With Fed tapering set to reduce money growth even more, Van Hoisington and Lacy Hunt believe slowing velocity coupled with global nonproductive debt will continue suppressing GDP, inflation and Treasury bond yields.

Key Points:

  • The US economy was already in a massive debt overhang in 2019, then COVID pushed debt levels even higher.
  • Negative real yields in these conditions are a singular event unprecedented in history.
  • Below-zero yields prevent investors from earnig real returns sufficient to cover risks, causing investment to fall and eroding productivity gains.
  • This is a worldwide phenomenon, with a pattern similar to the 2011 Arab Spring – this time with much higher debt levels.
  • Nonproductive debt means transitory growth spurts like Q4 2021 probably won’t continue.
  • Consumer sentiment is weakening as more households tap credit lines to fund basic necessities.

Bottom Line: Hoisington and Hunt believe the current transitory growth spurt will end soon, giving way to the weakening 2019 pre-pandemic trend. This will reinforce the debt trap, reduce GDP growth and push inflation lower.

As expected, the Federal Reserve signaled a rate hike in March.

FOMC: – With inflation  well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate. The Committee decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March.

The market quickly boosted the odds of a 50 bps rate increase in March.

And rate hikes are expected to keep coming.

 

 

The probability of five 25 bps rate hikes this year is now above 90%.

Here is what’s fully priced into the market currently.

 

 

The Fed’s posture was more hawkish than expected. Some were hoping that tighter financial conditions (market selloff, higher bond yields, etc.) would prompt the central bank to be a bit more cautious. But it’s full speed ahead. That’s going to be tough for both stocks and bonds.

Market pricing for the 2022 Fed rate increases is now well above the FOMC’s dot plot. However, the market is also starting to price an overshoot (a policy mistake) by the Fed, with some probability that the central bank may be forced to cut rates in 2024.

 

 

US Economy

 

  • Manufacturers’ prices paid (from ISM PMI) suggest that consumer inflation will begin easing in the months ahead.
  • US financial conditions have tightened substantially in response to the Fed’s policy guidance.

 

 

  • According to Stifel, slower growth in the broad money supply also contributed to tighter financial conditions.
  • The latest Markit PMI report indicates that growth in business activity slowed this month, especially in services, as omicron takes a toll (PMI = 50 means growth has stalled).
  • The US composite PMI decline (services + manufacturing) was sharper than in other advanced economies.

 

 

  • Factory hiring deteriorated.

 

 

  • But service companies are boosting prices at an accelerating pace.
  • The fourth-quarter GDP growth topped expectations. However, over 70% of the increase was due to companies building inventories.
  • Wells Fargo is forecasting robust GDP growth for 2022 and 2023.

 

 

  • Consumer spending growth was exceptionally strong last year
  • Durable goods orders were robust in December, but capital goods orders appear to have peaked for now.
  • The Kansas City Fed’s regional manufacturing index ticked higher this month driven by rising optimism about future business activity.
  • Hiring expectations surged.
  • And manufacturers are increasingly planning to boost prices.
  • Pending home sales declined more than usual in December.
  • Exceptionally low housing inventories continue to be a drag on sales

 

Market Data

 

  • The end of QE will sharply reduce demand for Treasuries relative to issuance.
  • Fund managers see inflation peaking.
  • As demand for goods eases, we could see rapid declines in the CPI.
  • Last week’s selling pressure caused 42% of Nasdaq stocks to be cut in half from their 52-week highs. The stocks seeing selling are being sold extremely hard. More than a quarter of Nasdaq stocks are now at 52-week lows. Among sectors, Healthcare stocks have been hit even harder than Technology.
  • Investor sentiment has collapsed, with the AAII bull-bear spread hitting the lowest level since the taper tantrum in 2013.

 

 

  • The selloff has been more severe than the US indices would suggest.

 

 

  • Valuations are approaching pre-COVID levels (which of course doesn’t mean stocks are cheap).

 

Thought of the week

 

“A two sigma is the kind of deviation that should occur every 44 years.

Because we’re a little wilder and less efficient than we should be,

it happens every 35 years. Every 35 years feels about right…

one event in a career and twice in a lifetime.

 

Three sigma events should occur once every 100 years.

Now we, as I like to say, do crazy pretty well as a species.

Therefore, three sigma events occur much more often than they should,

and they are out of kilter much more than two sigma events.

 

With two sigma events, you can have some reasonably standard bubbles.

They give you a certain amount of pain in the minus 30, 40 to 50% area.

 

Super bubbles can pretty much wipe you out like 1929. And that’s where we are now.”

 

– Jeremy Grantham,

Co-founder and Chief Investment Strategist of

Grantham, Mayo, & van Otterloo (GMO)

 

Pictures of the Week

 

 

 

 

 

All content is the opinion of Brian J. Decker