The Fed Finally Fights Inflation

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The Fed Finally Fights Inflation
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In his Daily Market Notes report to investors, while commenting on inflation, Louis Navellier wrote:

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Q3 2021 hedge fund letters, conferences and more

After A Tough Year, Odey Asset Management Finishes 2021 On A High

For much of the past decade, Crispin Odey has been waiting for inflation to rear its ugly head. The fund manager has been positioned to take advantage of rising prices in his flagship hedge fund, the Odey European Fund, and has been trying to warn his investors about the risks of inflation through his annual Read More

Markets are manic crowds and like to panic from time to time. However, our survey this week shows that only 27% of retail investors believe the Omicron variant will cause a market sell off by the end of the year.

Consumer Confidence Down

Viruses mutate and tend to become less deadly over time, just like the Spanish Flu fizzled out within a couple of years.  Although Dr. Anthony Fauci said the U.S. should be prepared to do “anything and everything” to fight the Covid-19 Omicron variant, he also added that it is “too early to say” whether we need new lockdowns or mandates.  However, it would be political suicide to impose new domestic lockdowns or mandates, so I do not expect fears over the Covid-19 Omicron variant to impact consumer confidence and spending. 

Although Black Friday sales were reported to be down 28% compared to last year, the Black Friday sales this year started early, so I still expect this holiday shopping season is shaping up to set all-time records.  As an example, Commerce Department reported personal income rose 0.5% in October, while consumer spending rose 1.3%.  The personal savings rate declined to 7.3% in October.  Anytime consumers are willing to incur debt bodes well for both consumer confidence and holiday spending.  I should add that the Atlanta Fed is now estimating 8.6% annual GDP growth for the fourth quarter, which will largely be driven by robust consumer spending.

The manufacturing sector also remains strong.  As an example, the Commerce Department announced that durable goods orders rose 0.5% in October.  Durable goods have risen for 15 of the past 18 months since the April 2020 pandemic low.  Core capital goods rose 0.6% in October as business spending rebuilding inventories and consumer spending remained strong.  Year to date, durable goods orders have risen 22.1%, but shipments have risen 13.1%, so businesses continue to have robust order backlogs that have been complicated by component and part shortages.

When both consumers and businesses are healthy, it is effectively acting as a “one-two” punch to propel the U.S. economy and the stock market dramatically higher.  The Fed remains dovish and although the monthly quantitative easing has been curtailed from $120 billion per month to $105 billion, the decrease in quantitative easing was lower than many economists anticipated.  Furthermore, Fed Chairman Jerome Powell was reappointed for a second four-year term, so the Fed is expected to remain dovish.

As a result, the “Goldilocks” environment of low-interest rates and persistent quantitative easing persists.  The Wall Street Journal had a fascinating article about Modern Monetary Theory (MMT) and how deficit-financed governments, including the U.S., have gone beyond the point of no return without any “fear of debt.”  The fact that all the money pumping in recent years has not driven interest rates significantly higher has lured politicians into compliancy and put many central bankers in a corner where they cannot raise key interest rates too much.

As an example that there is no government fear of debt, the infrastructure bill that passed the House of Representatives and is expected to be extensively modified by Senate in 2022, will be largely financed by more MMT, since hiking taxes in an election year is political suicide.  This essentially means that the Biden Administration will be putting more pressure on the Fed to continue its quantitative easing and money printing so it can continue to boost the federal government’s spending.

Strong USD

The other “force” helping to keep Treasury bonds low is a strong U.S. dollar.  Since late June, the WSJ Dollar index has appreciated almost 6% against major currencies.  The primary reason the U.S. dollar is rallying is due to higher government bond yields than Japan and Europe, plus a strong economic outlook.  Eventually, a stronger U.S. dollar helps to lower the prices on most important goods as well as commodities (since they are priced in U.S. dollars).  So the Fed’s argument that inflation is “transitory” has some merit, since a strong U.S. dollar will help to push down the prices of imported goods and some commodities.

In the meantime, the fear of the Covid-19 Omicron variant and reduced international travel has pushed crude oil prices below $70 per barrel.  Natural gas prices are much more dependent on winter weather, since a cold winter can cause natural gas prices to surge, so energy inflation may persist a bit longer.  The good news is most of our inflation is related to food (high natural gas prices impact fertilizer costs), energy and used vehicle prices (due to the shortage of new cars due to the semiconductor chip shortage).  So much of this inflation is expected to eventually moderate by late 2022.

The National Association of Realtors this week announced that existing home sales rose 7.5% in October compared to September.  In the past 12 months, existing home sales have declined 1.4%.  Mortgage rates have risen to an average of 3.22% at the end of October according to Mortgage News Daily. There are only 1.25 million homes for sale, which represents a 2.4-month inventory at the current sales pace.  Median home prices are expected to continue to rise due to tight inventories and continued low mortgage rates.

The Conference Board on Tuesday announced that its consumer confidence index declined a bit to 109.5 in November.  The present situation component declined to 142.5, while the expectations component fell to 87.6.  This drop in consumer confidence is very minor and consumers were likely perturbed by the prices at the pump and other inflation that is finally starting to moderate as crude oil prices decline on the Covid-19 Omicron fear.

Fed Finally Fights Inflation

ADP reported on Wednesday that private payrolls rose by 534,000 in November.  I should add that economists are expecting that the Labor Department will be reporting 548,000 new November payroll jobs on Friday.  The labor force participation rate and average hourly wages will be closely scrutinized.  Clearly, everyone that wants a job can get a job in the currently ultra-tight labor market, so I hope the Fed concludes that its unemployment mandate has been fulfilled.

Speaking of the Fed, Chairman Jerome Powell, who was just reappointed for a second term, before the Senate Banking Committee on Tuesday admitted that “The risk of higher inflation has increased.”  Furthermore, Powell also said “To get back to the kind of great labor market we had before the pandemic, we’re going to need … price stability,” then concluded by saying “To get back to the kind of great labor market we had before the pandemic, we’re going to need … price stability.”  Translated from Fedspeak, Chairman Powell basically admitted that the Fed is finally getting ready to pivot from its unemployment mandate to its inflation mandate.

Chairman Powell also hinted that the Fed may further reduce its quantitative easing by saying “The economy is very strong and inflationary pressures are high, and it is therefore appropriate in my view to consider wrapping up the taper of our asset purchases … perhaps a few months sooner.”  So the Fed Chairman is starting to lay the groundwork for fighting inflation in the New Year.  Amazingly, the 10-year Treasury bond yield fell below 1.5% as the Fed Chairman spoke in front of the Senate Banking Committee.

The Institute of Supply Management (ISM) on Wednesday announced that its manufacturing index rose to 61.1 in November.  The new orders component rose to 61.5, while the production component surged to 62.2.  The backlog of orders component slipped to 61.9 in November, which is still very healthy since any reading over 50 signals an expansion.  Overall, 13 of the 15 industries that ISM surveyed expanded in November and the manufacturing sector remains very healthy.

Heard & Notable

Canada taps into its strategic reserves to deal with a massive shortage of maple syrup. Worldwide demand jumped 21% prompting The Canadian group Quebec Maple Syrup Producers to release about 50 million pounds of its strategic maple syrup reserves — about half of the total stockpile. Source: NPR

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