While central banks look to contain the inflationary pressures of the post-pandemic recovery, global supply shortages continue to present major challenges for the recovery.
Feds signals when tapering will begin
Federal Reserve Chair Jerome Powell recently announced that the Fed could begin tapering its asset-purchase program in November.1 The start of the process may coincide, he said, with the next Federal Open Market Committee meeting, which will be held November 2-3.
While Chair Powell cautioned that the timing of the tapering would not establish a countdown for when interest rates will be raised, he did say rates would not increase until the tapering process is completed. That may not be until the middle of next year.
Chair Powell is reported to be more dovish than many of his colleagues on the Fed’s Board of Governors who might favor a more hawkish approach to the timing of tapering.
Other central banks are also taking a more aggressive stance to fend off inflation. This month, Bank of England (BoE) Governor Andrew Bailey said the BoE could raise rates before the end of this year and even before its bond-buying program expires.2 While Governor Bailey acknowledged the importance of not impeding the United Kingdom’s nascent economic recovery, England’s central bank appears more ready than its American counterpart to take aggressive steps to curb inflation.
The central banks in Mexico, the Czech Republic and Colombia have raised interest rates, as well. While the increases can help curb inflation, they also post a challenge for many companies. Higher rates increase the cost of borrowing. That higher expense is often felt most by younger firms that are not yet profitable and still highly dependent on debt to finance their growth.
Higher bond rates spur the growth-to-value stock rotation
The Fed’s broad comments on a timetable for tapering and rate hikes caused bond prices to decline. With higher yields available on the 10-year Treasury, investors became more concerned about the relative value of tech stocks, with their low dividend yields and lofty valuations.3 Those concerns caused a selloff in tech stocks, as the market seems momentarily less comfortable with growth stocks and more optimistic about the prospects for the value names in economically sensitive sectors like financial services and energy.
Higher economic growth could, ironically, help value stocks more than their growth counterparts. At times of low economic growth and low interest rates, investors are willing to pay more for the pockets of the economy where higher growth can be found. When growth is more widespread across many sectors, and cyclical stocks are doing well with the economic uptick, investors are more willing to question the valuations given growth stocks. That prevailing sentiment helps value stocks, and they have historically done well in recoveries.
Strong growth in U.S. this year
The U.S. economy grew at an annual rate of 6.7% in the second quarter of 2021, according to revised numbers from the Bureau of Economic Analysis.4 That promising news came even amid the spread of the Delta variant. But there is cause for hope on that front, as well. Delta arrived earlier in Europe, and new cases already seemed to have peaked there. If the U.S. follows suit, the rise in new cases caused by Delta might start to slow. Gaining some control over the virus and reducing its disruptive impact would only enhance the prospects for strong economic growth to continue in the months ahead.
A short-term compromise on the debt ceiling debate
Faced with an October 18 deadline for a vote on whether to raise the debt ceiling, Senate Majority Leader Chuck Schumer of New York announced on October 7 that a compromise had been reach with Republicans to increase the ceiling through early December.5 Senator Minority Leader Mitch McConnell agreed to the compromise to avoid the risk of the U.S. government defaulting on any of its debt.
The extension will give Democrats more time to determine if the budget reconciliation process can be used to lift the debt ceiling on a more permanent basis. Through budget reconciliation, only 50 votes are needed to pass legislation, a majority the Democrats have. Under normal procedure, 60 visits are required to break the filibusters that can be used to block legislation. With the likelihood that no Republications would vote for the debt celling increase, a permanent measure could not be passed under normal Senate procedure.
Haggling over major legislation continues
Democrats have set the end of the month as the deadline for passing two key components of President Biden’s economic agency – an infrastructure plan and a significant boost in spending on social programs.6 An original proposal to spend $3.5 trillion on infrastructure has been deemed as too little by progressives in the party, while Senator Joseph Manchin of West Virginia has proposed spending no more $1.5 trillion. Senate Majority Leader Chuck Schumer of New York is now trying to broker a compromise between the progressive and moderate sides of his party.
Facebook revelations could lead to tighter regulations for tech
Frances Haugen, a former employee of Facebook, testified before Congress on October 5 that the social media giant often puts its own profits ahead of public safety by using algorithms that steer users to high-engagement posts that have harmful content.7 Haugen has also filed a whistleblower complaint with the Securities and Exchange Commission, claiming that Facebook misled its investors and advertisers by not accurately revealing how much it knew about the ways disinformation is spread on its platform and what it is doing to combat the problem. While Facebook dismissed Haugen’s allegations, the revelations seem to have raised enough concerns among the public and members of Congress for legislators to consider increased restrictions on technology companies.
China steps up its efforts to ban cryptocurrencies
This month, Chinese officials announced that cryptocurrency transactions are banned in China, and they will take steps to stop the mining of digital currencies.8 In response, Huobi, a popular offshore crypto exchange, stopped allowing new users to register if they have a phone number from mainland China. Huobi also said it will retire existing user accounts from mainland China by December 31.
Bitcoin declined on the news, but previous crackdowns in China have led to a brief setback that was followed by a rally for the digital currency.
Some investors in digital currencies did view China’s latest moves as a buying opportunity. This latest ban does appear to be more decisive and restrictive than previous measures. It remains to be seen what long-term impact this crackdown will have on digital currencies.
Shortages led to panic-buying of fuel in the United Kingdom
Shortages of gasoline caused a run on petrol stations across the United Kingdom.9 The panic buying only increased the number of stations that didn’t have enough supply to meet the demand. Long queues, reminiscent of those seen in the U.S. during the Arab oil embargo of the 1970s, formed at stations where fuel was still available.
A combination of factors has created the shortages. The supply chain disruptions brought on by the pandemic have contributed. Uncertainties about COVID-19 and the status of immigrant workers under Brexit have also sent many delivery truck drivers back to their home countries.
In response to industry demands, the government had to issue 5,000 short-term visas, which was a reversal of Prime Minister Boris Johnson’s Brexit policies on immigrant workers. Still, many predict that will not be enough. The army has been put on standby, as drivers from the military ranks may be needed to make fuel deliveries.
There are concerns that the shortages could hurt the U.K.’s post-pandemic recovery, and that would only heighten the supply-chain problems.
Shortages of natural gas globally have also brought a surge in prices and raised concerns that heating homes and powering manufacturing plants could become a challenge this winter.10 The supply constraints could be a major impediment to the recovery economies around the globe have been experiencing. The shortages, along with higher Treasury yields, and the Republican-Democrat standoff on raising the debt ceiling have built a substantial wall of worries for equity investors.
Supply chain problems are having a widespread impact
The supply chain challenges faced by the Kohl’s, the department store retail chain, caused its stock to plunge. Bank of America changed its rating on the stock from “buy” to “underperform” because of concerns about the retailers’ supply-chain problems. With the potential for items to be out of stock in Kohl’s promising active and women’s private-label apparel business, analysts and investors concluded Kohl’s post-pandemic recovery would be stalled.11 While the ratings downgrade on Kohl’s attracted the headlines, its issues are simply one attention-getting example of a supply problem that is plaguing many companies.
Evergrande’s troubles not likely to be a “Lehman moment”
U.S. investors have also been skittish about the implications of the Chinese real estate developer Evergrande defaulting on its debt. Some fear that a default could be a “Lehman moment,” as the U.S. investment bank’s collapse in 2008 is considered to have been a harbinger of the impending Global Financial Crisis.
The fears about the global implications for any troubles Evergrande may have in meeting its debt obligations may be exaggerated. The ripple effect of any default should be limited to China. Even that impact may be contained. While the company does have $300 billion in debt, China, given the size of its GDP, should be able to absorb any hit.
Tags: Inflation, Interest rates, Taper