THE NEW YEAR BEGINS with many of last year’s major themes intact — Joe Biden’s poll numbers are in the doldrums, Covid is still a concern but less lethal, Congress remains dysfunctional, and serious challenges loom from Russia and China. But there’s one big difference — interest rates.
YIELDS MAY BE BREAKING OUT to the upside, as investors grapple with three major developments: the tight labor market, which should be apparent in this Friday’s jobs data; signs that inflation and the supply chain gridlock aren’t over; and the determination of the Federal Reserve to begin tightening policy.
THIS UPSIDE THREAT WAS CLEAR YESTERDAY, as the Treasury 10-year bond yield rose to 1.63%, shrugging off the media hysteria over Omicron, which has infected millions but seems to be no worse than a bad flu.
THE BIDEN ADMINISTRATION has done a terrible job of messaging on Covid; even Dr. Anthony Fauci seems to change his assessment every few days. The bottom line appears to be increasingly clear: the new variant will probably peak within weeks and — finally — the virus may subside by spring.
SO WE THINK THAT ANY COVID-RELATED ECONOMIC WEAKNESS in the first quarter will be temporary, and the bond market apparently agrees. (Fourth quarter growth should be robust; the Atlanta Fed GDP forecast is for growth of 7.6%).
AN EVEN MORE BULLISH SIGNAL comes from the labor market, where persistent shortages have prompted employers to raise salaries, accept COLA hikes, and offer sign-up bonuses. Friday’s non-farm payrolls are expected to rise by about 400,000 jobs, with the unemployment rate nearing 4% — perhaps a sign of imminent full employment.
WE STILL DON’T RULE OUT FISCAL STIMULUS this year, as progressive Democrats browbeat Sen. Joe Manchin, who could agree to a package of “only” $1 trillion or so. Biden, facing a GOP takeover in the House in November, will take whatever deal he can get.
BIDEN DESPERATELY NEEDS TO SHOW THE PUBLIC that inflation is subsiding, but that may not occur until summer or later. So he will accuse meat producers, energy firms and other companies of price-gouging, very convenient scapegoats. What Biden needs is a Fed Chairman who will talk tough on inflation, and it looks like he has one.
THUS THE YEAR BEGINS with a clearly hawkish Fed, inflation still hot, and the economy in surprisingly good shape. Two or three rate hikes in 2022 won’t crush the economy or the markets, especially as Covid begins to subside. The big change in 2022 will be learning to live — and invest — with higher yields.
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