MANHATTAN (CN) — The party may not have ended for Wall Street, but it certainly took a breather after the Federal Reserve announced it would hike interest rates three or more times in 2022 and speed up its tapering process.
By the end the week, the Dow Jones Industrial Average lost 604 points, most of it on Friday, while the S&P 500 and Nasdaq declined 92 points and 461 points, respectively.
The Fed, which had been calling rising inflation “transitory” for more than the past year, also changed its wording about price hikes, instead called inflation “elevated” for the first time in one of its statements. The central bank predicted inflation to reach 5.3 by the end of 2021 and hit 2.6% next year.
The central bank had looked to keep rates low and bond-buying stable to achieve its goals of “maximum employment” and an average 2% inflation over an unspecified period. Inflation over the last year has crept up much higher than that, with experts now worried it may not relent until further into 2022.
For some, the change in the Fed’s plans is almost too little too late. Last Sunday on the CBS program “Face the Nation,” former Pimco CEO Mohamed El-Erian said the Fed has lost control of the inflation narrative and shed some of its credibility by continuing to call inflation transitory. “The characterization of inflation as transitory is probably the worst inflation call in the history of the Federal Reserve, and it results in a high probability of a policy mistake,” he said.
Some experts believe that inflation, while remaining high in 2022, will drop somewhat as energy prices continue their slide and supply shortages ease, but they note as well that deflationary pressures will likewise be only temporary.
“The bigger problem,” wrote Paul Ashworth, chief U.S. economist at Capital Economics, “is the clear sign of building cyclical price and wage pressures, which will be much longer lasting."
Ashworth added that the Fed also faces a Catch 22 next year, since long-term interest rates haven’t risen in so long that short-term rates are likely to climb. “When long rates remained stubbornly low during the 2004 and 2005 tightening cycle, which is usually attributed to a global savings glut, the lack of any tightening in broader financial conditions set the foundations for the housing bubble and the resulting financial crisis a few years later,” he wrote.
Tom Essaye of the Sevens Report wrote in an investor’s note that “investors are OK with the significant hawkish shift we have recently seen by global central banks on one key condition: the economic recovery remains strong and new strains of Covid do not lead to new economic lockdowns.”
He added that recent inflationary concerns and soft economic growth data have investors worried the Fed and other central banks possibly blundered by hinting that interest rates will rise soon. “With all of that in mind, the market landscape is going to be increasingly difficult to navigate as we begin 2022, as a lot of things have to go right in order for stocks to continue to rally,” Essaye wrote. “If any of these things ‘go wrong’ it will be a source for broad market volatility.”
Meanwhile, the surge in Covid-19 cases due to the quickly spreading omicron variant also picks away at equities.
“Even if an omicron wave is associated with lower hospitalization rates, health care systems could still be overwhelmed,” analyst Ben May at Oxford Economics wrote. He added that “three key issues will need to be considered to evaluate the extent to which omicron may weaken growth: the speed of infections, hospitalization rates, and the response of governments and populations.”
According to data compiled by Johns Hopkins University, more than 50 million Americans have contracted the deadly virus, with more than 800,000 deaths attributed to it.
Other data points remain as they have been in recent months. Unemployment claims still are coming in at years-low levels, with the most recent Labor Department report showing just 206,000 initial claims for the week ending December 11.
In its economic projections, the Fed predicts unemployment will drop next year to 4.3%, half a percentage point lower than the central bank forecast three months ago.
Small businesses remain both optimistic about the prospects of hiring but also increasing worried about inflation, according to a survey by the U.S. Chamber of Commerce. According to the group, 38% of small businesses expect to hire more workers in 2022, up from 28% who said that last quarter and the highest point in the index since mid-2017. A little less than two-thirds of respondents say their businesses are in good health, up from 55% last quarter, but three-fourths of small businesses say that inflation is a major concern and 71% say that inflation has had a significant impact on their businesses this year.
“Small business owners’ optimism is plowing through economic uncertainty, but they now face new obstacles with rising inflation, labor shortages, and supply chain challenges,” said Tom Sullivan, who heads up small business policy at the chamber.
On the consumer side, inflation remains a major concern, as well. One-year inflation expectations increased from 5.7% in October to 6%, which is double what consumers predicted back in January, in the latest consumer expectations survey from the Federal Reserve Bank of New York.
Median inflation uncertainty, which is the measure of uncertainty regarding future inflationary outcomes, reached a new series high in both the short- and medium-term horizon, the NY Fed said.
The survey also noted, ominously, that “perceptions about households’ current financial situations compared with a year ago deteriorated in November, with more respondents reporting being financially worse off than they were a year ago.” Fewer respondents in the latest survey expect their financial situation to improve a year from now.
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