Are Retail Reports a Sign of a Slowing Recovery?

Will Increasing Oil Prices Put a Ceiling on Global Economic Growth?

How Will Uncertain Inflation Outlook Impact Stock Market?

Will The Federal Reserve Create a Taper Tantrum in 2021?

How Will a Steepening Yield Curve Impact Markets?

How Will the Projected Commodity Super-Cycle Impact Investors in 2021?

Commodity Super-CycleAs the January 2021 World Bank Pink Sheet documented, prices increased month-over-month from November 2020 to December 2020. Highlights include the price of oil jumping by 15 percent. The cost of fertilizer jumped 2.2 percent, grains increased by 3.8 percent and iron ore jumped by 25 percent. While there’s been no official “commodity super-cycle,” according to economists or financial analysts, the trend certainly shows commodity prices increasing.

2020 caught the world off-guard with the coronavirus pandemic, sending the price of oil negative. According to Rice University’s Baker Institute for Public Policy, on April 20, 2020, “the prompt contract price” or how much a barrel of West Texas Intermediate (WTI) cost for May 2020 deliveries went negative, falling $50. It eventually rebounded to $45 per barrel in November as vaccine optimism began to take hold.

For other commodities, the story was not as bad, signaling what might be another commodity super-cycle. On Aug. 4, 2020, gold broke the $2,000 mark. With central banks and governments spending to support the economy due to the pandemic, it put pressure on global currencies. For example, with the U.S. dollar index dropping nearly 10 percent from March 2020 to August 2020, precious metals such as gold became a hedge against inflation.

Many would assume that commodities surged in part from the economic damage of COVID-19 but, looking at the data, commodities were seeing a resurgence at the start of 2020 – well before the pandemic negatively impacted the global economy.

With data as recent as March 5, the International Monetary Fund shows how commodities changed before the pandemic, during, and as the recovery is underway for the first two months of 2021. Looking at the IMF’s “Actual Market Prices for Non-Fuel and Fuel Commodities” chart, one can see how commodities bottomed out during the pandemic and are showing signs of significant growth.

One metric ton of wheat was $186.10 in 2018, $163.30 in 2019, $185.50 in 2020. In Q1 of 2020, it was $173.80, Q2 was $174.80, Q3 was $183.00, Q4 of 2020 was $210.5. Then the first two months of 2021, one metric ton of wheat was $237.90 and $240.80, respectively.

For metals, one metric ton of copper was $6,529.80 in 2018, $6,010.10 in 2019, $6,174.60 in 2020. In Q1 of 2020, it was $5,633.90, Q2 was $5,350.80, Q3 was $6,528.60, Q4 of 2020 was $7,185.0. The first two months of 2021, the price was $7,972.10 and $8,470.90, respectively.

Spot Crude priced per barrel in U.S. dollars was $68.30 in 2018, $61.40 in 2019, $41.30 in 2020. In Q1 of 2020, it was $49.10, Q2 was $30.30, Q3 was $42.00, and Q4 of 2020 was $43.70. Then the first two months of 2021, Spot Crude was $53.50 and $60.50, respectively.

For the Spot Crude figures, the IMF uses the Average Petroleum Spot Price (APSP), which averages equally three crudes: West Texas Intermediate, Dubai, and Brent.

Will China Lead the Globe’s Super-Cycle?

As the United Nations defines it, a super-cycle is when there’s a paradigm shift toward increased demand, lasting at least a decade and up to 35 years “in a wide range of base material prices.” It focuses on “industrial production and urban development of an emerging economy.”

Looking at China could signal what the globe will follow economically. According to Refinitiv, China saw a positive growth of 2.3 percent of its GDP in 2020, compared to the global average of -3.5 percent. As the world emerges from the pandemic, it will undoubtedly consume more commodities. When it comes to 2021 GDP expectations for China, the World Bank expects the country to grow by 8 percent to 9 percent.

Looking forward to 2022, Eikon predicts that China’s GDP will grow by 1.6 percent more than the rest of the world, and 3.1 percent higher than America’s GDP expected growth rate in 2022.

Much like the pandemic was not in anyone’s economic forecast, if the global economy is in a commodity super-cycle, savvy investors will be ahead of the curve if a super-cycle materializes. 

How Will the Biden Administration’s China Policy Impact Markets?

The Obama and Trump administrations couldn’t have had a more different approach when it came to U.S. relations with China. As the Institute for China-America Studies (ICAS) explains, under the Obama administration, the United States favored a trade and investment approach when dealing with China, while the Trump administration had a national security focus. The ICAS believes the Biden administration will address trade and economic imbalances through a modified approach, including reducing tariffs on imported Chinese goods over time to decrease inflation for American consumers. Another example is maintaining pressure on China to cut government subsidies for competing industries, currency games, and exporting products to the United States at artificially low prices.

While the Obama administration engaged China through trade and investments, it didn’t emphasize engaging the country on the national security side. The Trump administration looked to make American industries independent of Chinese production, especially for rare earth metals, pharmaceutical precursors, etc. With the inauguration of President-elect Biden, the incoming administration is expected to maintain the Trump administration’s quest to give many American industries a fighting chance of survival, albeit how it will be accomplished will likely vary.

The Biden administration is projected to lower tariffs on Chinese imports gradually. This is expected to be done to reduce the tension of the existing trade war. It’s also expected to be done to lower the rate of inflation and help businesses that import input materials from China.

Based on statistics according to the American Action Forum, approximately $57 billion was paid by consumers on an annual basis per 2019 import numbers, due to tariffs instituted by President Trump. This action is likely to increase consumer spending and increase companies’ earnings. However, the Biden administration is still expected to keep other forms of trade pressure on what many believe are unfair trade practices by China.

Biden also is expected to raise the same concerns the Trump administration did regarding Chinese trade and commerce, including China subsidizing its industries, flooding the American market with goods to undercut American producers, and requiring so-called forced technology transfers from U.S. companies.  

However, the trade deficit the U.S. has with China isn’t expected to see much attention. This could negatively impact how much China is ultimately expected to import from the United States.

When it comes to colleges and universities, research-based collaboration, and artistic-based areas, relations are expected to be more friendly. However, when it comes to fighting China’s human rights violations, individuals or business entities might be targeted. Based on Vice President-elect Kamala Harris’ proposed Uyghur Human Rights Policy Act of 2020, there’s an expectation the Biden administration will keep the pressure on China.

Beginning in 2017, Biden began to discuss plans for America and how some of America’s crucial industries could be more self-sufficient and less reliant on China. Examples include pharmaceutical products, medical equipment, and rare earth minerals.

Potential actions the Biden administration could implement against China include sanctions; U.S. government-sponsored legal action against Chinese firms; and becoming more involved in the World Trade Organization (WTO) and similar organizations. This is seen by some as the U.S. becoming more in-step with Europe to better pressure China in WTO and related disputes. It might also include courting America’s allies in reducing or prohibiting Chinese investment of domestic industries to make it more difficult for Chinese firms to obtain cutting-edge technology.

While there is no way to accurately predict how the Biden administration will treat China, there will likely be continued pushback on China. How these actions will ultimately impact trade and the markets will be seen in the near future.

How Will the Biden Administration Influence the Federal Reserve?

With the nation on the precipice of a transition of administrations on Jan. 20, 2021, there will need to be many roles filled both in and out of the White House. With the potential for Janet Yellen to replace Steven Mnuchin as the next treasury secretary, there is much speculation about how the Federal Reserve will be shaped by the Biden administration.

Predicting Changes to the Federal Reserve

When 2022 arrives, Chair of the Federal Reserve Jerome Powell’s term will expire. While presidents have historically given another term to first-term chairs who were appointed by the outgoing administration, there is no indication that Powell will stay on for another year. President Trump deviated from this norm when he appointed Powell to replace then-Chair Janet Yellen. Originally appointed by Obama to the Fed in 2012, Powell was first a Fed governor and a Republican politically.

First Vice Chair Richard Clarida’s term expires in January 2022. Vice-Chair of Banking Supervision Randal Quarles’ term expires in October 2021. Both vice-chairs are expected to be replaced when their terms are up.  

With two Fed board seats still unfilled, and if the Biden administration nominates Fed Governor Lael Brainard to become the next Treasury Secretary, it would create a third Fed board seat opening. Brainard is favored as a strong candidate because many economic experts see a need for the Fed and the U.S. Treasury to work together closely.    

While President Trump attempted to fill one of the empty Fed seats with Judy Shelton, on Nov. 17, the U.S. Senate declined her nomination to sit on the Federal Reserve Board of Governors; Christopher Waller still could be confirmed during the Senate’s post-election session. Assuming he doesn’t get confirmed before Congress adjourns and 2020 closes, the nomination will expire.

What’s Not Expected to Change

When it comes down to how the Fed handles monetary policy, chances are things won’t change much from the current status quo. Since the U.S. economy is still in a malaise due to the harmful effects of the COVID-19 pandemic, the Fed has made a crystal-clear statement that interest rates will remain at “near zero” for the next 36 months, at a minimum.

In August 2020, the Fed announced that it’s recommitting itself to maintain existing rates as the economy emerges from the downturn for a longer period of time, compared to past Federal Reserve efforts to spur economic growth. Then on Nov. 5, the Federal Reserve’s FOMC Statement reinforced that the federal funds rates will stay at 0 percent to ¼ percent, as long as economic growth is threatened.

Promoting Diversity

Part of the Democrats’ legislative agenda is for the Fed to take action to reduce racial inequality. The objective is for this to become part of the Fed’s existing mandate, which currently includes price stability and maximum employment. If President Biden endorses this legislation, it would likely have an even greater impact on the Fed.

Another thing to consider is that Biden is expected to appoint more minorities to the FOMC, which, with the exception of Janet Yellen serving a four-year term, has been all white men.

Many at the Fed already recognize the importance of including all Americans in opportunities to benefit from a robust economy. During August 2020, the Fed announced that it is taking its time boosting interest rates, in contrast to how it handled past economic challenges, in order to produce an economy that favors job seekers, especially minorities.

Chairman Jerome Powell explained to the media that the Fed is ready and able to implement its financial instruments to prop up the economy and ensure that the country’s emergence from COVID-19 will be assisted. Powell has called on Congress to pass more stimulus, especially to help those who lost jobs from the pandemic.

Depending on who is selected and confirmed as treasury secretary, there could be a renewed hope for recently discontinued stimulus programs, some in conjunction with the Fed. In a letter dated Nov. 19, Treasury Secretary Steven Mnuchin indicated to Jerome Powell the following Federal Reserve programs that will cease functioning on Dec. 31, 2020:

  • Program 1: Primary Market Corporate Credit Facility (PMCCF)
  • Program 2: Secondary Market Corporate Credit Facility (SMCCF)
  • Program 3: Municipal Liquidity Facility (MLF)
  • Program 4: Main Street Lending Program (MSLP)
  • Program 5: Term Asset-Back Securities Loan Facility (TALF)

Funded via Congress’ CARES Act, these programs give the Fed the power to loan as much as $4.5 trillion to markets.

Naturally, this move is currently opposed by the Fed because it takes away additional tools that can be deployed to support the economy and its underlying financial systems. Treasury Secretary Mnuchin’s actions will return $429 billion from the Fed to Congress to be re-appropriated.

One program that will be lost is the MSLP, which was recently modified to give loans as small as $100,000 per applicant. With no more access by year-end, this will likely impact smaller businesses.

It is noteworthy that the following programs were extended for an additional 90 days after Dec. 31, 2020. These include Commercial Paper Funding Facility (CPFF), Market Mutual Fund Liquidity Facility (MMLF), Primary Dealer Credit Facility (PDCF), and Paycheck Protection Program Liquidity Facility (PPPLF), used to shore-up money market liquidity. Though, depending on who is the treasury secretary in 2021, there might be a reconsideration of any or all of these programs. 

How Would a Second Stimulus Check Impact Markets?

The $1,200 stimulus check sent out to individuals had mixed impacts on our economy, based on academic research, including by the University of California-Davis. For recipients with $3,000 or more in their bank accounts, there was no positive impact on the economy. However, for recipients with bank account balances up to $500, they spent 44.5 percent of their check, on average, within 10 days of receiving the stimulus check.

The first stimulus check was part of the CARES Act, which guided how the checks were issued:

The IRS began with those who filed 2018 and/or 2019 taxes, and looked at their adjusted gross income (AGI) as a starting point.

  • For “eligible individuals,” they received a full $1,200 check if they earned up to $75,000. If they earned between $75,000 and $99,000, the payment would be reduced by $1 for every $20 earned beyond $75,000. If they earned $99,000 or more, they would not be eligible for a stimulus check.
  • For “head of household filers,” they would get a $1,200 check for earnings up to $112,500. For earnings up to $136,500, the payment would be reduced by $1 for every additional $20 earned. If they earned $136,500 or more, they would not be eligible for a stimulus check.
  • For “married couples filing joint returns,” they would get a $1,200 check for earnings up to $150,000. For earnings up to $198,000, the payment would be reduced by $1 for every additional $20 earned. If they earned $198,000 or more, they would not be eligible for a stimulus check.

Depending on the filer, if they had a qualifying child 16 years or younger who they claimed on their tax return, each child could qualify for $500 in additional stimulus funds.

While the language is still subject to change because there’s no legislation passed and signed into law, uncertainty still exists regarding proposals for a second stimulus check/plan.

One proposal includes increasing the payments for dependents to $1,000 from $500. Another proposal includes casting a wider net for dependents – college students and/or older parents who reside in the same household, giving $500 for this category.

A September report by the National Bureau of Economic Research (NBER) shows how consumers across the income distribution levels handled their stimulus checks.  

The NBER study found that once a stimulus payment was received, the typical individual spent $250 per day, compared to $90 a day before stimulus checks were available to recipients. Within 10 days, more than 20 percent of each dollar was spent. However, the report found different activity depending on the respondent’s income level and job security.

The study found that for recipients with checking accounts with more than a $4,000 balance, only 11 cents of stimulus money was spent in the month following receipt of their check. Looking a month out from when a stimulus check was received, those who had more assets were far less likely to spend their check quickly. However, for respondents with bank account balances of less than $100, more than 40 percent of their stimulus check was spent within one month.

These consumer expenditures offer a good indicator of how spending from another stimulus check would impact the economy. As the U.S. Department of Labor and U.S. Bureau of Labor Statistics show for 2019, there are different spending trends for each quintile or income strata (20 percent per quintile) for different income levels.

During 2019, each quintile increased, with the bottom quintile’s income growing by 6.6 percent, compared to the top quintile’s income growing by 6.7 percent. Quintiles two through four saw increases of income between 3.2 percent and 4.9 percent.

For reference, the 2019 “lower income bounds” are as follows:

  • Second quintile: $22,488
  • Third quintile: $43,432
  • Fourth quintile: $72,234
  • Fifth quintile: $120,729

“Average annual expenditures” for 2019 were $63,036 for “all consumer units,” or 3 percent more than 2018. A consumer unit is defined as either a family, an individual living on his or her own, and/or sharing costs with others or maintaining a residence with other individuals, but retaining the financial means to take care of themselves.

During 2019, while every quintile increased spending, the bottom quintile spent 8.6 percent more, versus the second quintile increasing their spending by 1.3 percent. All quintiles saw growth in spending for food at home, housing, transportation and cash contributions. Except for the second quintile, healthcare expenditures increased. For the food away from home category, the first, third and fifth quintiles increased spending. For apparel and services, the first, third and fourth quintiles saw increased spending.

Based on analysis conducted after stimulus checks were issued to individuals and families, sending out an additional stimulus check to those in the lower to mid-quintiles, along with promoting job growth and a strengthening job market, looks like the best way to help the economy recover. 

Examining Fed’s New Targeted Inflation Policy

Looking back to 2012, the Federal Open Market Committee (FOMC) – a collaboration of the 12 regional Fed banks and the Federal Reserve Governors in Washington – came together and published a Statement on Longer-Run Goals and Monetary Policy Strategy.

This officially rang in the FOMC’s public commitment to maintain inflation at 2 percent. It is based on a yearly change in the Personal Consumption Expenditures (PCE) price index, and is in accordance with The Federal Reserve’s “mandate for maximum employment and price stability.”

Guided by three events in the economy, according to the Brookings Institution, the FOMC was prompted to take a second look at 2012’s existing framework. The first factor, an approximation of the “neutral level” of interest rates, or interest rate levels correlated “with full employment” and inflation targets, kept dropping globally. The “lower neutral rate” is achieved when short-term interest rates, which are controlled by The Fed, stay at levels closer to zero versus higher levels. When this occurs, The Fed has little room to further lower interest rates, and therefore stimulate the economy. The next factor involves inflation rates and anticipation for future inflation rates to stay below The Fed’s 2 percent target. The last factor was unemployment falling to a five-decade low.

The FOMC’s Aug. 27 update reveals that the inflation rate has been lower than the 2 percent inflation target in recent years, despite housing, food, and energy increasing in price for consumers.

When there’s too little inflation, as The Fed explains, it can negatively impact the economy. If inflation remains below The Fed’s “longer-run inflation goal,” it can propel a self-fulfilling prophecy of further declining inflation levels.

As originally explained in 2012 and updated in August, the FOMC’s purpose is to “promote maximum employment,” keep prices stable, and “moderate long-term interest rates.” It also guides individuals and business owners with more information to make decisions, promotes greater “economic and financial certainty” and increases “transparency and accountability.”

The Fed, based on their FAQ section, has said that when inflation runs below 2 percent for an extended period of time, monetary policy will adjust to run above 2 percent for a period of time. Therefore, the FOMC is hoping to ensure that “longer-run inflation” will average at 2 percent.

The FOMC’s monetary policy is a big determinate in keeping the economy stable when the economy and financial systems are put out of balance due to factors such as inflation, long-term interest rates, and employment. The FOMC accomplishes its monetary policy via the “target range for the federal funds rate.”

Looking at the “level of the federal funds rate consistent with maximum employment and price stability over the longer run,” this rate has dropped compared to past average rates. With this in mind, the federal funds rate is generally expected to remain on the lower end of the rate spectrum more so now, versus years back. With interest rates closer to the bottom end, the FOMC believes that inflation and employment perils are more likely to stay depressed.

Based on comments from The Fed in August, the FOMC clarifies its Congressional Mandate regarding price stability and maximum employment, along with determinations on its short-term interest rate and other monetary policy considerations.

Following up on its Congressional mandate for The Fed to ensure maximum employment and price stability, the first thing to focus on is price stability or inflation.

Before, The Fed had a price stability target of 2 percent inflation, based upon the Personal Consumption Expenditures price index. The FOMC called this price stability “symmetric,” meaning that inflation above or below the target is equally concerning.

However, its new stance will now focus on attaining “inflation moderately above 2 percent for some time” after an ongoing time period of tame inflation. Based on comments from Fed Chair Jerome Powell, this is a flexible form of average inflation targeting.

This end goal of average inflation targeting suggests that when inflation is below the 2 percent target over an extended period of time, the FOMC will adjust its policy to encourage inflation above the 2 percent target to attain balance. However, The Fed didn’t give details regarding the time frame for its new averaged 2 percent inflation target, nor did it specify what actions it will implement to achieve it.

The Fed also made noteworthy changes to its “maximum employment” mandate. When it comes to this measurement, it originally compared the projections of “the long-run rate of unemployment” to the unemployment rate. According to the Brookings Institution, this also can be referred to as “the natural rate of unemployment or the non-accelerating inflation rate of unemployment (NAIRU).”

Since live estimates of the NAIRU can be unreliable, it’s no longer being considered. While the Summary of Economic Projections will still include estimates of unemployment statistics by FOMC members, it will unofficially take the place of the NAIRU readings. However, these FOMC members’ long-run estimates of unemployment will have less impact on monetary policy decisions.

How Do Interest Rates Looking Going Forward?

With these two changes to The Fed’s Congressional mandates, many expect monetary policy to be quite loose over the coming years, according to the Brookings Institution. By permitting hotter than normal inflation and low rates of unemployment, there’s a remote chance The Fed will increase interest rates prior to inflation running north of 2 percent for a measurable time period.