December 31, 2021


     Despite elevated inflation, renewed COVID concerns and heightened market volatility, the resilient economic recovery largely remains on track.  A tight jobs market and strong wage gains are supportive of consumer spending.  Although the November payrolls underwhelmed, the unemployment rate has declined rapidly, falling to 4.2% from 6.7% at the end of 2020.  Elevated retirement rates, health concerns and child-care disruption leading to lower female participation have constrained the supply of labor.  The October Job Openings and Labor Turnover Survey (JOLTS) showed job openings topped 11 million, close to its recent record high.  Initial filing for jobless benefits briefly fell below pre-pandemic levels and consumer prices continued to accelerate.


Boom Bust


     There are various factors pushing the inflation rate upwards.  The Consumer Price Index (CPI) showed another hefty increase in November with the year-over-year rate registering 6.8%, the highest level in nearly 40 years. The Personal Consumption Expenditure (PCE) Deflator rose to 5.7%, also a 39-year high.  With supply bottlenecks ongoing, the demand-supply imbalance is leading to elevated prices.  In addition, labor shortages are forcing companies to raise wages to attract and retain workers.  The increased labor costs are translated to higher prices on final goods and services.  Higher prices for key non-discretionary items such as food and gas are limiting what consumers can spend on other categories.   Higher inflation is proving persistent, and the Federal Reserve has taken note. 

Fed Funds and core inflation

     The tight labor market and inflation overshoot pushed the Fed to scale back its quantitative easing (QE) asset purchases more quickly.  At the Federal Open Market Committee’s (FOMC) final meeting of the year, the Committee announced that it would double the pace of tapering from $15 billion to $30 billion per month – reducing Treasury purchases by $20 billion and Agency mortgage-backed securities (MBS) purchases by $10 billion.  At this pace, the end of the QE program would occur in mid-March 2022.  With a greater focus on reigning in generation-high inflation, the Fed’s dot plot now shows the expectation to raise rates three times in 2022, followed by three rate hikes in 2023 and another two in 2024.




     In the post-meeting press conference, Fed Chairman Powell confirmed the hawkish pivot by the central bank.  He made clear that interest rate increases will not begin until the bond taper ends and said the Fed will take steps it has to take “in a thoughtful manner”.  While the Fed’s goal of “full and equitable” employment has not been fully met, the labor market is moving toward it.  At the end of the asset-buying program, the Fed will still have a bloated balance.  Powell acknowledged the sequencing and timing of bringing down its holdings would be discussed at upcoming meetings.

Consumer Sentiment and Spending

     The Fed could not be clearer about their planned path for short-term rates, but there are still risks that could cause the Fed to adjust or even abandon their plan to move toward normalizing rates.  The greatest risk to economic growth currently stems from the omicron variant of COVID-19.  It is spreading rapidly and widely and is causing some new restrictions on activity to be put in place.  The severity and extent of the new wave of the pandemic remains fluid and uncertain.  The fear is that it could disrupt the global economic recovery.  It has given rise to some skepticism that the Fed will raise rates as far or as fast as projected.