The Federal Reserve continued to shift its policy towards a less accommodative stance last week. From September, the Fed first indicated its intention to slow the pace of its bond purchase program. This was followed in November by the decision to start what is known as tapering, which is to be completed by the middle of 2022. Last week, the Fed stepped up the pace of tapering, which is to be completed by ‘here March. At the same time, he indicated the possibility of three quarter-point interest rate hikes next year, up from a follow-up to the previous release of his economic projections in September, and none following his meeting of June.
The Fed is reacting to a spike in inflationary pressure that it no longer qualifies as transitory. It raised its inflation forecast for 2022 for the core PCE deflator to 2.7% from 2.2% in September. At the same time, the labor market has recently strengthened, pushing the unemployment rate to 4.2% in November. In response, the Fed moved forward a year, to 2022, when it estimates the unemployment rate will drop to 3.5%. As a result, the Fed now sees the fed funds rate ending 2022 at 0.9%, down from 0.3% in September. In 2023, he now sees the fed funds rate at 1.6%, down from 1.0 in September. And in 2024, it experiences a rate of 2.1% against 1.8 in September. Importantly, he hasn’t changed his outlook for longer-term federal funds beyond 2024, leaving it at 2.5%. Overall, the Fed is now anticipating policy tightening a little faster, but not higher, than before. However, markets remain skeptical that the Fed will ultimately raise the fed funds rate well above 1.5%.
Market response to the Fed’s outlook has been mixed; Bank of England raises rates
Market reaction to the Fed’s revised outlook has been subdued. Stocks rallied initially, ending Wednesday’s day sharply higher. But those gains dissipated over Thursday and Friday to end the week almost exactly where they were before the decision was released. The VIX index edged down to 22 from 23. The yield on the ten-year Treasury bill edged down from 1.44 before Wednesday’s decision to close at 1.40% on Friday. The yield on the more sensitive two-year note slipped three basis points to 0.63%. And the DXY dollar index was unchanged.
The Bank of England went further than the Fed last week, raising its key rate 0.1 to 0.25%, taking markets by surprise, a day after learning that UK consumer prices had increased at a rate of 5.1% faster than expected in November. In contrast, the European Central Bank left rates unchanged and said it expects them to remain unchanged next year. However, it announced the end of its emergency pandemic bond purchase program by March, partially offset by an increase in the size of its previous program.
Intensifying Covid Infections Creates Economic Uncertainty
For the week, US stocks fell nearly 2%. It was the fourth weekly decline in the past six, leaving inventories virtually unchanged since early November. While most of the attention last week was on the Fed, there was a lot of attention on the economic calendar, as well as the spread of the Omicron covid variant. Producer prices in November climbed 9.6 percent, suggesting that consumer prices should remain under upward pressure. Retail sales in November disappointed, but the previously strong October report was revised up. And the overall spending this holiday season is expected to be robust. Initial jobless claims edged up but remained at a low level, while continuing claims continued to descend to pre-pandemic totals. Housing starts rose, far beating expectations, while industrial production and flash PMIs remained slightly below expectations, but remained at solid activity levels. Over the short week ahead, we’ll see November’s personal income and expenditure, PCE deflator, new and existing home sales, durable goods orders, leading indicators and consumer confidence. And President’s Build Back Better Bill appears to be in trouble following reports that West Virginia Senator Manchin will vote no.
The accelerating rate of new Covid infections is creating growing economic uncertainty. Especially in Europe, new restrictions are imposed on travel. And the Netherlands have imposed new confinement. President Biden will speak on the matter on Tuesday, as officials warn of overloading hospital systems. The World Health Organization said over the weekend that the Omicron variant has now been found in 89 countries and the rate of infections is doubling every one and a half to three days.
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A 10-year Treasury bill is a debt obligation issued by the United States government that matures in 10 years.
The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market expectation of 30 day volatility. The VIX is constructed using the implied volatilities of a wide range of options on the S&P 500 Index. VIX values above 30 are usually associated with high volatility resulting from increased uncertainty, risk. and fear of investors. VIX values below 20 generally correspond to stable and stress-free periods in the markets.
the personal consumption expenditure (PCE) measures of the prices that people living in the United States pay for goods and services. The PCE price index is known to capture inflation (or deflation) across a wide range of consumer spending and to reflect changes in consumer behavior.
The US dollar index (DXY) is an index (or measure) of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of currencies of trading partners of the United States. The index rises as the US dollar gains “strength” (value) against other currencies.
the PMI flash services is based on approximately 85 to 90 percent of total PMI responses each month. It is designed to provide an accurate advance indication of the final PMI data. As flash services PMIs are among the top economic indicators of each month, providing evidence of changing economic conditions ahead of comparable government statistics, they can have a significant effect on currency markets.
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