I thought, or at least hoped, that this might be a quick “Happy Holidays” missive closing out the year and wishing everyone the best as we approach 2022. However, that sentiment shifted quickly as the Omicron variant emerged around Thanksgiving, and both the equity and bond markets experienced sporadic convulsions that have not completely abated. Pictures are worth a thousand words, and as the chart below depicts, following a post-Thanksgiving “Black Friday” that witnessed a nearly 1,000-point drop on what might normally would have been a relatively quiet trading session, Omicron-inspired concerns (coupled with ongoing uncertainty on the economic front as inflationary pressures continue to build) have driven some wild days over the roughly two weeks since. An old Wall Street adage opines that greed and fear drive the Market, and in an environment like this you realize that fear is a much stronger emotion. It would seem that, once again, in the absence of complete information (what impact will this variant have? what will the Fed do? will inflation run rampant? are supply chain disruptions more extensive and longer-lasting than expected? will labor shortages ultimately subside as workers return from the sideline? etc.), volatility will dominate market activity for the foreseeable future:

Context is necessary to better understand both the forces at play and the sometimes-emotional gyrations reflected in the stock market. Succinctly re-hashing well-discussed dynamics that have been in place for nearly two years, the economy continues to emerge from a veritable coma that effectively brought everything to a standstill back in the Spring of 2020. Massive government stimulus and myriad support programs looked to keep the gears of the economy’s machinery well-oiled and functioning while healthcare concerns were addressed, and also keep both families and businesses afloat amidst all the uncertainty swirling around us. Much as the onset of Covid was both swift and dramatic, and the resultant shutdowns and healthcare protocols drove seismic social and economic shifts across the globe, the forces now re-emerging that are releasing massive pent-up demand and a burning desire to return to something closer to normal have continued to distort the business landscape. We can debate the use of “transitory” in describing all of this (although that term has now officially been retired by Fed Chairman Powell), but clearly “volatility” has moved to the forefront as emerging variants cast uncertainty on the healthcare front and policy directives seek to corral inflationary pressures that are clearly heightened. I routinely check the Volatility Index (VIX) calculated by the Chicago Board Options Exchange, and it jumped 54% the day after Thanksgiving. It is not based on historical data or statistical analysis, but rather is a measure of expected stock market volatility in the near term. It is commonly referred to as the “Fear Gauge”, and it has remained slightly elevated over the past few weeks.

Statistical data continues to pour in on multiple fronts, reflecting both positive developments such as continued economic expansion, and also disconcerting empirical and anecdotal evidence that the Fed clearly has its challenges in front of them. Jobless claims, a proxy for potential layoffs, continue to decline and measured approximately 184,000 last week. This was the second consecutive week well-below 200,000 and falling to a level last seen in 1969. For context, in the year before the pandemic, weekly jobless claims averaged approximately 218,000. For further context simply to underscore how swift and dramatic the impact of the pandemic was on our economy, the prior record-high filings for jobless claims were 695,000 in 1982. In April 2020, one week witnessed more than 6 million filings.

Unemployment has also continued to decline, measuring 4.2% nationally last month (and roughly 6% here in Michigan). But while the recovery has witnessed the return of approximately 18 million workers to the payrolls after more than 22 million were initially idled in early 2020, the labor participation rate has fallen and reflects that there are roughly 2.4 million fewer people in the labor force than pre-pandemic. This has exacerbated labor shortages and a resultant tight job market, as more than 10 million job “openings” currently exist for the approximate 4 million workers that remain on the sideline. Adding in the pre-existing unemployed, the effective “3 job openings for every 2 unemployed workers” is simply one of a myriad of factors contributing to inflationary pressure, and clearly challenging the Fed’s efforts to carefully balance its dual mandate of full employment and modest inflation. On the inflation front, price stability as measured by standard inflationary readings such as the Consumer Price Index (CPI) or the Personal Consumption Expenditures Price Index (PCEPI), and the Fed’s favored measure of “core” inflation that look to exclude the more volatile categories of food and energy prices from these metrics, all remain elevated and stubbornly (at this time) persistent. The CPI readings over the past two months, or what is commonly referred to as “headline inflation” in the financial markets, has been recorded at 6.2% (October) and 6.8% (November), with some economists believing that we are likely to see measures north of 7% in the coming months before ultimately (hopefully) abating as supply chain disruptions and labor market shortages diminish. In another seemingly endless list of proclamations these days that begin with “The first time in more than 50 years…” or “Last seen more than 4 decades ago…” or “Comparable to what we saw right after World War II…”, that 6.8% CPI measure recorded in November was the biggest surge since 1982. With the Fed aiming for “core” inflationary readings within a sustainable range of 2% over time, such significantly elevated measures, whether they be core or not, are clearly disconcerting.

And the earlier volatility referenced in the equity markets, has been no less disquieting when looking at the bond markets and the uncertainty it appears to be underscoring. Less than a year ago the general expectation was that the Fed would probably commence some sort of tapering program during the course of 2022 and any rate increase(s) were unlikely to occur until well into 2023. Fast forward to today and the sand is shifting rapidly beneath our feet. The Fed is meeting as I type, and it is expected that they will update the market coming out of their policy meeting on the direction, speed and magnitude of current initiatives. The possibility exists that tapering will accelerate, which could position the Fed to begin raising rates earlier in 2022 than recently anticipated (fed funds futures projections were targeting a possible hike next summer and and/or maybe in the fall, but now are beginning to signal that increases could come sooner, and three to four hikes may be in the cards versus one or two). Looking at the chart below, which isolates the prevailing 10-year yield both in recent months and over the past few weeks, while also looking at the existing spread between the 2-year and the 10-year treasury bonds during this same time frame, seems to reflect contradictory forces at work:

This is clearly an overly simplistic interpretation of bond market dynamics that looks to easily distill voluminous economic data that is not easy to distill, so my apologies in advance for a somewhat unsophisticated take on this chart: while the 10-year has trended lower from the 160’s (basis points) to the 140’s, the “spread” between the shorter-end and the longer-end has compressed roughly 30-40 basis points. In effect, the yield curve has been flattening as expectations of Fed rate hikes have moved shorter duration yields higher, but uncertainty caused by the virus and inflationary pressures has signaled worries over economic growth and concern about monetary policy, triggering in part a “flight to safety” in longer duration U.S. Treasuries and the potential that a more “hawkish” approach to rates in an effort to tame inflation may mitigate the need to increase rates over the longer-term. Again, a bit overly simplistic, but directionally accurate in underscoring one of the many challenges that bankers face looking to put massive amounts of balance sheet liquidity to work amidst an uncertain economic landscape that is slowly trying to nurture and cultivate signs of emerging loan growth in what had been a tepid, at best, environment.

As we talked about a few months ago (“Not Necessarily as Bad as it May Appear”; 9/16/21) and reiterated in our presentation at the MBA’s Bank Management and Directors Conference in Detroit on December 3rd, earnings expectations across the industry for 2022 are projected to be down for most shops anywhere from 10% to 40%. This is largely attributable to the fading of all the “noise and distortions” caused by the pandemic over the past two years and a gradual return to traditional “core” earnings drivers that will be fundamentally more comparable to performance metrics reported in 2019.

I’ve spent most of this article talking about inflation and yield curves and the gyrations in the Dow Jones Industrial Average, and have not touched on the way the pandemic accelerated digitization across the banking industry, nor the political battleground surrounding potential nominations to the Fed (particularly with regard to the Supervision seat) and its implications with regard to regulatory oversight and consolidation dynamics, nor a whole host of other items facing institutions as they enter 2022. Let’s leave that for more casual one-on-one discussions as I again crisscross the state next year. I always welcome the interactions, and thoroughly enjoy the opportunity to get to know you and your community better. And hopefully I never overstay my visit, as I truly appreciate the time and energy many of you put in motion to accommodate my travels.

As I’ve commented in the past, the resiliency of Michigan’s banking sector has been tested, and validated, many times over the decades through economic downturns, war, natural disasters, civil unrest, political upheaval, and most recently a devastating healthcare crisis. We always seem to come out the other side both stronger and wiser for those able to weather the prevailing storm. Maintain underwriting integrity and discipline. Manage capital and reserves carefully. Emphasize sound risk management practices and a robust architecture. You are stewards of your shareholders’ investment. The constant, for successful banks, has been adhering to solid credit standards and sound cost controls. This pandemic has distorted many things and forever changed numerous personal and business interactions. And while it is not yet firmly in the rearview mirror, it too will hopefully one day soon pass. Do what you need to do so that when it does, you are still standing with a fundamentally sound franchise and an opportunistically positioned platform to capitalize on any dislocations that have arisen.

In closing, attached please find our monthly summary of Michigan’s financial institutions. As you and your Board take your organization forward, please do not hesitate to reach out to me and/or my colleagues at ProBank Austin if we can be of any assistance in helping you assess the competitive landscape. My best wishes as you close out 2021 and prepare for 2022. And again, this simple but heartfelt counsel: Be careful. Be smart. Stay healthy. Take care of your family, your colleagues, your community. Most important, be sure to take care of yourself.

And one final request, if I may: please keep the folks in Oxford in your thoughts this Holiday season. That community has been simultaneously shocked and shattered by recent events, and as the solid, decent and compassionate community bankers all of you are, I know you recognize when your colleagues and their customers have been shaken. Them knowing your support is unconditional through these difficult times is invaluable. God bless.