Renewed Virus Fears and Other Market Concerns

Fears of the Omicron virus variant pulled ahead and telescoped the stock market decline that risked unfolding in H1 of December in anticipation of faster Fed tapering at the December 14-15 FOMC Meeting.   The markets' reactions may have been overdone on Friday, however, since news reports say /1/ drug companies are already testing vaccines against the new virus and /2/ the symptoms seem to be mild for vaccinated/healthy people.  But, if these mitigating factors are seen as significant, a decision to speed up tapering at the December meeting can reassert itself as a downside risk.  So, the stock market could stay under pressure until then, particularly given expectations of strong November Employment and CPI reports and the need to raise the debt ceiling.

At this point, because of the emergence of the Omicron virus, the probability of an increase in Fed tapering at the next meeting has receded.  By then, the Fed may not yet have a handle on the effectiveness of vaccines against this mutation, since a sense of the latter is expected to take several weeks to develop.  Moreover, from the Fed's perspective, the mutation underscores the downside risk to the its economic forecast, mentioned in the FOMC Minutes.  Along with the sharp market reactions, this downside risk may persuade the Fed not to change the pace of tapering.   Even if the November Employment and CPI reports are strong, Fed officials could agree to be patient and wait to see what effects the Omicron virus might have and if its baseline forecast of a moderation in inflation bears out.

However, this week's testimony by Fed Chair Powell and speech by Vice Chair Clarida (both on Tuesday) will probably keep open the door for a faster pace of tapering at the December meeting.  They could mention the Omicron virus as a downside risk to the outlook, but likely balance it with the risk that inflation may not slow as quickly as desired.  A policy shift most likely needs to await a full consensus of members at the FOMC Meeting.

The drop in oil prices, nonetheless, supports an expectation of slower inflation ahead, even if some of the plunge reverses in the next week or so.  This is because the oil price drop may not fully reverse -- it could reflect more than the possibility of a renewed virus-related slowdown in global economic growth.  OPEC officials are reported saying the release of oil reserves by the US and other countries will result in a global oil glut early next year (and suggests this week's OPEC meeting will not result in any significant production increase).  Moreover, US domestic oil production continues to climb.  The Baker-Hughes Oil Rig Count rose again the latest week.  Lower oil prices will feed through to non-oil prices that are impacted by fuel costs.

Besides the possibility of continuing virus and tapering fears, fear of a debt ceiling crisis in mid December could weigh on stocks in the next few weeks.  This latter fear is typically overdone, however.  While there tends to be a lot of noise and blame out of Washington ahead of a debt ceiling deadline (December 15), an extension almost always is approved by Congress.  A short-term extension will likely be the compromise again.  A longer extension, if at all, likely will await resolution of the spending/tax bill.

This week's November Employment Report should be strong, but the consensus Payroll estimate may be too high.  Consensus looks for +550k m/m Payrolls, versus +531k in October.  Some evidence, however, such as Unemployment Claims, points to a smaller jobs increase in November than in October (although to a further decline in the Unemployment Rate, as well).   One possible reason for a larger November increase, however, is a surge in holiday-related retail, warehousing and delivery jobs.  Seasonals look to offset such increases, to be sure.  But, if they don't fully do so, a compositional shift toward lower-paid workers could push down Average Hourly Earnings below the consensus (and near-term trend) of 0.4% m/m. A low AHE print could soften the market impact of a large Payroll gain.

Stocks and The Risk of Faster Fed Tapering

The stock market should be supported this week by President Biden's announcement of the next Fed Chair -- regardless of whether it will be Powell or Brainard.  Both are highly capable, and the decision would remove some uncertainty.  Also, the market tends to do well in the Thanksgiving week.

But, stocks are likely to turn cautious, if not turn down, over the first half of December on fears the Fed will decide to increase the speed of tapering at the December 14-15 FOMC Meeting.  Fed Vice Chair Clarida raised the possibility in last week's speech, making one wonder whether Biden asked both Chair candidates to do something to bring down inflation.  If that were the case, there may not be much new information regarding tapering in this week's release of the October FOMC Meeting Minutes.

The November Employment and CPI Reports (due December 3 and 10, respectively) -- risk exacerbating the market's fear of faster tapering.  The data may have to be particularly soft to persuade the Fed to stick to its announced $15 Bn per month tapering path.  This will not likely be the case.

Early evidence does point to a smaller m/m increase in Nonfarm Payrolls in November than October's +531k.  But, the pace will likely remain above trend, as the Insured Unemployment Rate so far suggests another decline in the Civilian Unemployment Rate.  If Average Hourly Earnings prints above 0.3% m/m, as it has in the past 7 months, the Fed could feel the need to respond to growth-related inflation pressures stemming from a too-tight labor market (unemployment rate below NAIRU as discussed  in last week's blog).

Both Total and Core CPI risk printing high.  Retail gasoline prices rose in November, with seasonals exacerbating the increase again.   Also, there is a risk the higher Used Car wholesale prices in September and October will show up in retail Used Car Prices in the November CPI. 

A pullback in the stock market could be short lived, however, for several reasons.  /1/ Economic growth should remain solid next year, even with a faster pace of tapering.  In part, growth could be boosted by an easing of the chip shortage and other supply disruptions.  /2/ Q421 corporate earnings, due in January, should be strong.  The Atlanta Fed model's latest estimate is +8.2% (q/q, saar) for Q421 Real GDP Growth.  /3/ Inflation may ease.  Supply-related price hikes over the past several months, such as for motor vehicles, could reverse.  Also, oil prices may fall further.  Their decline could help hold down a slew of goods and services prices.

While the increased risk of faster Fed tapering may have contributed to last week's drop in oil prices, there are fundamental reasons for the latter to continue to stay low, as well.   /1/ US Domestic oil drilling and production have begun to move up sharply.  (Perhaps the Biden Administration has quietly signaled a positive message to the industry?)  The October Industrial Production data show a 9.3% m/m jump in oil and gas drilling.   And, the Baker-Hughes Oil Rig Count rose in November after plateauing in October.  Both pieces of evidence are in line with the International Energy Agency's prediction that Non-OPEC oil production will finally make a noticeable move up in Q421, with US production accounting for a good deal of the increase.  /2/ The partial shutdowns in Europe and China also should temper increases in demand for oil in the immediate future.

Stocks Can Handle Inflation For Now

The stock market should continue to recover from last week's inflation shock be for several reasons.  /1/ The Fed is likely to remain on its gradual tapering path, which could be reiterated by some Fed speakers this week. One inflation report will not change Fed policy.  And, Powell will likely want to maintain a stable policy while Biden is deciding whom to nominate as Fed Chair.   /2/ Economic growth is strong.  Even if growth moderates ahead, which is a possibility, it would be positive for stocks by holding down inflation.  /3/ Much of the jump in the October CPI is attributable to temporary factors.  And, a main underlying culprit -- oil prices -- appears to have stabilized for now.  So, the Fed can wait and see.  Nevertheless, the inflation risk remains as long as economic growth is above trend and pushes down the Unemployment Rate.

The very high October CPI likely overstated the trend in inflation.  About half of the 0.6% m/m jump in the October Core CPI resulted from /1/ Used Car Prices (+2.5%), /2/ New Vehicle Prices (+1.4%), /3/ Medical Care Services (+0.5%) and /4/ Recreational Services (+0.8%).  The run-up in car prices should reverse once the chip shortage abates.  Medical Care Services Prices are volatile on a m/m basis.  And, the jump in Recreational Services reflected an 8% jump in Admissions to Sporting Events, which is not likely to be repeated in coming months.

In addition to the easing of temporary factors, a moderation in price inflation is conceivable considering the underlying reasons for the speedup:

 /1/ Some of the increase in inflation could be just a one-off adjustment to the re-opening of the economy -- and this factor should end soon.  The shortages and bottlenecks stemming from the speed of recovery should work themselves out in coming months. 

/2/ The pass-through of higher transportation costs -- reflecting higher fuel costs and a trucker shortage -- is likely a major reason for the run-up in food and other prices.  Oil prices rose sharply as OPEC held back production relative to demand and as the Biden Administration pushed against lifting US domestic oil/natural gas output.  The Administration may have influenced the OPEC decision, as well, by moving against Saudi Arabia in a number of ways and moving favorably toward Iran, Saudi's enemy.  The OPEC decision could have been in retaliation or a snubbing of the US.   Oil prices have stabilized at this point.  But, some Saudi officials have been reported seeing the potential for these prices to climb to $150/bbl.  Perhaps the possibility of a cold winter is behind this potential.

/3/ The extended Unemployment Benefits most likely kept some people from taking jobs, thereby pushing up wage inflation.  While the Democrats might think boosting low-paid workers' wage rates was a good result, the pass-through of these higher wages to prices undercut the real benefit -- as reflected in the drop in the University of Michigan Consumer Sentiment Index.  With the extended Unemployment Benefits expired, labor costs could moderate in coming months and hold down price inflation. 

But, the risk of higher inflation remains as long as economic growth is above trend.   At 4.6%, the Unemployment Rate already may be below the Non-Accelerating Inflation Rate of Unemployment (NAIRU) -- the level of the Unemployment Rate below which inflation accelerates steadily.  NAIRU had been estimated to be in the mid-5% range before the Trump years.  But, even if NAIRU is lower, the Fed is aiming for the Unemployment Rate to fall to the pre-pandemic low of 3.5%.  A further tightening of the labor market will likely move the Rate closer to if not below NAIRU and boost wage inflation. 

 

 

 

Stocks Should Weather This Week's Inflation Reports

The stock market's rally should not be derailed by this week's inflation reports (October PPI and CPI), even if some are higher than expected.  High inflation prints, at this point, will not deflect the Fed from its gradual approach to tapering and thus should not damage stocks significantly.   What would be a more important negative for stocks is if oil prices break out of their recent range to the upside.   The passage of the infrastructure bill should not be a problem for stocks.  The bill's impact on economic activity will not likely be seen soon, possibly at least a year from now.  So, it can be put on the back burner from a market perspective.  But, a year from now, the bill's economic boost could be a factor pushing the Fed to raise rates.

The consensus estimates of +0.6% m/m Total PPI and +0.5% Core PPI risk being too high.  The Trade Services component could be lifted again by higher gasoline prices.  But, it has slowed in the past two months.  And, it could be offset by lower airfares, as was the case in September.  Moreover, intermediate prices, which lead finished prices, have slowed in each of the past 4 months.

Consensus expects +0.6% m/m Total CPI and +0.3% Core CPI.  While the consensus estimates have a good chance of being right, there is upside risk to the Core CPI.  Owners' Equivalent Rent should remain high, as it catches up to the large increases in rents reported in the press.  Used Car prices at the wholesale level surged over the past two months and could begin to show up in the Core CPI.  But, Used Car Prices should be ignored.  They will probably fall sharply once motor vehicle production becomes unhindered by the chip shortage.  This may be happening sooner than many expect.  Ford already said that the chip shortage is becoming less of a problem in Q421.  And, the jump in motor vehicle jobs in October seems to support this possibility.

Last week's reports muddied the picture regarding Labor Costs -- the primary determinant of price inflation.  While the Q321 Employment Cost Index had broken to the upside, the two latest reports -- Compensation/Hour and Average Hourly Earnings -- did not confirm the breakout.  Compensation/Hour slowed to 2.9% (q/q, saar) in Q321 from 3.5% in Q221.  The average pace so far this year is 2.6%, which is below the pre-pandemic trend (3.7% over 2019).  Unlike the ECI, compositional shifts toward lower-paid workers could be behind the slowdown.  But, Compensation/Hour is the most comprehensive measure of labor costs, so should not be entirely dismissed.

The 0.4% m/m increase in October Average Hourly Earnings was back to the rate seen from June through August.  It suggests that while wage inflation is higher than its pre-pandemic pace, it is not snowballing.  The components were mixed relative to their recent trends and split almost equally between a speedup and slowdown from September.