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Capital Markets Perspective brings you what to watch in the markets this week, published in partnership with Great-West Investments.
Week in Review
March 7- 13
In 1994 James Carville, political advisor to President Bill Clinton, famously quipped that when he died, he wanted to be reincarnated as the bond market because if you’re the bond market, “you can intimidate anybody.”
That statement probably needs a refresh. While the bond market remains one of the most powerful and least-understood forces in the econosphere (kind of like “dark matter” is to the world of physics, I suppose,) its immense attractive power has recently been supplanted by another dark force that is just as spooky and equally misunderstood: oil prices.
Under normal circumstances, the relationship between oil and the modern economy is maybe best described as a “weak force of nature.” Sure, there’s an obvious relationship between the two: when oil prices are high and rising, the price of doing business goes up and consumers face an implicit “tax” on consumption (a tax, incidentally, that hits consumers in lower income brackets much harder than those in higher brackets, making it the very definition of “regressive.”) That, together with other impacts too numerous to detail here, obviously reduces demand across enormous swathes of the economy, thereby creating a drag on economic growth.
But for the most part, that impact isn’t nearly as massive (or as obvious) as it once was. The amount of energy required to generate a single dollar of real GDP in the US has declined steadily and significantly for decades[1], and even though domestic oil production has declined notably since peaking at the end of 2019, today the US produces about 68% more barrels of black goo today than in 1994 when Carville gave his props to the bond market[2]. Together, these things mean that, at least under ordinary circumstances, changes in oil prices hold far less sway over our collective economic future than they once did.
Until now.
The current volatility in oil prices has hit at perhaps exactly the wrong moment. As you might have guessed, the primary mechanism through which higher oil prices are transmitted to the macroeconomy lies in how it impacts inflation. And with inflation already the highest it’s been since the early 1980s, the last thing we needed was an external shock that makes those already raging flames burn even hotter.
But even forgetting inflation for a moment, almost two years of aggressively accommodative policy (not to mention equally aggressive fiscal stimulus) has left the Federal Reserve and its international central banking peers somewhat offsides with regard to monetary policy. Even without all this inflation, the Fed and its pals around the world would probably have found it necessary to begin pulling away the punchbowl soon anyway. Said a little differently, monetary authorities today have a very high bar to clear if they might have otherwise been tempted to keep things loose to make up for the impact rising oil prices are having on consumers. That’s why market expectations for a 0.25% increase at this week’s FOMC meeting hardly budged even though oil crossed the $120/bbl mark on Wednesday before declining into the weekend.
So oil matters to markets right now. No coincidence, then, that since Russia’s invasion of Ukraine there has been a very clear link between oil prices and stock prices: when oil rises, stocks (mostly) fall; when oil falls, stocks (mostly) rise. It’s also no coincidence that the best day for stocks so far all year was last Wednesday, when oil prices suddenly dropped by around $15 bucks per barrel after the United Arab Emirates’ Ambassador to the U.S. told CNN that his country – one of a small number that reportedly has spare capacity to offer global oil markets – favored a boost in production beyond current OPEC quotas[3].
Those comments were quickly walked back by the UAE’s energy minister by the end of the day when he reconfirmed the country’s commitment to OPEC’s monthly quota-setting process[4], implying that any formal increase in OPEC production would have to wait until at least March 31, when the cartel next meets to set production schedules for its members. But from an oil price perspective, the “damage” had already been done: oil prices dropped back below $110/barrel and remain there today as I write this on Monday morning.
Markets of course liked that just fine. But if you’ve been at all paying attention, you’ll know that oil prices – and therefore market performance in the near-term – are now more or less in the hands of a small Russian dictator of questionable motives and sanity.
With oil prices and Ukraine so dominating the narrative, it’s hard for something as mundane as a consumer price index report to grab much attention (which it didn’t…) But for the record, yeah, inflation remains off-the-charts high: the CPI rose at an annualized pace of 7.9% in February[5], led by some of the biggest increases in food prices on record as well as a 6.6% rise in retail gasoline prices (and that didn’t even include the impacts of the steepest rise in oil prices, which took place after the CPI survey period was already over.) But alas, after months and months of eye-watering price increases, the fastest inflation in a generation has lost its shock value and markets hardly noticed.
But inflation continues to leave a mark on confidence, and we got two separate examples of how deep those wounds are last week when the National Federation of Independent Businesses released its monthly survey of small business confidence, and the University of Michigan announced the mid-month results of its well-respected consumer sentiment survey. Both sets of survey-takers were in a predictably sour mood, with small business owners bemoaning declining profit margins, still-tangled supply chains and slower revenue growth[6], while consumers painted themselves pessimistic about everything in the current economic environment other than the jobs market[7].
And as an added bonus the UofM economists even dared to use “the S-word” in their write-up: citing several parallels between today’s macroeconomic environment and that of the 1970s and 80s, the good professors wrote: “th(e) persistent strength in demand was a critical factor that shaped the last inflationary age from 19865-1982, with stagflation <gasp! pause for dramatic effect…> peaking only near its end.” It’s of course chilling to see the word “stagflation” used in such a credible and closely-watched report as the UofM’s consumer sentiment survey.
What to Watch This Week
March 14-20
Notable economic events (March 14-18)
Monday: No major economic releases expected
Tuesday: PPI, Empire State Manufacturing
Wednesday: Fed announcement, retail sales, NAHB builder’s sentiment
Thursday: Housing starts/permits, Philly Fed, weekly jobless claims
Friday: Existing home sales, Leading Economic Indicators
It’s Fed week.
The Federal Reserve’s Open Market Committee – the group tasked with setting the Federal Funds Rate – meets on Tuesday and releases its decision on rates Wednesday afternoon, followed by a press conference by Chairman pro tem Jerome Powell. (He temporarily wears that title because he has yet to be formally re-confirmed by the Senate.) To say that the markets expect an increase of 0.25% is an understatement: Powell all but promised as much during his semi-annual testimony in front of congress two weeks ago, and futures markets place the probability of a quarter-point increase at around 95%[8] (roughly the same odds that my NCAA tournament bracket will be busted by the middle of the second round.)
Beyond that, we’ll get another opportunity to pretend to be shocked by how fast prices are rising (Producer Prices are released on Tuesday,) as well as multiple checks on the health of the housing market. Housing data on tap this week includes the NAHB’s monthly builder sentiment survey on Wednesday, housing starts and permits on Thursday and existing home sales data on Friday. But like Tuesday’s PPI data, it’s hard to imagine anything that would catch anyone off-guard: rising mortgage rates and still-nutty price gains for homes are putting a very real damper on transaction volumes. Maybe this week’s starts and permits data will bring some relief in the form of happier inventory expectations, but markets are so focused on the Fed, Ukraine, oil prices and inflation that it would take something truly outlandish to draw much more than a polite acknowledgement that the housing market still exists from the financial press.
Of slightly more consequence, we’ll also get our first two regional Fed manufacturing reports for March: Empire State on Tuesday and Philly Fed on Thursday. These two reports will be among the first survey-based reports to cover a timeframe that incorporates the Ukraine invasion, so read-through into how manufacturers are feeling about the latest out-of-left-field development that threatens to snarl their supply chains even further will be crucial.
Empire State and the Philly Fed might also provide an important cross-check of something buried deep within last week’s NFIB confidence survey (see above,) that you might have missed: namely, that small business owners are increasingly concerned not only about declining profit margins (which was widely known to be a concern as soon as the Fed gave up the “inflation is transitory” fallacy late last fall,) but also about declining revenue growth. If it’s true that small businesses sometimes represent the canary-in-the-coalmine for businesses writ large, then the worry that sales might be slipping should be worrisome indeed (and could even make the UofM’s invocation of the S-word <gasp!> feel prescient.)
My own view is that the regional Fed reports like Empire State and Philly do a better job predicting the future direction of economic trends than most, so it might be worth spending an extra minute or two screening those reports for corroboration of the NFIB membership’s latest phobia.
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Personal Capital Advisors Corporation (“PCAC”) is a wholly owned subsidiary of Personal Capital Corporation (“PCC”), an Empower company. PCC and Empower Holdings, LLC are wholly owned subsidiaries of Great-West Lifeco Inc. Source for index data: Bloomberg.com; GWI calculations.
[1] US Energy Information Administration (eia.gov)
[2] https://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MCRFPUS1&f=M
[3] https://www.cnn.com/2022/03/11/middleeast/mideast-summary-03-11-2022-intl/index.html
[4] https://www.reuters.com/business/energy/uae-favors-oil-production-increase-media-citing-ambassador-us-2022-03-09/
[5] https://www.bls.gov/cpi/
[6] https://www.nfib.com/surveys/small-business-economic-trends/
[7] http://www.sca.isr.umich.edu/
[8] Cme.com
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