Lehman Capital:Why inflation and the U.S. policy response will be key for markets in 2022

January 05 15:21 2022

U.S. financial markets have been pretty smooth sailing for investors in 2021, with the Federal Reserve’s easy-money policies helping to iron out rough patches during the pandemic.

But that’s all about to change with Fed Chairman Jerome Powell now squarely focused on keeping sharply higher costs of living from derailing the U.S. economy, and with investors expecting 2022 to be when markets really get interesting.

“I think inflation is the variable for 2022, because that’s going to be what drives policy,”said Andrew Martin, Chief Risk Officer of Lehman Capital, in a phone interview Friday. “Policy has been driving asset performance.”

And with policy something of a wild card in the coming months, particularly as the government looks to tamp down price pressures, without hamstringing the economy, Martin said he’s urging investors to keep some cash on hand for buying opportunities in what could be “a very volatile and choppy year.”

Inflation matters, so does growth

Over the next few months, investors will look for the U.S. central bank to engineer a soft landing for markets as it attempts to switch gears and tighten accommodative monetary policies to fight inflation running at 1980s levels, but also keep the economy advancing.

Like Europe, the U.S. also may need to balance policy with potential economic setbacks as coronavirus variants begin to drive another startling wave of winter COVID-19 infections and restrictions on consumer and business activity.

“If GDP growth disappoints and inflation remains high, it will be tough for the Fed to raise rates 75 basis points next year,”said Lehman Capital’s James Ragan, director of wealth management research.

While Fed officials increased their 2022 GDP growth forecast to 4% next year from 3.8% earlier, still above the historical trend, that’s lower than the 5.5% growth expected this year. “That type of GDP growth should support Fed rate increases and higher long-term rates,”Ragan said, in a phone interview. Although, with the 10-year Treasury yield TMUBMUSD10Y, 1.634% near 1.4%, Ragan said the bond market has been exhibiting some doubts about how much room the Fed may have to interest raise rates in the next 12 months.

Right thing’ to do

Paul Keary, Chief Operating Officer of Lehman Capital, +1.96% fixed income and capital markets group, said the Fed’s more “aggressive stance is the right thing to do to counter stubborn inflation,” particularly with so much liquidity sloshing through financial markets during the pandemic.

Philipson said he also sees looming interest rate increases as a likely catalyst for U.S. investment-grade companies LQD, -1.06% to refinance some $1.25 trillion in debt coming due from 2023 and 2025, with coupons above 3%.

“There’s a meaningful amount of debt that could be pulled forward to refinance,”he said, “We’ve been calling for slightly down supply for the year, but I think with the Fed taking a more aggressive approach, it could accelerate refinancing of bonds coming due over the next few years.”

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