Image Source: Pixabay

Week in Review

February 7- 13

A question for movie fans: Which is scarier, a hockey-mask-wearing and machete-wielding Jason Vorhees standing in front of you, or that same Jason hiding somewhere off-camera in a barn?

If you’re like me, the hiding-in-a-barn Jason is WAY scarier. After all, the best filmmakers know that suspense is a far more effective tool than simple fear alone – movie franchises like “Friday the 13^th” are built on it, and some fiction writers (looking at you, Stephen King) have made their entire fortunes based on skillful repetition of the premise.

Markets had to manage their own version of that dynamic last Thursday when St. Louis Fed President (and FOMC voter) James Bullard, in the wake of a breathtakingly high CPI print^[1],  told Bloomberg News that he hoped to have at least 100 basis points of tightening in the pipes before July^[2]. That was scary enough for markets because it formally introduced the concept of a 50-basis point increase in the Federal Funds rate at some point between now and next summer.

But markets probably weren’t too shocked by that idea: let’s start with the idea that Bullard is a self-avowed “hawk” on rates, meaning his comments weren’t all that far out of character. Moreover, futures traders were already starting to bet that the Fed might push rates a half a point higher at their next scheduled meeting even before The Big Bullard had his interview with Bloomberg. That bet has now become consensus, with the odds of a 50-basis point hike at the March 16^th meeting now approaching 70.^[3]

That’s the standing-in-front-of-you-with-a-machete version of Jason, and markets were understandably unnerved by it. Stocks sold off moderately, with the S&P 500 Index down 1.8% on Thursday and another 1.9% on Friday. For their part, bonds reacted with a big sell-down on Thursday that sent 10-year yields above 2% for the first time in a long while and 2-year yields skyrocketing by a full quarter-point before Friday’s Ukraine-based worries allowed Treasuries at both maturities to recover some of that lost ground, sending yields back toward earth for a softer landing.

But far more frightening for moviegoers who were paying attention was something else that Bullard said in the same interview: “You’ve got the highest inflation in 40 years and I think we’re going to have to be far more nimble and reactive…(t)here was a time when the committee would have reacted to something like this (by) having a meeting right now and doing 25 basis points right now^[4].”

That’s the hiding-in-a-barn version of Jason Vorhees, and maybe markets should be more unnerved by it than they seem to be. Here’s what I mean: the phrase “nimble and reactive,” followed shortly thereafter by “…having a meeting right now…” seems to suggest that at least one voting member of the FOMC – the already hawkish but now apparently even more so James Bullard – is advocating for a potential intra-meeting hike in rates. That introduces a whole new level of terror that markets might not be ready for.

The Fed has used intra-meeting changes in rates before, and indeed even seems to place a real value on the “shock-and-awe” value that they can provide, seeming to admit that a shift in Fed policy is naturally more effective when it’s entirely unexpected. But the Fed has been far more likely to use such shock-and-awe tactics to loosen policy than to tighten it, having done so in response to the mortgage crisis (2008), the collapse of Bear Stearns (also 2008,) and the 9/11 attacks (2001.) So while it’s probably unfair to describe the intra-meeting tightening move that Bullard seemed to hint at as within the realm of possibility as “experimental,” it might be safe to describe it as, uh, “mostly untested” or something similarly vague. (Notable, too, is that these intra-meeting moves have all been in excess of the 25 basis point moves that have become the Fed’s default move in rates.)

So from at least one perspective, the reaction to Bullard’s comments on Thursday was, if anything, perhaps a little muted. If Jason really is hiding in the Barn, we seem only to be waiting for the scary music to start.

Thankfully for those of us who comment publicly on markets, James Bullard, Vladimir Putin, and the Los Angeles Rams provided plenty of drama last week. Good thing, too, because without them, there wasn’t much else was for us to write about: earnings season is starting to wind down and the list of planned economic releases was pretty slim. That said, here are some highlights.

First, on earnings, inflation was very much in focus when consumer staples companies like Coca-Cola, PepsiCo, Kellogg’s, and Philip Morris reported earnings last week. Results were fine, with three of the four beating estimates and one (Pepsi) more or less meeting them^[5]. What was perhaps more interesting, though, was that each had something less-than-encouraging to say about inflation, collectively pointing out that they expected inflation to continue to rage for at least another quarter or two. But a bigger deal may be that to a differing extent, they each expect their own customers to begin losing patience with the price increases the companies themselves have had to implement in order to deal with it. This is where the inflation debate moves out of the realm of policy debate and into the mainstream, and it might signal trouble ahead for consumer demand.

Not that that would be an entirely unwelcome development. One of the clever things about the modern economy is that it tends to be self-regulating: in the case of inflation, runaway prices sometimes resolve all by themselves when demand cools in response to those same rising prices, slaying the inflation beast before it gets too out-of-control. On the other hand, there is always the possibility that such an adjustment to demand might overshoot, sending the economy into a premature contraction or even recession. (And, at the other end of the spectrum, there is still always the threat of the emergence of a wage-price spiral that throws the whole thing into hyperdrive.)

In my view, threading that needle between cooling demand and runaway prices without tipping the economy into recession will be key to the economic outlook for the remainder of 2022. Of course, you could do much worse than consumer sentiment data like that compiled by the University of Michigan for a read into how things are going. And last week’s mid-month update from the most famous survey-takers in the consumer-survey universe was almost precisely on-point: The UofM’s index is now signaling “the onset of a sustained downturn in consumer spending,^[6]” which would of course raise a yellow flag over the beach for those on the lookout for recession.

But on the other hand, the UofM release also pointed out that the post-COVID environment is unlike any other, with unspent stimulus funds and fewer ways to spend that largesse still swelling consumers’ bank accounts, while hyper-partisan views distort the survey results. That, together with the fact that consumers aren’t always very good at seeing economic downturns before they happen creates enough uncertainty and hope to suggest that yes, this time might be different. But it’s still notable that the UofM’s numbers are now below levels that signaled the onset and depths of 2001, 1990, 1982, and 1974 recessions.

Food for thought, moviegoers…

What to Watch This Week

February 14– 20

Notable economic events (February 14-18)

Monday: No planned economic releases

Tuesday: PPI release, Empire State Manufacturing; earnings: WYNN,

Wednesday: Fed minutes, retail sales, industrial production, NAHB builder survey; earnings: AMAT, CSCO, R

Thursday: Housing starts/permits, Philly Fed, weekly jobless claims; earnings: WMT

Friday: Existing home sales, Leading economic indicators; earnings: DE

The political backbeat continues, with Ukraine tensions likely to continue their bid to replace COVID as the external threat du jour for markets. It’s, of course, impossible to know how markets might react to a sudden escalation in Ukraine, but ironically it might have at least one “benefit” (if an armed conflict can ever be said to have any “benefit” at all…) in that it might take some of the steam out of the more hawkish arguments now being made about rates, such as James Bullard’s comments last Thursday that we spent so much time discussing above.

The logic runs like this: if Ukraine tensions escalate, that would inevitably inject even more uncertainty into an already iffy economic outlook. The Fed, recognizing this uncertainty, might therefore be more willing to pull its punches and avoid doing anything rash like bumping rates by 50 basis points, or between scheduled meetings. So while the impact of, say, of Russia crossing the border with tanks and troops would itself almost certainly not be very positive for market sentiment, there might also be a small silver lining from the market’s perspective in that it might derail (or at least slow down) some of the best arguments for an even more aggressive Fed stance, which might limit the damage such a border-crossing might otherwise do to markets. I guess that’s just a sign of how crazy the times in which we live have become.

Whether or not this pure hypothetical represents a cogent view or a twisted fever-dream might be made more clear on Wednesday when the Federal Reserve releases the minutes from its January 26 meeting. While the Ukraine crisis first captured the market’s attention as early as November of last year, the Fed’s statement after its late January meeting made no explicit mention of it (or even an acknowledgment of geopolitical tensions^[7].) That said, the Fed minutes always include a detailed analysis of the Fed staff views on a wide range of issues, and any mention of rising geopolitical tensions might give a hint into how Fed policy might adjust to a Russian invasion of Ukraine.

On to the more mundane. This week’s biggest event from a scheduled release point of view will probably be Tuesday’s PPI release. Last week’s CPI data was eye-opening bad, at 7.5% year-over-year on the headline^[8], but it also wasn’t all that unexpected. This week’s PPI data could be just as striking, with some economists even expecting prices at the producer level to have expanded by 10% or more on a year-over-year basis. Others are expecting it to begin a long decline back to normal, however, and that perspective – whether the trend in prices is accelerating, plateauing or decelerating – is what markets will likely be most interested in.

Beyond PPI, the next-most interesting data will likely be our first two regional Fed manufacturing reports, Empire State on Tuesday and Philly Fed on Thursday. If, as I suspect, the market narrative will soon shift from “how high is inflation?” to “how much is economic activity cooling?” then reports like the regional feds will become even more interesting.

In a similar vein, Wednesday’s retail sales numbers might also provide insight. As last week’s earnings reports and UofM confidence data both suggested, consumers are on the verge of becoming fed up with rising prices and may continue to scale back buying activity even with all that unused stimulus cash still sloshing around in their wallets. You might remember that December’s retail sales report, released almost exactly a month ago, was a wide disappointment. A repeat performance might raise a few eyebrows.

Finally, this week will bring us our first installment of monthly housing data, with the NAHB builder survey on Wednesday, starts and permits data on Thursday, and existing home sales on Friday. While there isn’t much controversy in these numbers (it almost universally recognized that housing markets are taking a breather for now), another component of consumer wealth that might make a contraction (or recession) less likely in coming months is all the home equity that the average US homeowner now holds. If housing markets soften too much, that could place all that equity at risk and further damage consumer sentiment.

[1] https://www.bls.gov/news.release/pdf/cpi.pdf

[2] Bloomberg, 2/10/22

[3] CME.com

[4] Ibid.

[5] Company reports, Zacks.com, Bloomberg

[6] http://www.sca.isr.umich.edu/

[7] https://www.federalreserve.gov/monetarypolicy/files/monetary20220126a1.pdf

[8] https://www.bls.gov/news.release/pdf/cpi.pdf