by 4.8 percent.

The Conference Board Consumer Confidence Index takes a broad measure of the economy and the generally expected course of future commercial events. It documents how retail buyers see the economy going forward, what they are likely to purchase in the future, how they will pursue leisure activities, how they see their cost-of-living impacted, the performance of equities, and how interest rates will perform going forward.

The July 2021 Consumer Confidence Survey reported an index of 129.7, slightly above June’s reading of 128.9. As the Conference Board elaborates on this reading, numbers indicate that consumers are still expecting to purchase durable consumer goods.

With mixed economic data and the rate of people opting to take the COVID-19 vaccine in flux, the more people who become fully vaccinated the more likely a full economic recovery will occur, including in the retail sector. 

Will Increasing Oil Prices Put a Ceiling on Global Economic Growth?

Will Increasing Oil Prices Put a Ceiling on Global Economic Growth?

Increasing Oil Prices According to the U.S. Energy Information Administration’s Short-Term Energy Outlook, the June price of $73 per barrel for Brent Crude Oil was up by $5 per barrel over May. With more vaccinations being rolled out, uncertainty over OPEC+’s production moves, and a reduction in worldwide oil availability, the outlook for oil prices seems upward. If the price of energy – especially oil – keeps increasing, will it halt the improving economy in its tracks?

As part of the commodity boom, crude oil is not immune from the rapid rise, creating an increase in inflation that’s subject to contention of being “transitory” or longer-term. Based on the World Bank’s semi-annual Commodity Markets Outlook, the positive price of crude oil is expected to remain at present levels through 2021.

The price of energy is projected to be, according to The World Bank, about 33 percent more in 2021 compared to 2020, when oil averaged $56 per barrel. In fact, The World Bank explained that crude oil is not the only commodity expected to increase in cost, and attributed it to the recovery from the COVID-19 pandemic.

With more economies coming online, fossil fuels experiencing greater demand, and OPEC+ maintaining production cuts, The World Bank projects the price of crude oil to average $60 per barrel in 2022. One noteworthy factor is that although present levels of demand for gas and diesel are nearly at pre-pandemic levels, jet fuel demand is still lacking since air travel is not back to pre-pandemic levels.

However, The World Bank sees lower crude prices in these situations: the pandemic wears on longer than projected; there’s a major change in U.S. shale production; OPEC+ changes its production agreement; or if some combination of these three factors impacts crude oil demand.

U.S. Shale

One noteworthy statistic the International Monetary Fund (IMF) points out regarding U.S. shale production is that before the COVID-19 pandemic, shale oil output reached 2 million barrels annually, versus present-day production of approximately 500,000 barrels. While the Biden Administration has banned drilling on federal land, this shouldn’t impact shale production much. However, it signals a bigger approach with the administration’s statements on green energy.

Based on statistics from the U.S. Energy Information Administration’s (EIA) Drilling Productivity Reports, different regions show changes in oil rig production from July 2020 to July 2021. There’s been an uneven recovery over the 12-month period.

In July 2020, the following regions reported the following regarding oil rig production: Bakken at 1,385, Anadarko at 1,001, the Permian at 824, and Niobrara at 1,460. Looking one year later to July 2021, Bakken hit 2,400, with Anadarko dropping to 993, Permian increasing to 1,234, and Niobrara growing to 1,919.

Factoring in OPEC+

On July 18, OPEC+ agreed to phase out production cuts of 5.8 million barrels per day by September 2022, in response to higher prices. With Brent Crude Oil rising 43 percent between the start of 2021 and mid-July 2021, oil is forecast to hit $80 per barrel during the back half of 2021. They will therefore begin to increase oil supply at a rate of 400,000 barrels per day on a monthly basis, which will eventually reduce prices again.

Unknown Variables

Additional unknowns to the price of crude oil and the economy include projected actions by The Federal Reserve. If The Fed increases interest rates, it increases the strength of the U.S. dollar and decreases the strength of a foreign currency. This, in turn, lowers the cost of oil for U.S. dollar purchases and increases costs in foreign exchange, providing mixed demand for fossil fuel demand.

Another variable, according to the Federal Reserve Bank of Kansas City, is that 16 percent of U.S. white-collar workers are expected to work from home at least twice a week. If the Delta variant increases work from home and overall lockdowns, it could also depress oil demand.

With many unknown variables still present with the COVID-19 pandemic and the impact to commodity prices, including crude oil, the economy at-large will remain touch and go until the globe gets the Coronavirus crisis under control.