Markets are experiencing increased volatility, driven by a Federal Reserve that is moving away from its highly accommodative monetary policy and rising COVID cases.

However, we remain optimistic on our outlook for the economy and markets for 2022 and have the following observations.

As expected on Wednesday, the Federal Reserve announced that it would complete its securities purchases more quickly than previously scheduled, opening the way for higher interest rates as early as March. The acceleration in their timeline is due to rapidly improving labor market conditions and high inflation readings.

As an emergency response to financial stresses and deteriorating economic conditions early in the pandemic, the Federal Reserve dropped interest rates to zero and started purchasing $120 billion in securities each month. Supported by massive fiscal stimulus and the accommodative Fed policy, the economy has encouragingly shown significant improvement since reopening after the hard lockdown in the spring of 2020.

This economic rebound has led to improving labor markets and strong demand for goods and services that is driving inflationary pressures, which are being aggravated by persistent supply-chain disruptions. Given the Fed’s dual mandate of full employment and stable prices, they are now in a position to normalize interest rates.

Despite pulling forward the projection for higher interest rates, history shows that stocks can move higher in the months leading up to, and following, the first interest rate increase. It is only at the point when the Fed has increased rates so high that it adversely impacts economic performance that stocks begin to significantly falter.

This critical relationship between economic performance, corporate profits, and ultimately stock market performance is why we focus so much on economic fundamentals. Importantly, the economic fundamentals remain healthy and should allow for interest rate normalization. In addition, the Jay Powell-led Federal Reserve has shown in the past that they are willing to rapidly adjust monetary policy based upon incoming financial and economic data—important for avoiding a major adverse impact on the economy.

While the recent Delta and Omicron led surge in the virus poses a headwind, this is the fourth surge we are experiencing since the start of the pandemic. The healthy underlying economic fundamentals allowed the economy to withstand these previous headwinds. We believe the economy remains well positioned to withstand the current virus surge.

Last Week’s Economic Data Continues to Support Our Positive Outlook: While retail sales saw the smallest gain in four months at 0.3% in November, it was still up 16.2% on a year-over-year trend basis. While off the record pace of earlier this year, this is still several times higher than pre-recession and is a faster annual growth rate than in any other expansion since 1968. The deceleration is also likely due in part to consumers planning ahead and pulling forward their holiday purchases this year amid widespread supply-chain problems. Indeed, on a three-month average basis, retail sales were up 0.9%, the second most since May.

The Markit Flash Composite PMI (a preliminary combined manufacturing and services business survey) slipped in December to a three-month low, indicating a modest deceleration in business activity at year-end. However, growth is still faster than the historical trend. Additionally, business optimism about the year-ahead growth outlook increased in both manufacturing and services.

Housing starts jumped 12% in November, the biggest monthly gain since March, while building permits rose 3.6%, up in four of the past five months. Meanwhile, jobless claims are hovering near the lowest level since 1969. All of this bodes well heading into 2022 and suggests the economy can withstand interest rate normalization.

The Week Ahead: This is a short week with U.S. equity and fixed income markets closed on Friday in observance of Christmas. However, investors are likely to focus on the November PCE inflation indicator, which is released on Wednesday—a key inflation gauge of the Federal Reserve. We also get fresh consumer sentiment surveys, new and existing home sales reports, and the November Durable Goods release.


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