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Whomever Biden appoints to run the Fed is going to have their hands full.

June 30, 2021
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The old hockey adage goes, “Don’t skate to where the puck is, skate to where you think it’s going to be.”

That same phrase could apply to investors once earnings season gets going in July. It’s not so much where the reporting companies have been or what they recently accomplished. Instead, both individual stocks and the market as a whole are more likely to move based on what firms say about the rest of the year. 

This could come in the form of official guidance, or more casually through comments on earnings calls. The things they say and the forecast could end up having a lot of influence over how markets perform this coming month and year. Earnings are important and either confirm or negate projections, but what they say is more important because it tells us what they are going to do in the future. 

While you always want to consider corporate guidance, it could be especially important this time around. That’s because corporate America is arguably at a crossroads coming out of the Covid pandemic. Many analysts expect Q2 earnings to be the peak of the recovery, with research firm CFRA predicting a 60.1% overall rise year-over-year in S&P 500 earnings per share. After that, its estimates drop to 20.6% for Q3 as companies start to lap the beginning of last year’s post-Covid recovery. 

The S&P 500 Index (SPX) hit a new record high in late June, but it’s also priced at a firm-level vs. analysts’ forward earnings estimates. Unless companies overwhelmingly surprise to the upside with their guidance for the second half, it may be tough to find new traction on Wall Street, and this long period of range-bound trading we’ve been in since May might be hard to break out of. When earnings optimism is high overall, like it is now, any company that disappoints or comes up short in some way could see shares get slammed. At the same time, even those that surpass estimates might already have priced in the good news and not see a lot of rewards.

As usual, there’s plenty on the July calendar other than earnings reports. Key touchpoints include another Fed meeting, more possible progress or lack of it on President Biden’s infrastructure bill, and a first look at how China’s economy performed in Q2 after an amazing 18.3% reading in Q1.

Obviously, none of the stuff that troubled Wall Street through May and June like inflation worries and rising crude prices is necessarily going away just because the month changes. Those two items are likely to remain in focus, along with the sudden rise in the U.S. dollar amid ideas that the Fed might turn more hawkish. This could mean the tug-of-war between so-called “growth” and “value” stocks continues for a while.

Last time around, the biggest Wall Street banks helped kick off earnings season with a bang. Firms like JPM, GS, and MS started 2021 on a high note thanks in part to heavy trading activity and fast-rising yields. Both of those factors are traditionally supportive, partly because if more people are trading and investing, more money tends to go into the banks’ wallets. And higher yields traditionally help the net interest margins not just of Wall Street behemoths, but of banks in general. The industry’s profit margins tend to rise when banks can lend money at higher rates which is coming. For now, those banks are trading at P/Es of over 100. 

Back to Washington:

One of the key decisions President Biden will make later this year is who is going to run the Federal Reserve for the next four years. Current Fed chief Jerome Powell's term as chairman runs out in February 2022. We think the choice will ultimately come down to two people: Roger Ferguson or Jerome Powell.

The case for Roger Ferguson is easy. First, presidents like to appoint people from their own party and Ferguson is a Democrat. Second, Ferguson already has experience at the Fed, having been appointed as a Governor and then Vice-Chairman by President Clinton in the late 1990s and serving through 2006.

Third, Ferguson has both a law degree and a Ph.D. in economics from Harvard. Fourth, he was the CEO at TIAA-CREF for almost thirteen years after leaving the Fed. And last, he would be the first Fed chief of African descent, which should make him politically attractive to the president. Notably, Ferguson retired from TIAA-CREF in March, which means he's available at a moment's notice.

However, we also think Biden will take a long hard look at re-appointing Powell. The last "dot plot" from the Fed, setting out projections for the future path of monetary policy, showed seven policymakers thinking short-term interest rates will rise in 2022 and a majority (13 of 18) thinking rates will go up by the end of 2023. In fact, the "median dot" shows two rate hikes (25 basis points each) by the end of 2023. And yet, based on our interpretation of his comments after the meeting and since, Powell is likely to be one of the policymakers projecting no rate hikes through 2023.

So, if you're Biden, and you want the Fed to postpone rate hikes as along as possible, Powell makes an attractive choice. As chairman already, he has both credibility with the financial markets as well as inside knowledge of how other policymakers are thinking about monetary policy. Based on his experience, he might be better prepared to privately debate more hawkish policymakers and convince them to hold off on rate hikes.

Regardless of who Biden picks, if we are right about inflation outstripping the Fed's expectations next year, the next chairman will face a potential mutiny starting late next year. Monetary policy is extremely loose right now and likely to stay that way. But there is no financial crisis; markets are working fine. Yes, some of the inflation is "transient" – used car prices are not going to keep soaring like they have recently – but just wait until rents start going up later this year when limits on evictions are removed. Bottom line is that inflation is real and prices will continue to go up as long as the Fed sits on its hands leaving rates at current historic lows. 

 Whomever Biden appoints to run the Fed is going to have their hands full.

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