Weekly Market Update 11/15/2021
The Federal Reserve is shifting gears, with its evolving stance headlined by an early November decision to start reducing asset purchases. Such buying of bonds in the open market, which dates to the start of the pandemic, now is seen as less vital, as inflation is rising rapidly; products and services demand is strengthening; and the incidences of COVID-19 are mostly receding.
The asset tapering moves are modest, and are in line with the Federal Reserve’s cautious approach to adjustments in monetary policy. It appears that not only is the lead bank wary of inflation, but it also is concerned that the economy’s trajectory is uncertain. This latter point was driven home by a sharp drop in GDP growth from the second to the third quarter of this year.
The main concern, though, is inflation. This view was affirmed when information on October’s non-manufacturing sector, a category that accounts for the lion’s share of the nation’s business activity, revealed both soaring demand for key services, and a Prices Index that reached its second highest reading ever. If this trend towards higher inflation persists and the economy strengthens in the coming weeks, as we expect, the Fed may start raising interest rates (i.e., the federal funds rate target) by mid-2022. In all, the Fed’s position was dovish and stocks pushed higher, with the Dow eclipsing 36,000.
Meanwhile, things are looking up in critical areas, with manufacturing activity holding at a high level, growth prospects in the non-manufacturing areas brightening, job growth accelerating (531,000 positions were added in October on significantly higher average hourly wages), and incidences of COVID-19 declining in most places. Given all this, GDP growth should at least double from the third quarter’s pedestrian 2.0% rate to better than 4%, in the current term.
This prospect has investors smiling. Not surprisingly, records continue to be set by the major equity indexes. True, there’s an inflation problem and it may not be as transitory as the Fed suggests. Still, unless the bank steps hard on the brakes, the edge would seem likely to remain with the bulls.
Conclusion: Some caution may be in order, but we would not adjust equity positions just yet.