Fed to Chart the Course Ahead in First Policy Meeting of 2022

Markets finished the prior week in negative territory and extended a January cold streak, as investors eyed bond markets and priced in tapering along with prospects for several rate hikes from the Federal Reserve in 2022. Increasing tensions on the Ukrainian border and the potential U.S./NATO response to Russian troop build-ups added an additional variable to consider.

It’s Federal Reserve policy week, and Fed Chairman Jerome Powell will deliver the committee’s views on the economy and the bank’s plans for 2022 on Wednesday afternoon. You can bet markets will be watching that one closely.

We fully anticipated a jerkier ride in 2022 compared to 2021 given the volume of near-term uncertainty about omicron, inflation, the global economy and the central bank policies here and abroad. There were bound to be growing pains as the Fed weans the U.S. economy off its prescription of pandemic-driven stimulus so it can stand on its own. In that sense, we aren’t embarking on a “new” policy regime; we’re simply getting closer to “neutral” Fed policy that neither aids nor inhibits economic growth. Amid this backdrop, we expect solid earnings growth (though not to 2021’s stellar levels) amid a still accommodative backdrop. That shapes up for a year when markets can reasonably still climb higher, though there may be a few more hills and valleys along the way.

Selling that was initially concentrated in so-called “meme” stocks and high-growth names has expanded into the broader market. The American Association of Individual Investors Survey (AAII) weekly sentiment survey last week showed that only 21 percent of respondents were bullish. That’s well below the long-term average of nearly 38 percent and has only been this low 59 times out of 1777 reports since 1987. While the number may not look good on its face, sentiment is very often a contrarian indicator.

Cyclical sectors like energy and financials have been more resilient. We expect the selling pressure in markets will fade as economic growth and rising optimism will provide fuel for these segments to push the market higher.

Now, let’s get to the week that was and the week ahead.

Wall Street wrap

Leading Economic Indicators Up: The U.S. leading economic indicators index rose 0.8 percent in December, a sign of steady growth despite a difficult environment. The LEI is a weighted benchmark of 10 variables that’s designed to signal the ups and downs in the business cycle. December’s gain puts the six-month annualized growth rate up 8.1 percent. One thing to keep in mind is that market recessions and corrections don’t always coincide with economic recessions. Given the LEI read, there are no red flags signaling macroeconomic trouble. Remember, markets can correct even if the underlying economy is in pretty good shape. The good news is our research shows market pullbacks tend to be less severe and shorter in duration when they aren’t coincident with an economic recession.

U.S. Corporate Earnings Roundup: Quarterly earnings season kicked off recently, and 64 of 500 companies have reported. Roughly three of four companies that reported beat earnings estimates — and by an aggregate average of 8.4 percent. Northwestern Mutual Senior Portfolio Manager Matt Stucky shares a few more highlights:

• Roughly half of financial services companies have now reported, and we’re watching the sector with interest given these companies sit at the crossroads of several macroeconomic forces, such as interest rates, credit trends, inflation, economic growth and loan demand. Lending remains strong, deposits are growing, and credit is performing well across the board. Interest rates and inflation were the hot topics on earnings calls.
• Goldman Sachs CEO David Solomon said, “There is real wage inflation everywhere in the economy,” during an analyst call. JP Morgan CEO Jamie Dimon told analysts they would remain competitive in pay, even “if that squeezes margins a little bit for shareholders; so be it.”
• Word from UnitedHealthcare is that 75 percent of hospitals are facing labor shortages, which is putting pressure on procedures and pricing for staff, though the company is forecasting above-industry growth rates on the year. The current spike in cases is having an impact on hospital visits, which means lower utilization rates.
• Supply chain issues and labor shortages dented topline growth at medical robotics maker Intuitive Surgical, and the company forecast elevating costs.

We’ll have more in the coming weeks as earnings roll in.

China Cutting Rates to Boost Its Economy: While the Federal Reserve in the United States is embarking on a journey to taper bond purchases and raise interest rates, The People’s Bank of China is heading in the other direction. The central bank last week lowered its benchmark rate to counteract slowing economic growth in the world’s second-largest economy. The economy there has been weighed down by sluggish real estate markets, with property giant Evergrande serving as the industry poster child. Strict enforcement of COVID-19 containment measures has also caused shutdowns that particularly impacted the shipping sector. The efforts to lower rates could bring down the cost of purchasing properties and rekindle demand in the housing sector.

The Communist Party’s Politburo has placed economic “stability” as its top priority for the country in 2022, so it’ll be interesting to see the monetary policies that are deemed necessary to achieve it.

Eyeing the Supply Chain: Moody’s U.S. Supply-Chain Stress Index showed a slight decline in November, down to 134.3 from 135.8 the month prior (anything above 100 indicates more stressed than pre-pandemic levels). Though omicron leads to less severe infections, it has caused cases to soar, as it is more virulent. Self-isolating worker absences in the shipping industry are stretching already bare-bones crews in many cases. Indeed, the U.S. Census Bureau estimated 9 million people missed work between Dec. 29 and Jan. 10. Keep in mind, the Baltic Dry Index (one proxy for the price companies pay to ship goods) has fallen substantially from highs set in summer. If omicron cases are indeed nearing a peak and people return to work, that could serve the needed boost to keep massaging stress out of supply chains and pull inflation lower.

The week ahead

Markets will have plenty to chew on during a packed week. In addition to the key data below, the notable earnings for the week include: Apple, Lockheed Martin, Verizon, Microsoft, Capital One, Johnson & Johnson, Abbott Labs, Boeing, ServiceNow, Tesla, KLA Corp, McDonald’s, Valero, Danaher and Visa.

• Monday: The IHS Markit manufacturing and service PMIs for January opens the week. These dual reads are great ways to gauge broader growth trends, but the reports will also provide our most up-to-date glimpse into producer prices, labor pressures, inventory levels and more — all pertinent to the push and pull between inflation and interest rates.
• Tuesday: A read on home prices in November won’t capture the recent activity in the bond market and, by proxy, the mortgage market. But this might be worth watching more closely going forward: Will rising mortgage rates (still at historic lows) impact consumers’ desire to buy a home? Another view on consumer budget outlooks, the consumer confidence index, will also hit newswires in the morning.
• Wednesday: The Federal Reserve meeting and comments from Chairman Powell are the focus today.
• Thursday: Durable goods orders is a standout here. Inflation is being driven, in part, by a sharp increase in durable goods spending that’s driven prices several percentage points higher following more than a decade of flat, even deflationary conditions. One thing we’re looking for as 2022 progresses is for durable goods spending to decelerate and fall back closer to its long-term trendline. Initial jobless claims, GDP and pending home sales are also notable reports today.
• Friday: The week finishes strong with PCE inflation and core PCE inflation indexes for December. These are the Fed’s preferred inflationary benchmarks and will be a point of discussion through the trading day. Consumer spending, the employment cost index and consumer spending are also notables.

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