Policy changes coming
Going into this week, I knew it was going to be a doozy. There were so many market-moving things happening, and I think we’re only part-way through the chaos. Anyway, the BIG thing that happened this week was the FOMC’s first meeting of 2022. It was largely expected that the Fed was going to announcing policy measures to get inflation under control, but we were waiting to hear just how far they would be willing to go. The Fed seems ready to raise interest rates as soon as March and is likely to reduce its balance sheet.
Moral of the story: The market is expecting four interest rate hikes by the end of the year from the Fed. Even though that means the absolute policy interest rate is still going to be quite low around 1%, it’s a really meaningful step-change from where rates have been. Higher rates = lower present value of stocks. This is most impactful for high-growth (typically tech) stocks because that future growth is worth less today. This phenomenon has been playing out in the market since Thanksgiving – pick any high-growth stock and its trajectory since the end of November looks similarly dismal. The impact of the balance sheet reduction is a little more difficult to pinpoint – but at the end of the day, it means that the boatload of cheap money (the stuff that got invested into the meme stocks by everyone getting trading advice on Tik Tok) is going away. This should help inflation come back to the ground because there will be less money sloshing around in the economy.
Pleasant surprise
Another bombshell for the week was the first look at our economic growth during the fourth quarter of 2021. Economic growth came in at 6.9% for the quarter, well ahead of expectations for 5.5%. Consumer activity and business spending were the biggest contributors despite the surge in COVID cases we saw toward the end of the year, dampening hiring plans and business outputs. We posted 5.7% economic growth for the year, the strongest rate of growth since 1984.
Moral of the story: The economy seems to be on solid footing, which only adds to the narrative that supportive policy from the central bank is no longer warranted. On Friday we also got a look at December Core PCE (the Fed’s preferred inflation metric), which came in at a blustery 4.9%, the fastest again since 1983, again pointing to the need for a policy response.
Earnings so far
All the reports this week told us the economy was on solid footing but also highlighted the elevated inflation levels that are going to result in tightening policy changes (higher interest rates and less cheap money). Plus, we had a busy week of earnings season. This meant that the markets had a wild rollercoaster of a week from the information overload. The S&P 500 index posted an intraday move every day of at least 2.25%, which is slightly nauseating. So far about a third of the S&P 500 companies have reported earnings – more companies are reporting profits than average, but they’re beating expectations by a smaller margin.
Moral of the story: Despite the strong showing on earnings, the common theme of cost pressures was an issue pretty much across the board. How that manifests itself throughout the year as policy changes flow through into the economy is still tbd.