Daily Comment (December 1, 2022)
by Patrick Fearon-Hernandez, CFA, and Thomas Wash
[Posted: 9:30 AM EST] | PDF
Good morning! Today’s Comment begins with our thoughts about Wednesday’s speech by Fed Chair Powell. Next, we give an overview of China’s move away from its Zero-COVID policy. We end with international news focusing on the growing fractures within the Western alliance.
Fed Talks: Fed Chair Jerome Powell signaled that the central bank is not prepared to lower rates; however, the market is not convinced.
- The market rejoiced following suggestions that the Federal Reserve would scale back the size of rate increases. On Wednesday, Powell hinted that the central bank may moderate the pace of hikes at its December meeting but also that the Fed was not done raising rates. The S&P 500 soared over 3%, there was a bullish steepening in the yield curve, and the U.S. dollar index dropped. This market reaction indicates that investors are confident that the Fed is nearly finished with its tightening cycle. The latest Fed Watch Tools show that the market has priced in a nearly 80% chance that the Fed will raise its policy rate by 50 bps at its meeting later this month. Meanwhile, market bets predict that the Fed will begin cutting rates in the latter half of 2023.
- This bullish reaction from investors was likely not the response Powell expected when he made his comments. Fed officials have insisted that they will not stop tightening until inflation makes sufficient gains toward its 2% target. Thus, we suspect Fed Governors Michelle Bowman and Michael Barr will attempt to rein in expectations when they speak on Thursday. Additionally, stronger-than-expected employment data to be released on Friday might also reduce sentiment that the Fed is close to ending its tightening cycle. Therefore, Wednesday’s gain could be short-lived.
- Although inflation remains stubbornly high, there are signs that price pressures are starting to ease. U.S. rent prices fell for the third consecutive month in November, according to ApartmentList.com. Meanwhile, data collected from the Standard & Poor’s Case-Shiller Home Price Index shows that national home prices are also falling. Shelter prices comprise a third of the Consumer Price Index, so a drop would weigh heavily on price pressures. That said, it generally takes several months for the index to pick up changes in the housing market due to how the data is tracked.
- There is also a risk that if the dollar weakens and OPEC+ follows through on rumored production cuts, energy prices could rise and prevent inflation from falling further.
China in Focus: Beijing is walking a fine line as it attempts to display confidence in its pandemic response while also pacifying a growingly disgruntled public.
- China hinted that it may reduce the pandemic restrictions as public anger arises after a new round of lockdowns. A top Chinese official announced that the latest variant of COVID was “less pathogenic” than previous strains. This sentiment was also reflected in the state media’s softer tone when discussing the virus. One editorial went as far as to say that people “should not be too afraid of Omicron.” Over recent weeks, the country has ramped up its vaccination efforts and has entertained the possibility of importing Western vaccines. The renewed push is likely a positive sign for Chinese equities.
- Although substantial policy changes did not follow the remarks, the market believes reopening is on the horizon. The news initially led to a sharp rally in the Hang Seng China Enterprises Index, which rose to as high as 3.7% on the day; however, most of those gains subsided as investors realized that a reopening was not expected to be smooth. Beijing will likely drop restrictions at a slow pace as it does not want to give the impression that it is caving to public pressures. Additionally, there may be some hesitancy among people still wary to leave their homes due to COVID concerns.
- The reopening of the Chinese economy provides both positives and negatives for the rest of the world. The loosening of restrictions should increase economic activity, which should then help boost global growth and relieve some supply chain pressures. However, the reemergence of the Chinese consumers will increase the demand for energy products and push up the prices for commodities. In short, the overall impact of China’s reopening is complicated, to say the least. Thus, a slow reopening will likely fare better for equities than a quick one would.
Friends or Foe: Allies within the North Atlantic Treaty Organization are becoming frustrated with U.S. foreign and economic policies.
- Turkey’s bullheadedness leads to more uncertainty in the Middle East and is straining U.S. ties. On Wednesday, the U.S. warned Ankara against further escalation in Kurd-controlled areas of Syria due to the danger it poses to U.S. military personnel. Tensions between the two countries have been brewing after Turkish President Recep Tayyip Erdoğan blamed Kurdish groups for a November bombing in Istanbul. The ongoing row between the two NATO allies may complicate coordination efforts for their considerable roles in supporting Ukrainian war efforts.
- Outside of Syria, Turkey has also backed Azerbaijan in its ongoing dispute with Iran. Tehran’s military presence along its shared border with Azerbaijan has angered Anakara. In response to Tehran’s actions, Turkey suggested that it may consider military actions if tensions escalate further.
- European countries continue to rail against the U.S.’s new climate law. French President Emmanuel Macron is the latest European leader to express his frustration. In a speech yesterday, he stated that the Inflation Reduction Act threatens to divide the West. The point of contention between the two sides relates to tax breaks for components used in renewable energy technologies like electric cars. Europe sees it as an opening salvo in a trade war. In our view, the Inflation Reduction Act was designed to convince Europe to prioritize its own industries over China through subsidies of its own. This is supported by U.S. Trade Representative Katherine Tai’s insistence that Europe create its own subsidy program.
- Differences between the U.S. and its allies over trade and foreign policy have yet to lead to a complete fracturing of ties. This is evident in the European Commission’s recent decision to follow through on a price cap on Russian oil, a measure pushed by the Biden Administration. However, that does not mean that things are all fine and dandy. If Washington fails to keep its Western and NATO allies onside, it could lead to a multi-bloc world led by Europe, the U.S., and China as opposed to a two-bloc world led by just the latter two. A fragmented world will likely complicate supply chain efforts, which could harm earnings for companies with foreign exposure.