Federal Reserve Chairman Jerome Powell's tone turned decidedly more hawkish this week, indicating that the Fed will be much more willing to raise interest rates faster to rein in inflation. I have been saying for some time that the pace and number of rate increases will be data-dependent in 2022; Powell confirmed that the Fed plans to be "humble and nimble," led by the incoming data and the evolving outlook.
U.S. employment data has consistently shown that we have many millions more job openings than there are unemployed people, and quit rates are rising, indicating that people feel comfortable that they can secure another job. With a tight job market and wages at decade highs, Powell said that he believes there is room to raise rates without threatening employment.
Any way you look at it, inflation is hot, not just in the U.S., where it is rising at the fastest rate since the early 1980s, but globally. In December, Eurozone inflation rose 5% year on year, but the European Central Bank is reluctant to raise interest rates. In the U.S. and globally, consumers are feeling it — at the gas pump, the supermarket, the repair shop, the vet, hotels and big-box stores.
Expectations for multiple rate increases sent the U.S. 10-year Treasury yield soaring from 1.34% in early December to a mid-January high of 1.87%. The rapid surge rattled equity investors already concerned about the omicron spike and inflation. Despite the drop in equities this month, the Fed will be driven by incoming data, not the market; current declines in no way match or surpass the gains we saw in 2021.
Though investors have many concerns right now, it's important to remember that we still have significant pent-up consumer demand. In recent weeks, J.P. Morgan Chase CEO Jamie Dimon said consumer balance sheets have never been in better shape; their debt-service ratios are the best since the bank started keeping records 50 years ago. According to Dimon, consumers have $2 trillion in more cash in their checking accounts than they had before COVID, and are spending 25% more today than before the pandemic. Dimon said he believes the U.S. is headed for the best economic growth in decades. Adding to the positive consumer picture are recent statements from airline and hotel companies about robust demand for bookings.
We're seeing a notable rotation into value and cyclicals, with many overvalued tech stocks taking it on the chin. In my portfolio, I remain focused on sectors such as financials and energy, as well as reopen names that will benefit from consumer spending, and am underweight growth — staying clear of companies that don't have real earnings growth or attractive valuations. At the same time, I'm keeping my eye out for strong companies on sale across several sectors, such as health care, tech, energy, and restaurants/reopen names.
Mixed Economic Picture
Earlier this month, the market jitters about inflation were confirmed with news that the consumer price index (CPI) rose 7% year on year in December, which was the largest 12-month increase since mid-1982. The producer price index, meanwhile, rose 9.7% year on year. Wages, too, are rising rapidly: December average hourly earnings rose 4.7% year on year.
Omicron is having an impact, which I view as temporary. Markit PMI slowed to an 18-month low, posting 50.8 in January, down from 57.0 in December. Markit reported that both manufacturing and service sectors reported broad-based slowdowns as the steep spike in omicron cases contributed to ongoing supply chain problems and labor shortages. On the bright side, demand growth remained more resilient, with new orders for goods and services rising strongly.
The latest Institute for Supply Management's Manufacturing Report on Business and Services Report on Business surveys showed that economic activity in both sectors grew for the 19th consecutive month.
All of the six biggest manufacturing industries — including chemical products, fabricated metal products, computer and electronic products, food, beverage and tobacco products, transportation equipment, and petroleum and coal products — registered moderate to strong growth in December.
