Rafael Gozlan, Chief Economist of IBI Investment House
Uncertainty about the effect of the new variant will continue to accompany the markets in the near future until it becomes clearer about the extent of the harm and the effectiveness of vaccines, but the emphasis is gradually shifting to the significant recent round of inflation in terms of inflation. In the latest interest rate decision the Fed came with a June tone, tried to buy time and stayed with the temporary inflation estimate, albeit with a lesser degree of confidence. The rise in energy prices, the acceleration in actual inflation and inflation expectations and a relatively rapid rise in wages have persuaded the Fed to abandon the assessment of temporary inflation. If until recently it was the various Fed members who declared the possibility of accelerating the process of reducing purchases, Powell came during the testimony to Congress and clarified in his language that the estimate of temporary inflation is no longer relevant, so current inflation has already exceeded the direct effects of the crisis.
The significance of this assessment is expected to be reflected in the acceleration of the rate of reduction in purchases, and it appears at this stage that the process will end at the end of the first quarter of 2022 and not at the end of the second quarter. What further sharpens the Fed’s late response to inflation is the fact that although the Fed now understands that the inflation environment is significantly higher than early estimates – the November index to be released this week in the US is expected to point to basic inflation of close to 5%. It seems that liquidity will continue to flow into the markets during the coming quarter as well.
The inflow of liquidity may to some extent moderate the sharp transition that is expected to characterize monetary policy during the first half of the year, ie from a situation of liquidity inflow through the purchase of monetary bonds to monetary restraint. The Fed will aim for significant tightening of financial conditions, mainly a negative wealth effect through the stock markets, an increase in credit spreads and pressure on commodity prices, which have so far remained at comfortable levels, in order to lead to a decline in the inflation environment.
The Fed interest rate contracts align with the expectation of accelerating the reduction in purchases and ending this process in the first quarter of 2022. Thus, the contracts embody a first interest rate increase during the second quarter of 2022 and close to 3 interest rate increases, to 0.75%, at the end of 2022. Yields continue to flatten from both ends, i.e. a rise in short-term yields and a decline in long-term ones, so the message from the bond market continues to be that of curbing inflation by the Fed at the price of a slowdown in activity.
While the effect of falling commodity prices and Powell’s hawkish tone has led to a crooked flattening in the US and a parallel decline in inflation expectations, especially in the medium to long term, in Israel the bulk of the move so far has been a sharp drop in inflation expectations. Fully align with the message that raising interest rates will eventually lead to a slowdown, a scenario that, if materialized, will probably affect Israel as well. Too mostly medium-long-term for redemption.
The U.S. employment report is not as weak as it seems at first glance
The increase in the number of employed persons in November in the United States was lower than expected and amounted to 210,000 against a consensus of 550,000, and the data for the previous two months were updated upwards by about 80,000 employed persons. . First, the first estimate of employment data has been updated in most cases in the last year upwards, and even significantly. Thus, the August-September data on first reading, which revolved around the same addition as the one recorded in November, were updated by 250-200 thousand to levels of 400-500 thousand. In addition, the famous figure is seasonally adjusted, while the original figure indicated an addition of close to 800,000, so it is not inconceivable that the seasonally adjusted disruption as a result of the corona crisis also played a role in the weak figure.
Beyond that, the household survey was considerably strong, indicating a sharp rise in the employment of about 1.1 million employed persons. This improvement led to a decrease in the unemployment rate from 4.6% to 4.2%, while increasing the participation rate from 61.6% to 61.8%. The increase in the participation rate is encouraging, as this rate has declined in the wake of the crisis, and if this trend continues, it may moderate to some extent the intensity of recent wage increases, rising at rates of about 5%.
Positive growth in the last quarter of the year, but potential for moderation in early 2022 under the influence of the corona
The effect of the increase in morbidity and spread of the new variant on activity has not yet been reflected in the latest data, and it is more likely that their effect will be felt during the first quarter of the year. During the week, the IMF signaled the possibility of lowering the forecast for the coming year, estimating at this stage that the balance of risks for growth tends downwards. Some of these assessments reflect the additional wave of morbidity that characterizes the current period, especially in Europe and with signs of escalation in the US as well, and this is before the spread of the omicron. According to an analysis by the Financial Times, the infection rate from the omicron is high compared to previous variants, but the good news so far is that the increase in morbidity (hospitalizations and severe cases) is relatively low.
At this stage, the indications emerging from the Purchasing Managers’ Indices are for a relatively high growth environment in the last quarter of the year, mainly in the US.
In China, the operating environment continues to be relatively moderate. Purchasing Managers’ Indices for November indicated a shuffle with a tendency for a slight contraction in manufacturing activity, compared with a relatively moderate expansion in the services industries. The slowdown in China continues to reflect the lagging effect of the credit crunch taken in late 2020-early 2021. The eurozone has seen an increase in the General Purchasing Managers’ Index as a result of an improvement in services industries in parallel with high levels of manufacturing activity. The relative weakness among the countries leading the bloc is in Germany, where the deterioration in its morbidity situation may exacerbate the slowdown in the near future. However, assuming the new variant does not turn out to have an exceptional hit, the eurozone is expected to close its growth gaps starting in the second quarter of 2022.
In the US, the ISM indices continued the high expansion in activity, and in particular the increase in services activity in November stood out to a record level of 69, an increase that reflects a recovery in activity after the moderating impact of the disease wave during the third quarter of this year. The growth of the Atlanta Fed, due to high growth in the last quarter of the year. The gap between new orders and inventories has narrowed considerably in recent months, and past experience shows that this reduction reflects a moderation in manufacturing activity over the next quarter or two.