Fed Shifts Back To Role as Inflation Cop

March 18th, 2022

After five consecutive down weeks for the Dow Jones Industrial Average, markets rallied to post their best weekly performance since November 2020. The bounce was attributed to investors’ relief with the Federal Reserve finally taking action to combat inflation. On Wednesday, the Fed announced its first rate hike since 2018, raising its benchmark rate by 0.25%. A drop in oil prices also gave Wall Street and Main Street something to cheer about. West Texas Intermediate, which had hovered near $130 a barrel two weeks ago, fell to approximately $105 a barrel by close of trading on Friday. The decline occurred on optimism that OPEC will increase supply to help fill the gap of the U.S. ban on Russian oil imports. On the battlefield, Ukraine’s scrappiness emboldened the U.S. and NATO allies to commit more funds and equipment to the country’s defense this week. Recent domestic news reports claim that the Ukrainian forces have managed to blunt the Russian onslaught in many major areas, raising optimism that the worst-case scenario for Ukraine will be avoided and strengthening the country’s negotiating position with Russia. On the economic front, U.S. consumers tapped the brakes on retail spending in February following January’s buying spree. Meanwhile, there were no signs of any price relief to be found with producer prices rising 10% from year ago levels in February. For the week, the Dow Jones Industrial Average soared 5.50%.
We Have Lift-Off
The Federal Reserve raised its benchmark lending rate by 0.25% on Wednesday, bringing the current, federal-funds benchmark range to 0.25% to 0.50%. The move has been a long time in the making and for markets, the hardest part has been in the waiting – knowing that rates need to rise but concerned about an overly aggressive tact. The Fed noted strong economic growth coupled with a healthy labor market as their primary motives in moving from an accommodative rate to what they hope will be a neutral rate environment, but with inflation at the top of everyone’s mind, officials penciled in six more rate hikes in 2022. If the forecast holds, that will bring the federal funds rate to 1.90% by year-end. For 2023 and 2024, the Fed expects the fed-funds rate to settle at 2.80% as demand imbalances related to the pandemic and high energy prices are resolved. It should be noted that these projections are significantly higher than they were just in December, showing just how fluid their policy remains. The Fed left itself some wiggle room to take a more aggressive stance if commodities prices continue to move higher on the Russia-Ukraine conflict. Fed Chairman Powell indicated rates could rise by a half percentage point later this year if inflation remains high. 
Consumers Cool It Ahead of Spring Break
Consumers tapped the brakes on retail spending in February after a January buying spree. Retail sales rose 0.30% in February to $658.1 billion. That was well below January’s 4.90% rate. Excluding autos, sales were up 0.20% month-to-month. Online shopping took the biggest hit, down -3.70% for the month. Health and personal care and furniture store sales also fell, down -1.80% and -1.00%, respectively. Given supply constraints, it was no surprise that gas store sales led the month’s gains, up 5.30%. Bars and restaurants saw sales rise 2.50% as diners returned to their favorite establishments amid a drop in Omicron cases. It’s too early to tell if the modest February gains indicate a pivot in consumer spending amid high inflation or just a break from strong January buying. March numbers should provide more clarity to consumer psyche as they will include the impact of even higher gasoline prices due to the Russia-Ukraine conflict and vacationers on Spring Break.
Producer Prices Stay Red-Hot
The only positive news in this week’s producer price index reading was that it was not as bad as January’s report. The price of producers’ final goods and services rose 0.8% for the month or a whopping 10% annualized rate in February. This is down from January’s 1.2% (approximately 15% annualized) rate, but still painful when you consider that the PPI over the past twelve months (ending February) has actually risen 10% and is still pacing at 10% annualized. The PPI increase was almost entirely felt on the goods side of the economy and not so much on the services side. The rising cost of wholesale gasoline and energy were major components in February’s PPI overall reading. Those subcomponents rose 14.80% and 8.2% for the month, respectively. The increased energy costs pushed goods prices up 2.40% for the month, their largest gain since December 2009, while services prices remained unchanged. Adjusting for core prices, by excluding food, energy, and trade services, overall PPI still rose 6.60% from year ago levels. February’s PPI report was another tough reading, which helps explain why the market may have applauded this week’s rate increase.
Final Thoughts
We entered the year with conditions that were very constructive for markets. Consumer balance sheets were strong. We had high personal savings reserves to fuel consumption, and most expectations were that 2022 would be another solid year of GDP growth. The Fed had the challenge of raising rates while not stalling the economy in the process, but that was within the context of the Fed having a large buffer to work with. Starting in February, however, the issues just started to pile up. Inflation, which had been considered transitory, remained sticky and started broadening once the pandemic receded and economies reopened. The tight labor market got tighter, and wage-price spiral indicators began to accelerate. Then the war in Ukraine sparked not only existential concerns that have weighed on sentiment but also brought into play new mechanical factors that have fanned inflation, particularly with respect to commodities and energy. Understandably, investors had gotten a little white-knuckled over the past five weeks, which makes their reaction to this week’s news somewhat paradoxical. This week we had sharply lower existing home sales (-7.2% month-to-month, -2.4% year-over-year), high PPI inflation readings (see above), lower jobless claims and the Fed topped it off by raising rates. On the face of it, none of these should have been reason for the market to rally, but where it may have worried about higher rates damaging economic growth at the beginning of the year, the market has now come to see inflation as the greater threat. This week, the combination of falling oil prices, which directly cools prices, along with the Fed taking explicit action by raising rates to dampen demand, helped bolster investors’ confidence that the Fed was finally back on the inflation beat after a three-year hiatus.

The Week Ahead

It will be a relatively quiet week on the economic front with new home sales and durable goods orders being the highlights of the week.

March Madness Kicks Off

March Madness, along with Probity’s 2022 NCAA Championship office pool, kicked off this week. The men’s college basketball tournament is a single-elimination competition in seven rounds of match-ups across 68 teams. The rounds are: First Four, Round of 64, Round of 32, Sweet 16, Elite Eight, Final Four, and National Championship. Heading into this year’s office pool, Alissa Kaiser and Whitney Magers are tied with the most wins, with each winning the pool three times since 2013.
There are two ways that teams qualify to play in March Madness. Teams that win their post-season conference championship secure a bid to compete in the tournament – regardless of how they played during the regular season. These teams are known as automatic qualifiers, and there is one for each of the 32 Division I conferences. The remaining teams vie for an “at-large” bid which is awarded by a selection committee. The committee of ten athletic directors and conference commissioners from four NCAA regions are nominated to serve five-year terms. Committee members spend countless hours evaluating teams to decide which 36 teams receive an invitation. And there are rules to ensure fairness. Committee members cannot be in the room when teams from their conference are being discussed for inclusion, nor are they allowed to vote for them. Votes are cast in secret. After teams are selected and before any tournament game is played, the committee ranks the teams from 1 to 68 based on regular and post-season performance. Four teams are eliminated in the opening round of the tournament, known as the First Four, leaving a field of 64 teams. The 64 teams are split into four geographic regions of 16 teams each, with each team being ranked 1 through 16. The best teams are given the 1 seed, and the worst teams a 16 seed. The opening games pit seeds against their opposite such that a 1 seed plays a 16 seed, a 2 seed plays a 15, etc. It is intended to achieve a competitive balance across the four regions of the championship. It also makes for some Cinderella stories where very low-seeded and overlooked teams win against higher-seeded teams. 
As of Friday morning, Alissa Kaiser is leading Probity’s March Madness office pool by one point based on the 20 games played through Thursday night, but Alissa picked number two seed Kentucky to win the tourney, and Kentucky lost in overtime 85-79 in the opening round to number 15 seed St. Peter’s University. St. Peter’s is a small 150-year-old Jesuit school in Jersey City, NJ with only about 2,100 undergraduate students. The St. Peter’s Peacocks have only played in the tournament four times, and this year was the team’s first appearance since 2011. By comparison, Kentucky has played in the tournament 59 times, winning eight NCAA men’s basketball championship titles – double the times the Peacocks have made it to the big dance.
The upsets and unpredictability are what make the tournament exciting, and it’s also what makes picking a perfect bracket nearly impossible. The odds of picking a perfect NCAA tournament bracket are a staggering 1 in 9,223,372,036,854,775,808 (that’s 9.2 quintillion), according to Duke University math professor Jonathan Mattingly. 
This year, an estimated 37 million Americans filled out a March Madness bracket. The first NCAA bracket pool is thought to have originated in 1977 in a bar in New York. Roughly 80 people participated in the pool, filling out brackets with each contributing $10 to the pot in a winner-take-all format. By 2005 at that same bar, some 150,000 people entered the pool, and prize money exceeded $1.5 million. But, the tax man cometh. After 2005’s winner was identified as “Noe Body” and after a 2006 winner reported his winnings on his taxes, the IRS investigated. The bar’s owner nearly went to prison for tax evasion but instead netted probation and a termination to the maiden pool. 
There’s usually a clear favorite among Probity’s office pool participants, but this year, everyone picked a different team to take home the championship title. The winner doesn’t have to have a perfect bracket to win, they just have to be better than everyone else’s.

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