As November ended and December began, it looked like equity investors were on Santa’s “naughty” list this year. Markets were firmly in the red by December 20th, and it looked obvious that investors would be getting coal. However, between Dec 20th and year end, the Santa rally was on, and markets went green.
Bond investors had a more mixed experience, with nominal yields rising a bit for US treasuries. Capital markets remained accommodative, with spreads for risky borrowers narrowing.
As we start 2022, there are more crosscurrents. Inflation is on everyone’s mind and Fed Chair Jay Powell recently retired the word “transitory” from his vocabulary. The Fed has turned hawkish in its tone and, in addition to winding down its bond buying program, the market appears to be pricing in three rate hikes in 2022. There is also some chatter about reducing the size of the Fed’s balance sheet. We will see.
A few things are worthy of note. While Omicron was a set-back to re-opening, we see some signs of supply chains easing. Moving into the latter half of 2022, we will have stronger base effects impacting inflation figures. It is also worth remembering as we enter a mid-term election cycle that the outcome could be divided government.
It is our view that Covid-related supply chain disruptions and government stimulus programs have been a bigger contributor to inflation than Fed policy. If supply chains ease and there is a stalemate in Washington, both of those inputs could change. We think that could occur when we are lapping the bump in prices from 2021. So, while the Fed has signaled its plans, things have a way of evolving that could alter those plans in a variety of ways.
