Welcome to the first weekly macroeconomic round-up of the new year, where we spotlight a few of the most significant events in the last few weeks.
The latest (December 2021) minutes from the Federal Open Markets Committee emphasise the need for imminent policy tightening, including tapering to reverse quantitative easing later this year. Some committee members suggested an imminent need for balance sheet shrinkage.
Observations from committee members included broad agreement that the Federal Reserve (Fed) should start reducing its balance sheet soon after its next interest rate rise, which is expected in the first half of 2022. Some committee members observed that the strength of the economic recovery to date should permit a faster rate of shrinkage than during the previous cycle. At present, the Fed is on course to wind down its quantitative easing programme by mid-2022.
This was a significant hawkish surprise for the markets, which had anticipated a pause between the end of tapering and the start of balance sheet shrinkage. Expectations for US interest rate hikes increased materially, with a knock-on effect on US sovereign fixed income yields. The US 10-year interest rate increased by the most in a week since the beginning of the pandemic, jumping from 1.51% to 1.80%. This represents a new post-pandemic high.
European inflation rises to fresh all time high
Economists had expected a slowdown in European price pressures, but Eurozone inflation continued to rise, moving from 4.9% in November to 5.0% in December. Energy inflation moderated from 27.5% to 26.0% over the past 12 months but this was more than offset by higher prices for unprocessed food, which rose from 1.9% to 4.6%. After stripping out volatile elements such as food and energy, core inflation was unchanged at 2.6%. With inflation still well above its 2% target, the ECB will remain under pressure to tighten policy.
US labour activity slows as Omicron weighs on confidence
US employers added only 199,000 jobs in December as news of the Omicron variant caused some to put hiring on hold. This was substantially lower than the 444,000 jobs expected by economists and a slowdown from November’s addition of 249,000 jobs. This brings the overall unemployment rate down from 4.2% to 3.9%, despite the fact that there are still 3.6m fewer jobs than at the start of the pandemic.
The shortfall is accounted for by a lower labour participation rate, with many of those who left work in 2020 electing to retire or find ways of earning income outside of the traditional labour force. For the Fed, unemployment below 4% equates to full employment, which is one of the central bank’s preconditions to start policy tightening.
Supply chain blockages may be clearing
In more positive news, there was some evidence that the blockages and disruption in supply chains that roiled US manufacturing firms for much of 2021 may now finally be clearing.
The ISM manufacturing survey showed that prices paid for factory inputs by US manufacturers fell by the most in over a decade. It was also encouraging that survey respondents noted improvements in performance by suppliers and an increase in on-time deliveries.
Market review - Higher yields prompt rotation towards value stocks
The surprisingly hawkish tone from the Fed dominated market movements last week, with the US 10-Year Treasury yield rising briefly to above 1.8% for the first time since the start of the pandemic. The dramatic increase in US yields triggered a rotation in equity markets away from technology and into shorter-duration assets such as value stocks. The domestic US equity market ended the week down 2.5% as measured by the S&P 500 index. Energy and financials companies outperformed other sectors.
Look out for next week’s update, where we’ll be focusing on the US inflation, China inflation and UK growth.
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