Expecting trouble

Stocks gave up early gains on Friday after a sentiment indicator showed that consumers have low expectations for the future. Bonds yields climbed on Friday as traders factored in more hiking from the heavy-handed Fed.

Expect the worst. You have probably seen the word pop up from time to time when reading about inflation. Remember from what seems to be a lifetime ago how the Fed and others were referring to inflation as being transient? That was the Fed’s way of referring to inflation as something that was just temporary and unworthy of its attention. Of course, we now know that the Fed couldn’t have been more wrong in its assessment and that inflation has become more like an unwanted house guest who will simply not pack up and leave. The Fed has changed its tune and is in the midst of attempting to make things so uncomfortable for that houseguest that it will no longer want to stay. The word to which I was referring to at the top of my note was entrenched. Entrenched inflation has been and still is the Fed’s biggest nightmare.

When it refers to inflation as being entrenched, it is not necessarily using it to describe inflation as not wanting to leave, though that is part of it. Entrenched inflation has a deeper meaning to economists. There are several drivers of inflation. The most common cause is referred to as demand-pull inflation. This is an obvious one in which demand for products is so high that prices rise. That one is on you and me. That is also the one that the Fed is trying so desperately to freeze out by raising interest rates. We have also been treated to another inflation driver known as cost-push inflation. This is when supply of in-demand products is limited. An example may be a nearly empty car dealership lot which causes buyers to have to pay a premium over sticker price in order to get their hands on a vehicle. These are basic economic drivers. Both high demand and low supply lead to higher prices, and in this post-pandemic economy, we have been stricken by both.

There is a third lesser-known inflation driver which is referred to as built-in inflation. It is this one that is implied by the Fed’s use of the word entrenched. This occurs when society begins to expect inflation to remain for the long term. When consumers begin to expect inflation to persist, they demand higher wages from their employers. Now, I know that you are shaking your head saying, “so what, like I am going to go into my boss’s office and tell her that she needs to pay me more so that I can afford to buy eggs?” Well, of course, you can try that, but don’t tell her I sent you. What I was referring to was all those workers who are still holding out and not filling the more than 10 million unfilled job openings in the US. It is not just that some workers are holding out for better pay. According to the latest employment figures, the unemployment rate is the lowest it has been since 1968, which means that labor supply is small. Employers desperate to fill positions will have to pay up to fill positions. That is sort of like the car shopper from the above example, but in this case that burden lands on the producer. If producers must pay more for labor, then they will be forced to raise prices further to cover higher costs. This is called a wage-price spiral by economists who typically file it under: hopefully, that never happens. Unfortunately, the probability of that occurring increases the longer inflation hanging around. Inflation, now clearly not transient, has hung around for some time, and according to last Friday’s University of Michigan Sentiment release, consumers have been increasing their expectations for inflation in the year ahead… and even in the longer term. Could this be a sign that the much-feared entrenched inflation is taking root? It really is too early to tell, but we will learn quite a bit about companies’ employment intentions in the weeks ahead with earnings releases. We are getting more and more reports of layoffs which, at some point, will find their way into the economic releases. If the trend continues and the labor market slackens, that feared, entrenched inflation may be avoided.

EARLY BIRDS

Bank of America Corp (BAC) shares are higher by +2.4% in the premarket after it announced that it beat EPS and Revenue estimates by +4.03% and +4.16% respectively. Dividend yield: 2.77%. Potential average analyst estimate upside: +29.5%.

Bank of New York Mellon (BK) shares are down slightly in the premarket after the company announced that it beat EPS and Revenue estimates by +9.04% and +0.89% respectively. In that past 6 months, 42% of analysts have modified their price targets, 0 up, 8 down, and 11 unchanged. Dividend yield: 3.85%. Potential average analyst estimate upside: +24.9%.

FRIDAY’S MARKETS

Stocks gave up early gains closing lower after inflation expectations came in higher than expected. The S&P500 fell by -2.37%, the Dow Jones Industrial Average traded lower by -1.37%, the Nasdaq Composite Index dropped by -3.03%, and the Russell 2000 Index declined by -2.66%. Bonds fell and 10-year Treasury Note yields climbed by +7 basis points to 4.01%. Cryptos slipped by -0.17% and Bitcoin fell by -1.08%.

NEXT UP

• Empire Manufacturing (October) may have cooled to -4.3 from -1.5.
• Later this week: earnings announcements pick up and we will get Industrial Production, Leading Economic Index, housing numbers, and Fed Beige Book. Check out the attached earnings and economic release calendars for details.