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Will Delta delay the Fed?

Global financial markets had a remarkably calm and productive summer in the face of multiple investor sentiment challenges, with US and global equities continuing to perform well while bonds held up for the most part. Now as we enter September, investors seem to have lost some of the complacency they developed over the summer. September was the worst month for stocks historically, with an average decline of nearly 1% since 1928, according to Barron’s.

Investors face three major short-term challenges.

The spread of Delta

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First, the delta variant of COVID is wreaking havoc on our economy and the global economy. While employment remains fairly stable here in the US, global travel and trade are clearly suffering from Delta’s rapid expansion. It’s hard to quantify how much Delta has slowed our recovery, but it has certainly stunted many companies’ plans to get their employees back to the office. The lack of mobility for workers around the world has also further disrupted supply chains, resulting in higher prices for both raw materials and finished goods, as well as many items being out of stock in many industries. However, in the sometimes upside-down world of Wall Street, the ailing economy has likely slightly helped investor sentiment as it likely tackled Challenge No.

Fed needs to thread the needle

Second, an awkward move by the Federal Reserve to tighten monetary policy could unsettle markets. The Fed has begun to fear its possible tightening of monetary policy, but has so far delivered this message to the markets in a reassuring tone. The first step the Fed would take would be to “cut” its bond-buying program, which is currently helping to support bond prices and thereby keep yields low. The second step, if our economy gets back on track when the pandemic subsides, would be for the Fed to start raising rates. For many investors, the turn from tailwinds to headwinds in Fed monetary policy is a very big problem for both bond and equity performance in the years to come.

Inflation is lurking

Third, investors watch inflation indicators very closely for signs that inflation is either easing or stabilizing. While the Fed believes that inflation will be largely temporary and will subside once the global economy is out of the pandemic and normalizes (somewhat), it has not so far. The inflation data is still quite high, although the rate of increase is slowing. The producer price index (PPI) for August rose 8.3% year-on-year – a record. The August core PPI, which excludes food and energy, rose 6.3% year-over-year – another record. Many investors are unsure whether inflation has prevailed more permanently than the Fed expects. In the months ahead, they will want to see inflation indicators wear off and really not one day wake up and hear the Fed say it was wrong and that high inflation will stay here and flood us in the end.

The growth in corporate profits continues

Despite the above factors, corporate earnings should continue to grow well in the third quarter and full year. However, the pace of growth should continue to slow as we get past the very difficult earnings figures from the early phase of the pandemic. Despite the uncertainties on the macroeconomic side, the earnings outlook for 2022 remains positive.

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