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Starting June 1, the Fed began reducing its balance sheet holdings of U.S. Treasuries by $30 billion a month for three months. Thereafter, it will double its reduction of U.S. Treasuries by $60 billion per month beginning in the fourth month. For its mortgage-backed securities, the first three months will see $17.5 billion roll off its balance sheet. Starting in the fourth month of the program, this cap will increase to $35 billion per month. As its dual mandate is to both maintain employment and a stable rate of inflation, this is another way the Fed is implementing its monetary policy to put the brakes on inflation and reign in out-of-control demand with limited supply. How will the Fed’s unwinding of its balance sheet impact markets for the rest of 2022?

Instead of quantitative easing (QE), where the Fed bought U.S. Treasuries and mortgage-backed securities to foster more demand for U.S. Treasuries and lower bond yields, QT is the opposite. According to the Federal Reserve Bank of St. Louis, quantitative tightening (QT) is the reverse type of policy that aims to unwind holdings on the Fed’s balance sheet. To tame inflation, QT removes liquidity from economic institutions and raises rates for long-dated assets.

In response to the COVID-19 pandemic, the Fed bought U.S. Treasury securities and agency mortgage-back securities (MBS) again in March 2020 to provide stability by maintaining a source of easily accessible credit for consumers and business owners. The Fed bought $80 billion of Treasury securities and $40 billion of MBS per month. The Fed’s balance sheet grew from $3.9 trillion (March 2020) to $8.5 trillion (May 2022). Looking at it from a percentage of GDP, it increased from 18 percent to 35 percent. When QT is in full force, it is expected to lower the Fed’s balance sheet by at least $1.1 trillion annualized. Over a three-year timeframe, it is expected to remove about $3 trillion over 36 months.

When it comes to the process of QT, it is important to understand how it works and impacts the overall market dynamics. When U.S. Treasuries and mortgage-backed securities mature, the respective issuing agency pays them off and the Fed receives payment. Unlike QE where the proceeds were reinvested, the proceeds will not be reinvested during QT and the Fed’s balance sheet will fall in size.  

When it comes to global central banks implementing their own versions of QT, it is estimated that as much as $2 trillion will be removed from markets over the next 12 months. Looking at the Fed alone, it is aiming to reduce $1 trillion or 11 percent of its holdings from the balance sheet over the next year. If QT continues through 2024, its holdings will drop from 37 percent of GDP to 20 percent. With the Fed’s balance sheet containing almost $9 trillion and inflation being 8.5 percent of the current CPI reading, this pace is higher because the last time it conducted QT, the Fed’s balance sheet held $4.5 trillion in assets with a CPI of 2.75 percent.

Looking at potential scenarios of QT outcomes, the Fed has published three respective impacts on the Fed’s policy rate. The Baseline scenario, or following what began on June 1, would lead to what’s effectively a policy rate increase of 56 basis points. This is compared to a “no-runoff scenario,” leaving the Fed’s balance sheet with another $2.1 trillion in Q3 of 2024, whereby there is no QT in place. Looking at the full-runoff scenario, it would let $0.8 trillion roll off the Fed’s balance sheet by Q3 of 2024, necessitating a nine-basis point drop in the policy rate to offset the balance sheet’s negative impact on the macroeconomy.

When the pandemic struck in March 2020, the Fed Funds rate was cut to between 0 percent  and 0.25 percent. On Jan 26, 2022, the FOMC maintained its target range for the federal funds rate at 0 percent to 0.25 percent. Fast forward to June 15, 2022: The FOMC raised its target range for the federal funds rate to between 1.5 percent and 1.75 percent. Depending on the evolving economic data surrounding inflation, the Fed appears willing to further adjust its target range. It is important to explore how the federal funds rate has led the market to interpret asset purchasing or unwinding actions by the Fed.

During 2017 and 2018, the FOMC increased the federal funds rate by 175 basis points, bringing it to approximately 2.25 percent. St. Louis Fed President Jim Bullard argued that once the federal funds rate is north of zero, be it QE or QT, how the balance sheet grows or shrinks has little say on how the Fed will steer its monetary policy.

While the economy is in uncharted territory due to its emergence from the COVID-19 pandemic and evolving monetary policy, only time will tell how much of an effect QT will have on the U.S. and global markets.

The Bureau of Labor Statistic’s Consumer Price Index rose by 8.5 percent year-over-year ending March 2022, leading most economists to agree that inflation is going to be with us for a while. With inflation seeming not to abate, at least in the near term, how will different types of investments react to inflation that is sustained and unknown when it will peak and begin to drop. Looking at a 2004 study from the Federal Reserve, an unexpected 25-basis point rate cut can be expected to see equities appreciate by one percent.

Defining Different Rates

The Federal Open Market Committee (FOMC) sets the federal funds rate – the overnight rate at which banks borrow from each other. This undoubtedly will impact the economy and the domestic and global stock markets. While it can take months, if not more than a year, for a change in interest rates to have a universal impact, the stock markets see the impact sooner. This is opposed to the discount rate, which is the interest rate banks are charged when loans come from regional Federal Reserve Banks – the so called discount window.

One main reason the Fed adjusts the federal funds rate is to shape inflation. When the federal funds rate is raised, it is trying to reduce the money supply available for consumers and businesses. With less money available to circulate throughout the economy, it costs more to borrow money as interest rates rise.

Another important reason to keep an eye on the federal funds rate is due to the fact that the prime interest rate is based largely on the federal funds rate. Whether a mortgage, credit card or other personal or commercial loan, the prime interest rate is an influential factor in these lending vehicles’ interest rates. As the Fed Board of Governors explains, the prime rate is how each individual bank determines its own interest rates. Their unique prime rate is based on the target level of the federal funds rate, which is how much other banks charge them for short-term loans. Once the prime rate is established, it is used as a reference base rate for a multitude of lending products, including personal and commercial loans and credit card lines.

FOMC and Federal Funds Rate Adjustments

As the Federal Reserve increases its discount rate, short-term borrowing costs for financial institutions increase. Financial institutions in-turn are pushed to increase borrowing costs for companies and consumers. Whether it is a credit card or a mortgage, rates increase. The higher the interest rate, the less spending ability the account holder has. The account holder also sees higher bills via the higher interest rates. The higher the bills, the less money they can spend elsewhere, often impacting the economy.

Rising Rates and the Markets

Publicly traded companies can suffer in different ways. A company may bring in less revenue or have higher borrowing costs, cutting into its growth forecast or reducing its profits. Companies also may see lower growth expectations and a decline in future cash flow projections. Assuming no other changes, the stock price will likely fall. Depending on how severe the increase in interest rates, this can impact entire sectors – and depending on how much weight a particular company comprises within an index, an entire index.

Bond Market Dynamics and Interest Rate Fluctuations

Compared to corporate bonds, where bondholders are first in line to be paid if a company goes bankrupt, government securities, such as Treasury bills and bonds, are viewed as more likely to pay their investors back even in more challenging financial circumstances. This is because, according to the U.S. Securities and Exchange Commission, they are backed by the full faith and credit of the U.S. government.

As the Financial Industry Regulatory Authority (FINRA) gives an example, interest rates have a noticeable impact on bonds. Say a bond is sold for X and matures in Y years down the road with a Z percent coupon at par value. Twelve months later, interest rates have risen and another of the same type and amount of bond is issued at the same par value but is issued with a one or two percent higher coupon rate. Based on these two different bonds’ characteristics, the original bond is less attractive on the open market. If the original bondholder wants to sell a bond issued a year ago, he will have to sell for less than face value due to the more attractive interest rate of the newly issued bond.

While there is much uncertainty in the financial markets, including the FOMC and the bond and equity markets, understanding how past market moves have occurred can offer guidance to how increasing interest rate environments may evolve in this rate-tightening environment.

According to the March 2022 Short-Term Energy Outlook (STEO) from the U.S. Energy Information Administration (EIA), the forecast is for high energy prices in 2022. The report found that Brent crude oil, used as a benchmark ex-U.S., is expected to see prices of $116 per barrel in Q2 of 2022. West Texas Intermediate (WTI), the price the U.S. uses as a benchmark, is expected to cost consumers, on average, $4.10 a gallon in Q2 of 2022.

The World Economic Forum blames volatile oil and energy prices in general on demand outstripping supply. This is attributed to OPEC not expressing a sense of urgency to ramp up supply, having a certain amount of spare capacity, and not being in a rush to create a glut in supply for global markets. Additionally, it’s attributed the lack of new exploration and resulting supplies coming online due to the shock of oil falling to -$40 per barrel during the COVID-19 pandemic. It also includes the transition to greener forms of energy, including pressure from activist investors looking to transition from fossil fuels. Hence, there are multiple factors putting pressure on traditional sources of fuel.

Looking further at the U.S. EIA’s March 2022 STEO, the price is expected to remain well above average. West Texas Intermediate (WTI) is projected to be $113 per barrel in March and average $112 per barrel in Q2 of 2022. The price per gallon domestically is projected to hit $4.12 in May of 2022, then drop through the rest of 2022. Over the entire year, the price per gallon of gas is projected to be $3.79 per gallon (the most expensive since 2014), and average lower to $3.33 per gallon in 2023.

It’s important to note that the EIA’s STEO was completed prior to the U.S. government’s March ban on importation of oil, liquified natural gas and coal from Russia, along with the United Kingdom announcing it was phasing out Russian oil imports by the end of 2022. The European Union also communicated that it would “significantly reduce fossil fuels” from Europe before 2030. These announcements were coupled with multi-national oil companies declaring plans to cease operations in Russia and end partnerships. These actions are expected to lower oil production by Russia, but the ultimate outcome is dependent on global reactions and how they impact fuel stocks.

When it comes to seeing how increased and likely sustained fuel prices will impact economies, history is a helpful guide to predict how things might play out in 2022. According to the Federal Reserve Bank of San Francisco (FRBSF), their data examines “the price of oil since the early 1950s.” According to the National Bureau of Economic Research, 1973 ushered in a period of volatility for oil, which contrasts with the FRBSF’s data on relatively stable prices through the 1950s.

In 1973, the Yom Kippur War disrupted prices and again the Iranian Revolution of 1979 saw another disruption. These energy market interruptions were both full of tepid expansion, hot inflation and too few jobs available for job seekers.  

Often considered a hidden tax on households, out of control inflation takes consumer interest away from other services and goods due to lowering a household’s affluence, along with giving consumers less economic certainty going forward. According to the Federal Reserve Bank of San Francisco, a 2007 study found that five of the past seven recessions occurred shortly after oil prices climbed substantially, attributed in part to lower levels of income and a less certain outlook for the economy.

As prices for gasoline increase, how much consumers will likely spend on other goods and services varies, according to a National Bureau of Economic Research paper titled “The Response of Consumer Spending to Changes in Gasoline Prices.” This research looked at the impact of gas falling during 2014. Based on U.S. Consumer Survey, the average total household spending was $53,495 in 2014, with $2,468 spent on gasoline per household in 2014. The same report points out that while crude was $100 per barrel in mid-2014, it went to sub-$50 per barrel by January 2015.

It’s important to keep in mind that while the price of oil was quite volatile, on par with that of the 1970s, inflation during the 1990s and 2000s didn’t really make material increases to inflation levels, impact GDP expansion negatively or lower the unemployment rate. The divergence and less deleterious effects of inflation during the 1990s and 2000s were likely set off by big gains in productivity realized in the first decade of the 21st century.

There’s nuance when determining if rising oil prices are helpful, hurtful or neutral for stock and market performances, according to a U.S. Energy Information Administration 2017 report called “Oil Prices and Stock Markets.” The study points out that looking at sectors or industries will give us a better picture of how oil prices impact stocks – whether it’s good, bad or neutral. For example, the study gives three ways to measure stock performance considering oil prices: “oil-users, oil-substitutes or non-oil-related.”

For example, all segments of the exploration, extraction, processing and refining of different energies (coal, natural gas, crude oil, etc.) will naturally see benefits. However, when it comes to manufacturers, transportation companies or food suppliers, these industries will see downward pressure on their earnings (and therefore stock price) due to pressure on increases of inputs and the mixed ability to pass on costs to consumers.

While the outlook for crude oil cannot be determined and geopolitical and economic conditions are fluid, it depends upon the sector and how businesses are managed when it comes to the probability of profitability of publicly traded stocks.

There’s much uncertainty surrounding if, how and when the Federal Reserve will raise its rates, end its bond and mortgage-backed security purchases, and wind down its balance sheet. For the March 16 Fed Meeting, the CME FedWatch Tool has a 47.9 percent probability of a 25 to 50 basis point increase, and a 52.1 percent probability of a 50 to 75 basis point increase for their Target Rate. There are many expectations for the Fed to raise its Federal Funds rate, or the so-called overnight lending interbank rate. However, there’s a lot of uncertainty as to how many times the FOMC will increase it.

John Williams, Federal Reserve Bank of New York president, mentioned at a recent event that the Federal Open Market Committee (FOMC) will start raising rates at its March 2022 meeting,  but he isn’t advocating for a particularly hawkish approach. Rather, Williams expects inflation to drop due to supply-chain bottlenecks being naturally worked out, along with the Fed’s measured policy actions moderating inflation. However, James Bullard, Federal Reserve Bank of St. Louis president, is more hawkish and has expressed a desire for a 50 basis point rate hike.

Lael Brainard, a member of the Federal Reserve’s Board of Governors, believes six rate hikes are an appropriate course for monetary policy, starting in March 2022. Charles Evans, Chicago Fed president, blames inflation on the pandemic and echoes that supply chain issues will resolve on their own as the world returns to its new normal. Evans also believes that hiring won’t be slowed with higher rates, compared to past rate hike cycles. However, this could change if inflation grows too high as 2022 progress, necessitating more rate hikes.

The Fed has communicated clearly that it will let 1) evolving economic data, in conjunction with 2) maximum employment, and 3) 2 percent longer-term inflation expectations, guide its monetary policy. Noting there’s been a strengthening labor market, it’ll continuously look at how the pandemic is managed healthwise, how global developments unfold and how inflation is expected to and materializes.

It’s important to note that during August 2020, the Fed took a new approach to inflation. Previously, the approach would be to increase borrowing rates during good economic times to prevent inflation from becoming a problem. However, as of August 2020, the Fed’s new approach is to maintain low rates until inflation actually materialized, permitting economic conditions that drive inflation above and below 2 percent. This would thereby create a longer-term average inflation rate of 2 percent when considering monetary policy adjustments.

This is within the perspective of inflation reaching 7.5 percent year-over-year in January 2022, according to the Labor Department. Month-over-month inflation readings include electricity rising 4.2 percent from December 2021 to January 2022. Food costs rose by 0.9 percent in January 2022, up from another 0.5 percent increase in December 2021.

According to the FOMC’s Jan. 26 meeting minutes, there’s much to be contemplated for any potential rate changes. The members found that inflation was elevated, with economic indicators showing inflationary pressures increased in the back half of 2021. In December, the 12-month change in the consumer price index (CPI) was 7 percent, while core CPI inflation was 5.5 percent over the same period.

The year-over-year November 2021 total personal consumption expenditures (PCE) price inflation was 5.7 percent, with the core PCE coming in at 4.7 percent for the same timeframe. When it comes to the unemployment rate, it fell from 4.2 percent in November 2021 to 3.9 percent in December.

Impact of Russia-Ukraine Conflict

Looking at the price of crude oil alone shows how inflation is fluctuating. On Feb. 24, futures contracts at one point had oil hitting $100 and $105 per barrel for West Texas Intermediate and Brent, respectively. While prices retreated, prices are still elevated and subject to international tensions, increasing demand due to the economy reopening from COVID and uncertainty over future output. Undoubtedly, the Fed will take inflation into account – both its new definition of longer-term 2 percent inflation and how it might impact the economy. Some speculate with the high volatility beginning in 2022, the Fed may raise rates by only 25 basis points, not the 50 basis points more hawkish FOMC members have mentioned.

With increased volatility since 2022 began and global uncertainty increasing by the day, it seems the FOMC will have the final say on how many rate hikes will eventually happen. 

According to the World Bank, there’s a mixed picture for commodities in 2022.

Globally, prices for crude oil are expected to hit $74 per barrel during 2022, compared to 2021’s $70 price tag. This is attributed to greater economic activity as the world continues its reopening. Metal commodities, on the other hand, are projected to drop in 2022 by 5 percent. Similarly, the “softs,” or farming-based commodities, are expected to find an equilibrium or fall nominally in 2022. With much uncertainty related to the pricing of commodities and their impact on 2022’s markets, how have commodity prices impacted company profits and past market cycles?

Earnings, Profits and Measuring Margins

When it comes to evaluating margins, we examine how profitable sales have been after factoring in external and internal costs. Be it at the net margin level, the gross margin level, or the operating margin level, businesses get a wide analysis of their profitability.

There are many reasons companies could see margin pressure, and therefore reduced profitability. Competition, internal production challenges (e.g., rising overhead caused by increases in wages, raw materials, electricity, etc.), so-called “black swan” events such as pandemics, and other geopolitical events impacting commodities and tariffs are among the many reasons for margin pressure.

The World Bank, focusing on the outlook for oil, sees a potential for domestic shale production to pick up less quickly, and the favoring of crude oil versus natural gas. Higher energy prices could slow growth, and the uncertainty of the pandemic could affect energy demand. However, based on reduced investments in crude oil, recovery has fallen since 2014, and again in 2020. Many initially think of the price they pay at the pump. However, indirect costs of increasing crude oil impacts shippers, retailers, airlines, fertilizer manufacturers and farmers, the transportation industry – and the stock prices of those publicly traded companies.

As for other commodities, there are considerations for direct and indirect industry performance. For example, the price of lumber can immediately impact how much homebuilders charge for a new home; however, it also impacts the real estate market, additions, and other industries that use large quantities of wood.

Analyzing Stock Market Sector Performance

When it comes to looking at commodity prices, consumer behavior, and market cycles for the past six decades (starting in 1962), consumer staples have been a steady winner. Looking 10 years back from mid-April 2021, based on Indices, consumer sector stocks grew by 8.2 percent, versus the S&P 500’s annualized returns of 11.86 percent over the same timeframe.

The consumer staples sector is one industry where high commodity prices are likely to impact earnings less than consumer discretionary. With consumer staples a necessity that is independent of the health of the economy, the level of demand is stronger than other sectors. While consumer staples aren’t immune from competition, they are often easier for companies to push price increases through.

In 2022, many Central Banks globally are expected to push a more hawkish monetary policy. Only time will tell whether or not global monetary actions will get a handle on commodity prices and influence markets accordingly. 

According to a Dec. 15 Federal Open Market Committee (FOMC) statement from the Federal Reserve, the federal funds target range will remain at 0 percent to 0.25 percent. Beginning in January, the FOMC will reduce its monthly purchase of assets to $40 billion in Treasury securities and $20 billion in mortgage-backed securities, with tapering expected to finish well before mid-2022. The FOMC also projects three rate hikes in 2022. These monetary policy adjustments are all subject to change based on the economic developments going forward, signifying uncertainty for markets in 2022.

What History Says

Looking back to the last “taper tantrum” in 2013 when Ben Bernanke was in charge of the Federal Reserve, equities lost 5.8 percent during June 2013 (similar to the decline in markets during September 2021). While many considered this a “market pullback,” the S&P 500 saw gains of 17.5 percent for the rest of 2013. Looking from WWII onward, there’s been 60 instances of the stock market falling initially by 5 percent to 6 percent, but the next month it was up 3.3 percent on average, and 92 percent being higher by year-end.

From the second half of December 2013 through October 2014, the S&P 500 advanced 11.5 percent, primarily because Wall Street was confident in the economy’s health in growing with the Fed’s bond-buying.

After the rallying months, markets have gained an average of 8.4 percent 100 days later. For the 2021-2022 cycle, the rally is expected to go through January 2022. However, historical S&P 500 trends suggest volatility and a drop of 5 percent or greater in February 2022. February is generally the second worst month of the year for market performance.

What’s Happening this Cycle

Fed Chair Powell clearly indicated that rates are to be raised soon and inflation is expected to stabilize. Inflation is expected to hit 6 percent in Q4 of 2021, and trading on Wall Street is expected to see bearish trends to start 2022.

Since the Fed has been crystal clear about tapering, such communication has likely resulted in a relatively smoother transition for the markets. According to the Board of Governors of the Federal Reserve System, quantitative easing (QE) began in 2008 due to the financial crisis, was rolled back at the end of 2018, but the Fed became more accommodative again during the COVID-19 crisis. As of October 2021, the Fed’s balance sheet was $8.5 trillion. This was double what the Fed’s balance sheet was in early 2020 and 10 times as large from mid-2007 levels of $870 billion.

With Powell yet to be reconfirmed for a second term, there is uncertainty, along with the 2022 mid-term elections and pressure from progressive politicians looking for a dovish Fed chair.

Powell’s comments at the recent FOMC meeting explained that once COVID-caused jams to the supply chain are resolved, inflation will subside. This perspective, paired with his continual observation of the economy and flexibility on raising rates, has become a tug-of-war between the Fed and Wall Street investors on market performance. The Fed also indicated that once the bond-buying is complete, it’s not an automatic trigger for interest rate hikes. However, depending on how inflation plays out, the market will have its own interpretation of how the Fed will react to unfolding inflation.

Putting the Fed’s Moves Into Perspective

QE and lowering the Fed funds rate both can be effective monetary policy. QE helps when the Fed increases its balance sheet by buying long-maturity bonds and mortgage-back securities to drive lower yields. Lower interest rates enable cheaper borrowing, which can help the economy grow employment and increase growth. If QE is rolled back, there will be uncertainty over whether the economy can stand on its own two feet.

The true question of the potential impact on markets is whether the Fed will taper only or also reduce its balance sheet holdings. Other ways the Fed can tighten monetary policy is by adjusting short-term interest rates via the discount window/federal funds rate. The Fed similarly can sell assets from its balance sheet via open market operations (OMO).

As the Board of Governors of the Federal Reserve System points out, Jerome Powell was appointed to a four-year term on Feb. 5, 2018. With the Fed Chair’s term expiring in February 2022, there has been much uncertainty as to whether he would be reappointed or replaced.

Powell’s first term as the Chair of the Fed began in 2018, after being nominated by President Trump in November 2017. If reappointed, Powell will serve another four years, where he will guide the nation’s short-term monetary policy and become the Federal Open Markets Committee’s (FOMC) chair.

During a Nov. 22 announcement, President Biden said that he’s renominating Powell for another term for the chair position of the Board of Governors of the Federal Reserve System. President Biden also announced that Lael Brainard has been nominated for the vice chair position of the Board of Governors of the Federal Reserve System. With the Fed vice chairman for supervision resigning at the end of 2021, these series of events are providing President Biden with additional nominations to promote his policies.

Understanding the Federal Reserve’s Influence on the Markets

Similar to a chief executive officer, the chair is entrusted to carry out the mandate of the Fed. The primary foci include influencing short- and long-term interest rates, maintaining price stability and encouraging a balance in employment.

The chair of the FOMC is the steward for the nation’s monetary policy by adjusting the federal funds rate, discount rate and buying/selling of government securities to support the economy in its role in fulfilling its economic goals.

How President Biden’s Decision is Expected to Impact Markets

With Brainard having a favorability for fintech and cryptocurrencies and the ability to curry favor with progressives due to her desire for strong bank regulations, her nomination will provide the market with greater stability in conjunction with Powell’s renomination. This is due to Powell’s past four years of steering the market through its challenges, especially with COVID-19. With Powell already communicating the timeline of tapering and when the Fed is likely to increase rates, it should provide greater certainty for the markets.

Additionally, the investment community believes the markets will perceive Brainard as more politically focused due to her contributions to Hillary Clinton’s presidential ambitions in 2016. With Brainard expected to consider and strongly influence the FOMC’s actions on the 2022 midterm elections, she’ll likely lobby the committee to raise interest rates deeper into 2022 after the “tapering” or bond purchasing schedule is complete, compared to the earlier path under Powell’s lead alone.

Political Implications

According to a Nov. 19 statement in support of a Fed Chair other than Jerome Powell and who is committed to addressing climate change, Rhode Island Sen. Sheldon Whitehouse and Oregon Sen. Jeff Merkley made their thoughts clear on how they want the nomination process to not go in favor of Powell.

While Powell has been renominated, he’ll certainly face Congressional pressure during confirmation hearings and beyond if he’s indeed confirmed for a second term. However if the Federal Reserve nomination process plays out for Biden, Powell and Brainard, the FOMC will certainly have its policy influenced by more than President Biden.

Energy is expected to increase in price as 2021 closes and 2022 begins, according to the Oct. 13, 2021 Short-Term Energy Outlook (STEO) from the U.S. Energy Information Administration (EIA).

Between October 2021 and March 2022, the U.S. benchmark, Henry Hub, is expected to average $5.67 million British thermal units (MMBtu). For 2022, the average price is expected to be $4.01/MMBtu. This is attributed to increased consumer need, a decline in domestic natural gas production, and sub-par inventories stockpiled as the weather becomes increasingly cold.

According to the EIA, the price of natural gas is influenced by a multitude of factors. These include supply and demand, production, storage levels, imports and exports, seasonality, the state of the economy and the availability of other fossil fuels.

For example, looking at hurricanes and seasonality in 2001, 25 percent of “dry natural gas” was produced in the Gulf of Mexico; however, only 2 percent was produced there in 2020. Cold weather also can impact prices due to slowing production – and if it’s coupled with increased demand, it can similarly increase natural gas prices.

Power generation creates additional need for air conditioning and power. With natural gas used for power generation, and if there’s increased demand coupled with limited inventories, trading on the cash market could see significantly higher prices than normal.

The Federal Reserve Bank of San Francisco (FRBSF) saw how higher prices of natural gas impacted individuals and businesses in its Federal District. The agricultural sector used it for greenhouse temperature control, using mechanical equipment to prepare crops for the market. It led to some farmers halting their operations due to unprofitability.

Consumers in the nation’s West use natural gas as their chief source for warming homes. During 1999 and 2000, the FRBSF explained that it wasn’t uncommon for the price to increase by 60 percent or even double.

Considerations for the Stock Market

With the price of natural gas projected to increase as the weather gets colder, it’ll impact businesses and consumers. Businesses will be forced to determine how much of their additional costs to absorb, impacting profit margins, and how much to pass on to consumers. For consumers, there are two considerations – they will be impacted by increases in prices of goods and services, and the likelihood of decreased consumer spending and confidence, both impacting the economy.

It’s important to understand how consumer confidence impacts spending and therefore is a good indicator of how publicly traded companies will perform on their quarterly earnings. According to the Organization for Economic Co-operation and Development (OECD), consumer confidence gives a good idea of how they’ll spend and save determined by a survey of their budget and their outlook on the overall economy. The higher the consumer’s confidence, the more likely they are to spend and save less.

With production low and supply availability uncertain globally, depending on how hard consumers are hit in the wallet, price fluctuations of natural gas will impact consumers accordingly – and in-turn, that of company earnings.

According to the Sept. 8, 2021, release of the Federal Reserve’s Beige Book, the U.S. economy is facing many headwinds.

The report found that restaurants and the travel sector saw a drop in activity. Home and auto sales were low because of fewer available houses on the market and a challenging supply of computer chips for auto makers. The same report found that although more people have found work, the level of newly created employment was mixed, despite a continuing need for more workers. Due to people quitting their jobs, people retiring, and those unable to find means of suitable childcare, the employment situation remains uncertain. With continued stressors on the economy, how will the stock market fare through the rest of 2021 and into 2022?

The Beige Book, officially known as the Summary of Commentary on Current Economic Conditions, comes out eight times throughout the year. Information collection begins six weeks before, and the report is released two weeks prior to Federal Open Market Committee (FOMC) meetings, providing an overview of the economic health of each of the 12 districts of the Federal Reserve Bank.

The Sept. 8, 2021, Beige Book Report found challenges in different sectors; however, some challenges, such as the semi-conductor shortage, were faced nationally. Based on past analysis, current sentiment reported by businesses and consumers will be confirmed or dispelled by forthcoming data.

As Northwestern University’s Medill School notes, the Beige Book is devoid of formulas, statistical analysis or industry jargon. Rather, it contains observational and comparative data derived from speaking with and sampling business owners and business analysts. In contrast to statistical data, it illuminates what business executives and consumers are worrying about.

It’s often referred to as a key gauge and is especially important because when the economy takes a downturn, the data deterioration often renders business statistics obsolete. It’s also relevant because the FOMC uses it to determine monetary policy chiefly via modifying the federal funds interest rate target. Similarly, when it comes to economic figures, it’s important to keep in mind the timeliness of such statistics because they are announced after they’ve been recorded.

During the coronavirus pandemic, especially when little was known in the beginning, the Beige Book offered Fed officials the ability to speak with industry insiders in the thick of it, especially when data was scant or unknown. Others observe that the Beige Book predicted the 2008/2009 housing crisis starting in October 2006 when mortgage delinquencies began appearing.

By viewing events in real-time, it offers anecdotal evidence compared to questionable forecasts. For example, the July 18, 2018, Beige Book Report found that well before the data confirmed manufacturers’ worries over the trade war with China and Trump’s tariffs, 10 districts reported “moderate economic growth.”

According to a 2003 study performed by Occidental College and the Federal Reserve Bank of Atlanta, the more confidence-inspiring news a Beige Book Report contains, the greater the correlation with higher interest rates, especially when it comes to long-term rates. It also expresses a bullish correlation with increases in stock prices when the economy is growing, but a deceleration during an economic slowdown. When banks set their lending rates, they directly or indirectly use long-term rates as reference. Policy makers also use this as an indicator for inflation expectations in the financial markets.

While no one has a crystal ball to predict how the economy and stock markets will perform going forward, the Beige Book is an important tool the Fed and those in the government factor in when attempting to steer economic growth.