Monday Morning Coffee: Wall Street Sinks as Omicron Worries Persist

Posted by Steve Graham on 12/20/21 1:20 PM

Wall Street finished lower on Friday, weighed down by Big Tech as investors worried about the Omicron coronavirus variant and digested the Federal Reserve’s decision to end its pandemic-era stimulus faster. The Dow Jones Industrial Average declined 1.48% to end at 35,365.44, while the S&P 500 lost 1.03% to 4,6270.64 and the Nasdaq Composite dropped 0.07% to 15,169.68. For the week, the Dow dropped 1.7%, the S&P 500 lost 1.9% and the Nasdaq Composite declined 2.9%. The indexes started to decline broadly on Wednesday after the Federal Reserve signaled three-quarter point interest rate increases for 2022 to combat inflation. Adding to the uncertainty, Pfizer said on Friday, the pandemic could extend through next year. European countries geared up for further travel and social restrictions and a study warned the rapidly spreading Omicron variant was five times more likely to reinfect people than its predecessor, Delta. Traders pointed to year-end tax selling and the simultaneous expiration of stock options, stock index features, and index options contracts known as triple witching-as potential causes for increased volatility.

Concerning the future, the main economic event last week was the Federal Open Market Committee (FMOC) policy meeting that ended on Wednesday, where some sizable changes in the monetary policy outlook were announced. Policy officials doubled the pace of tapering asset purchases, which leaves them to be completed in March, and indicated an earlier lift-off for interest rate increases than previously expected. The policy statement and comments by Chair Jerome Powell in its post=meeting comments indicate that the Fed believes that its inflation threshold has been met and the bar for rate hikes rests squarely on the progress of the labor market.

The Fed’s Summary of Economic Projections (SEP) release showed some notable changes. Next year's median estimate for core PCE inflation was raised to 2.7% from September’s 2.3% forecast. The change in inflation reflects the growing belief that inflation is not going to recede as quickly as previously expected. The Fed now believes that the unemployment rate will fall to 3.5% by the end of 2022. That is a level consistent with “maximum employment” and suggests that inflationary forces could become harder to rein in. Based on the fresh SEP projections, the Fed has penciled in three 25 basis point rate increases for 2022, followed by three more 25-basis in 2023 and a single-50 basis point increase for 2024. If realized that would put the fed funds range at 2.0%-to-2.25% at the end of 2024, just a touch below where the FMOC estimates policy would become restrictive.

While inflation is giving policymakers a headache, it has become a real issue for consumers. Almost everything today costs the consumer more and higher prices for non-discretionary items like gas and food are taking away money that could be spent on other items. In November, retail sales rose just 0.3%, less than half the consensus estimates. That did follow a big jump in October, suggesting that consumers started shopping earlier than usual. Since the supply chain problems are widely published, consumers likely started shopping early to make sure the items they wanted could be delivered by Dec. 25. Retail sales are released in nominal terms, that is, not adjusted for inflation and that makes the gains seem stronger than they are. Considering that consumer prices rose 0.8% in November, the inflation costs were significantly higher than the gain in sales. Even if December sales are flat, the gains in October and November point to a 10% gain in holiday sales this year. That is a very good number, but we must not lose sight is that the gain in nominal terms would be four-to-five percentage points higher thanks to inflation.

In other news, the industrial sector of the economy continues to recover. Industrial production rose 0.5% in November, but that still leaves total output 1.8% below its pre-pandemic peak in August 2018. The manufacturing sector is doing a little better than overall industrial activity. Manufacturing output rose 0.7% in November. There were hints that the supply chain problems may be starting to ease slightly. Auto production rose 2.2% in November, a second consecutive gain and that followed a 10.1% gain in October. Production, excluding autos, rose 0.6% in November, a solid gain. Auto production remains 5.4% below year-earlier levels. Capacity utilization increased 0.5 of a percentage point in November, the highest rate since December 2018. Overall capacity for the industrial sector rose 0.3 of a percentage point to 76.8%. Although still below its pre-pandemic peaks and well below the 1972-2020 average, the tightening of capacity and increases in auto production suggest the supply chains are improving.

Supply chain problems exist in almost every sector of the economy, and they have been evident in the housing industry. Labor is a critical input in housing development and the lack of workers has been holding back activity. The availability of building materials has been volatile month-to-month this year and varied widely by region. The shortages of labor and building material slowed housing activity in the summer months, but there does seem to be some improvement in the supply chains to allow housing starts to jump to an eight-month high in November of an annual rate of 1.679 million. Both single-family and multi-family starts rose in November. Permits rose 3.6% to an annual rate of 1.712 million units. With permits running well ahead of starts, housing activity should remain strong in 2022.

This next week will be relatively light for economic data. We do get a look at existing and new homes sales, personal income and spending, and durable goods orders.

Tags: Economy, Monday Coffee

Latest Data

The U.S. Economy:

The producer price index increased 0.8% in November, the largest increase since July. The PPI was up 9.6% from a year earlier, the biggest leap since the 12-month aeries were first calculated in November 2010. Final demand goods prices rose 1.2% in November, following a 1.3% advance in October. Final demand services rose 0.7% in November. Excluding food and energy and trade services, the core PPI rose 0.7%, the largest rise since July. The core index was up 6.9% in the last twelve months. Final energy demand rose 2.6% in November, despite falling oil prices and food was up 1.2%. Transportation and warehousing’s PPI rose 1.9%. Iron and steel prices jumped 20.7%. Supply chain bottlenecks and surging demand are the primary drivers of inflation and have only eased marginally in recent months. The Fed thought that much of inflation was “transitory” in nature. However, in recent days, the Fed has indicated that is speeding up the taper of its bond-buying program and have penciled in three quarter-point rate increases for 2022. Inflation should cool next year, but how quickly remains a question.

Retail sales remained healthy in November but did come in noticeably weaker than in October. Retail sales advanced 0.3% in November, following a 1.8% advance in October. Excluding the auto sector, sales also rose 0.3%, as auto sales were essentially unchanged from October. The November performance was mixed. Growth was led by gasoline sales, grocery stores, and sporting goods stores. There were declines in department and electronic and appliance stores. The year-over-year rate rose to 18.2% from 16.3%. The slower November growth in sales can be partly attributed to Americans starting their holiday shopping earlier than usual in October. Online sales were unchanged in November and sales at electronics and appliance stores dropped sharply. Higher prices for food and energy likely limited some discretionary spending. Spending is shifting to services and a slower pace for retail sales has been expected for several months. The slower spending in November did not change the view that the economy is regaining some steam in the fourth quarter after a weak third quarter. Rising COVID infections could slow spending over the winter months. Excluding automobiles, gasoline, building materials, and food services, core retail sales dipped 0.2% in November but accelerated 1.8% in October. The core spending rate does correspond most closely with the consumer spending component of GDP. The consumer will lead growth in 2022, but without stimulus, spending is likely to slow compared to 2021.

Business inventories increased strongly in October, suggesting that re-stocking could again support economic growth this quarter even as stocks in the auto sector remain depressed because of shortages. Business inventories rose 1.2% in October, following a 0.8% advance in September. Invento1ries were up 7.8% on a year-ago basis. Retail inventories edged up 0.1% in October, following a 0.1% dip in September. Motor vehicle inventories decreased 1.0%. Retail inventories, excluding autos, rose 0.5% in October. Wholesale inventories advanced 2.3% in October and stocks at manufacturers increased 0.8%. Business sales increased 2.1% in October, following a 1.2% advance in September. At October’s sales rate, it would take 1.24 months to clear stocks, down from 1.26 in September.

Industrial production rose 0.5% in November, following a 1.7% surge in October. Manufacturing rose 0.7%, following a 1.4% jump in October. Production at auto plants rose 2.2% in November after a 20.2% advance in October. Motor vehicle output remains 5.4% below its year-earlier level because of the global shortage of semiconductors. Excluding the auto sector, manufacturing output rose a solid 0.6% in November. The aerospace sector put in some good numbers, with a gain of 1.6%. Consumer goods output gained 0.7%. In the nondurable goods sector, there were gains in textile, paper, and plastics. Mining rose 0.7%, following a 4.3% surge in October which reflected the re-opening of production along the Gulf Coast following Hurricane Ida. For the industrial sector as a whole, non-energy production advanced 0.9%, whereas the output of energy production fell 0.6%. Capacity utilization for total IP increased 0.3 of a percentage point to 76.8 in November, 2.6 percentage points below its 1972-2020 average. Capacity utilization for manufacturing rose 0.5% to 77.3%, the highest rate since December 2018. The increase in capacity utilization and the two-month consecutive increase in auto production do suggest the supply chain problems are starting to ease. However, these problems will linger for a time. Inventories are low suggesting that production will remain robust, at least until demand cols enough and supply increases until a more historical balance is achieved.

New residential construction increased more than expected in November. Housing starts jumped by 11.8% in November to an annual pace of 1.679 million. Single-family starts rose 11.3% to an annual pace of 1.173 million. The multi-family sector equaled 491,000. The future activity looks good, as total permits rose 3.6% to 1.712 million. Single-family permits rose 2.7% to 1.1.103 million. Strong demand, low inventory, and high builder confidence should keep builders busy the next few months, even though supply and labor shortages will curb some activity. Builders still have a large number of backlogs to work through, which will boost activity in 2022.

Important Data Releases This Week

  • The November existing home sales report will be released on Wednesday, December 22 at 10:00 AM. We expect that existing home sales will increase to an annual pace of 6.6 million for November, continuing the turnaround in sales this fall after cooling earlier in the year. Sales of existing homes have increased four out of the last five months. Strong demand and sparse inventories mean that prices will stay high, although they have moderated somewhat. The high prices are keeping some first-time buyers out of the market.
  • The November personal income and outlays report will be released on Thursday, December 23 at 8:30 AM. We expect that income likely advanced 0.5% for the month, As the stimulus faded, incomes and salaries are taking up the baton of fueling Americans’ consumption. Since January, wages and salaries have increased 7.6%, the biggest year-to-date increase in 42 years. There is still strong demand for labor, as underlined by the record number of job openings. Spending is projected to have increased 0.7% in November. Inflation has been weighing in on the consumer. The PCE deflator is projected to have increased 5.7%, the highest reading since 1982. We expect salaries and spending to keep up a decent rate in 2022. Whether they keep up with inflation is still a guess.
  • The November advance durable goods orders report will be released on Thursday, December 23 at 8:30 AM. After the disappointing October drop of 0.4%, we believe the November report to be more-cheery, by rising 1.5%. October’s orders were weakened by a drop in defense and aircraft orders. Excluding transportation, October orders were a more solid 0.5%. Boeing had a decent November and that should solidify the transportation sector. For months, orders have exceeded supply and the result was inflation. There are some tidbits of evidence that the supply chain bottlenecks are starting to ease. Look for core capital goods orders for clues to business investment on equipment in the new year.





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