Market & Economic Outlook
Market Commentary - Q1 2022
As a new year begins, we see three key investment themes to watch going forward: the Federal Reserve’s pivot to reverse 2020’s unprecedented monetary stimulus measures; inflation soaring to a 40-year high; and the challenge of maintaining the recovery even as the economy faces various headwinds, such as an overstimulated economy.
The Fed’s intention to end its bond-buying program late in the first quarter of 2022 marks the beginning of a cycle of tightening the monetary reins. We expect that the Fed will raise short-term rates by 50 to 75 basis points over the course of two or three hikes in 2022 to tame building inflationary pressures.
Quantitative tightening—shrinking the Fed’s balance sheet through slowing the reinvestment of maturing securities—should also commence in 2022. Central banks around the world also might cut back on aggressive monetary stimulus programs and consider rate hikes of their own.
A nearly 40-year peak in inflation rattled investors during 2021. Looking beneath the headlines, however, the primary sources of inflation—pandemic-related supply chain and production constraints as well as demand for goods and demand for services—followed different paths. Flush with stimulus cash and built-up savings during the pandemic, shoppers went on a buying spree while demand for services was nearly unchanged versus prior periods.
But the worst of goods-driven inflation may be behind us if supply chains and production constraints normalize and consumer-savings levels continue to decline, while cheap credit due to low interest rates slowly wanes.
The Fed faces a daunting challenge and inflection point as it attempts to begin a tightening regime while simultaneously seeking to deliver on its two mandates of maximum employment and price stability. Too much tightening too soon could choke economic growth and, potentially, lead to recession. But tepid rate hikes could do too little to reduce inflation while leaving the Fed with a too small supply of “dry powder” to fight future downturns.
A “Goldilocks” monetary approach will be a challenge given the Fed’s narrow range of policy options. Complicating matters further, data the Fed relies on to make decisions have been whipsawed by the pandemic.
U.S. equities, as measured by the S&P 500 Index, ended the year on a record high. We believe that corporate earnings growth rates will remain positive in 2022, but rising rates might put a damper on stock valuations and earnings-per-share growth. Similar to prior record equity market peaks, we expect 2022 to be marked by more moderate advances.
Fiscal stimulus uncertainty, particularly the on-again, off-again Build Back Better legislation, could continue to perplex markets in 2022 as will the ongoing pandemic. The knock-on effects of a more hawkish Fed may be another headwind as rate hikes are often seen as negative for stocks.
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