Stocks and bonds traded in a tight range for most of the week. Some stocks were rewarded, while others punished, based on their earnings results. The U.S. dollar hit a series of new yearly highs, and just about everyone is waiting for President Biden’s pick to head the Federal Reserve Bank.
That announcement could come as early as this weekend. Chairman Jerome Powell’s term will end in February 2022. He is a Republican, picked by former President Donald Trump. He had a somewhat rocky relationship with the ex-president but did manage to maintain the independence of the central bank despite Trump’s attempted interference. His track record through the pandemic makes him a strong choice for a second term.
An equally strong candidate for the job is Lael Brainard, a Fed Governor since 2014, and an economist (as well as a Democrat). She is perceived to be a bit more dovish than Powell (if that is possible), but as far as policy is concerned, there is little difference between the two candidates.
There has been some talk that there may be a more hawkish dark horse candidate in the wings. Inflation has become both an economic as well as a political problem for the president. While the pandemic and its aftermath are the reasons inflation has risen, it is the person sitting in the White House who catches the blame. As such, some think Biden might be tempted to look further afield, picking someone who might be able to reign in inflation a little faster.
The country is still waiting for the second spending program to be addressed by Congress. There are a few Democrat hold-outs who refuse to vote on the $1.7 trillion plan until the Congressional Budget Office releases its estimate of what all this spending will ultimately cost the country in the years ahead. The Democrat leadership is hoping to put the package to a vote before Thanksgiving, but it remains to be seen if that can be accomplished.
Expectations for a strong holiday spending season were reinforced this week by several big retail companies who are predicting that consumers will be willing to spend, despite labor shortages, supply chain issues, and higher price tags due to inflation. While this is good news for the economy, it creates additional worries over the future rate of inflation for investors.
We are already seeing the impact of inflation on some companies where profit margins have suffered due to higher input costs. Passing those costs on to consumers works for now in some sectors, but there will come a time when consumers reduce their spending in the face of still-higher price increases.
The higher the inflation rate climbs, the more pressure it places on central banks to control it by raising interest rates. As I have written, several central banks (especially in emerging market countries) have already begun that process. Investors fret that the Fed has miscalculated the strength of inflation and will be forced to taper faster and raise interest rates sooner than they have indicated. The bond market is assuming the Fed will raise rates three times in 2022—in June, September, and a third hike in December. A change in those assumptions could spell trouble for the financial markets.
Normally, the holiday-shortened week ahead is kind to the stock markets. But there is no such thing as “normal” in today’s markets. Technically, financial markets are open all week, except for Thursday and half of Friday, but most traders take Friday off. Therefore, it wouldn’t take much to move markets, given the anemic volume and lack of participants. It wouldn’t surprise me to see an abnormal week ahead, either up or down.