Weekly Commentary

A brief review of last week's events

Cautiously Optimistic

Jacob Hess
October 11, 2021

The Week Behind

Three stories drove the conversation about the economy last week as the first full week of the new quarter signaled the start to the end of the year. Congress continued its squabble over the debt ceiling and spending. Energy prices soared in Europe and Asia as shortages threaten near-term activity. Finally, the week ended with a huge jobs report that could have implications for Fed tapering. Throughout it all, the equity and bond market were looking shaky after sell-offs in late September. It seems that the world is trying to maintain a cautiously optimistic outlook as uncertainty intensifies.

The threat of a US federal default will continue to loom until December now. This week, the Senate passed legislation to fund the government through early December after Senator McConnell backed off of a hardline stance to raise the debt limit temporarily. The bill raises the limit by $480 billion, the amount that the Treasury estimates it would need to fund through December. The resolution calmed the markets for short-term Treasury bills. The 1-month bill opened the week above 10 basis points and closed the week around 2 basis points.

In reality, nothing seems to be solved here except that there is more time to work towards a bipartisan agreement. Wells Fargo believes the bill "simply moves the problem from October to December." However, there still seems to be a general sense of denial that any catastrophic could come from this. Moody's Analytics insists that "it is unimaginable that lawmakers would allow the US to breach the debt ceiling." The $3.5 trillion Build Back Better bill is another issue that divides the two parties, and a resolution there could help diffuse debt limit disagreements. However, no one should get their hopes up.

From Wells Fargo

This summer has been all about supply chain disruptions, and what better way to start a new quarter than with an intensifying energy crisis. Fuel and power prices are rising as a result compounding previous issues with inflation. ING points out some supply factors to pay attention to including historically low levels of natural gas storage in Europe and Asia and supplier flows that are not increasing despite rising prices. Despite low storage levels, key OPEC suppliers to these regions are sticking with previously announced production increases in an announcement made on Oct 4th. Production for OPEC+ is set to be around 39.7 mil b/d with Russia included at 9.9 mil b/d. This will be a welcome 2.2 mil b/d hike over OPEC+ August production of 37.5 mil b/d (including Russia at 10.7 mil b/d).

The week was capped off with the last jobs report before the November FOMC meeting, and it did disappoint. The 194k jobs added in September was well below the 500k expected by a Bloomberg survey and the 720k expected by Dow Jones. The unemployment rate still saw a decent drop, down -0.4% to 4.8%, but remains -3.5% below its February 2020 level. Again, we saw another solid decline in permanent job losers, down -236k to 2.3 million, while temporary layoffs remained at 1.1 million for the 2nd straight month. The strongest job gains were in the professional and business services sector (+60k) and the leisure and hospitality sector (+74k), the sectors which also have the highest rates of job openings at 8.1% and 10.7%.

It's encouraging to see continued progress in these areas, and the Fed will undoubtedly use the fact the weakest sectors are still leading job gains as a point in the corner of "progress towards full employment." However, because gains are coming in those industries that are desperate for workers, wage growth has accelerated substantially to 4.6% YoY (the 3rd straight month above 4.0%). Cue further inflationary pressure, but not inflationary pressure that the Fed is likely to pay attention to. Instead, the FOMC committee might see that as a headwind for consumption growth in Q4. Overall, the report is probably not likely to have a major impact on the Fed's tapering decision. The hawkish tilt in the September meeting gives the impression that observing the September jobs report was just a formality.

Chart of the Week

From FRED and Federal Reserve

The unemployment rate dropped -0.4% to 4.8% in September, reaching the Fed's forecast for end of year unemployment a whole quarter early. Does this satisfy the central bank's requirements for tapering?

The Week Ahead

Key reports this week come in the middle of the week: JOLTS on Tuesday, CPI on Wednesday, PPI on Thursday. These updates will provide further guidance on the US economic situation for the Fed. German CPI also comes out on Wednesday and will give a helpful look into inflation in Europe. Further developments in the energy markets will be key as well. Early monday Morning, Brent crude oil traded up 2.6% to just above $84.

Sour Expectations Take Down the Market

Jacob Hess
October 05, 2021

The Week Behind

Turbulence has finally hit the equity market after a rather quiet summer of expansion. This past week saw volatility build on the week before leading the S&P 500 down -2.21% and the Nasdaq Composite down -3.20%. Investors were in risk off mode as the seasonally weak September ended. Over the course of the month, the VIX index jumped over 40% while the S&P 500 index fell a total of -4.76%. It seemed about time for a correction, and pressure from various negative macroeconomic factors had built up over the summer.

Is it just a coincidence that stocks saw red in the week following the September FOMC meeting? Many wouldn't be surprised if we see another rendition of the "Taper Tantrum" that caused volatility in markets in 2013, and this could be investors' reactions they were looking for. Yields on 2-year, 3-year, and 5-year Treasury notes have all increased since the beginning of August as the bond market senses a Fed hawkish streak. There has also been some reaction in currency markets with the USD rising against other key developed markets that are expected to be more dovish in its policy normalization: up 2.02% against the EUR and up 1.16% against the JPY. It's also worth noting that these two countries have seen lower spikes in inflation.

Typically a rise in yields indicates expectations of healthy growth which has been the case for the most of 2021. COVID restrictions were lifted in the United States and most other developed nations which led to a boom in growth after the contraction in 2020. The expectations of a boom spurred on pent up demand fueled by excess savings from unprecedented governmental support to consumer and businesses. This had all created a healthy environment for equities to grow in the first half of 2021. However, that environment has more or less eroded in the short-term creating an instance where future growth is uncertain. In the Chart of the Week, one can see a massive dip in the sentiment of manufacturers, not due to demand issues but due to supply issues, and that has by and large been the main driver of the weakness in September trading.

So where do we go from here? We've already seen some stabilization in trading in the beginning of October. Two strong positive performances by the S&P 500 on Oct 3rd and Oct 5th seem to have stopped the bleeding at around 4,300, and the 2-year Treasury found a bottom as well around the 27 basis point level. Pessimism seems to have calmed. Zurich Insurance seems to agree, leading its monthly analysis with: "We believe investor pessimism is likely to ebb in coming weeks." It points out that the AAII survey signaled a "pervasive downbeat sentiment" that it is a "contrarian indicator." If we see a bounce from this position, it suggests that investors believe that perverse macro conditions are likely a temporary phenomenon.

Chart of the Week

From FRED

The manufacturing PMIs from the Dallas Fed, the New York Fed, and the Philadelphia Fed measure firms current business activity and business activity expected in the future. This chart measures the spread between current conditions and future conditions. In September, the spread at 3.4 pts reached the lowest point since June 2006 when it was negative at -1.0 pts.

The Week Ahead

The labor report is still to come this week and will play a huge role in how the market sees the Fed's tapering schedule. The August jobs report was a bit of a disappointment, so a rebound is expected. Canada's labor force survey also comes out on Friday and will also serve as an indicator in how the Bank of Canada will proceed with tapering.

Fed Eyes Tapering While China Sees a Setback

Jacob Hess
September 26, 2021

The Week Behind

There was a lot to unpack last week after the Fed concluded its September meeting with a new release, new projections, and a fresh press conference appearance by Jerome Powell. Still no movement in policy though. Markets shrugged it off as the inaction was mostly expected, and concerns in China overshadowed.

The standard release in September indicated tapering is on the way more clearly, with the following phrase appearing for the first time: "If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted." This addition replaced wording that suggested the FOMC was still assessing the status of the recovery in July, and now members have confirmed that "conditions" are acceptable for tapering. Another thing to take from this is that the Fed does not see COVID risks as threatening to the overall economic outlook. There was only one minor change in the September implementation note; the per-counterparty limit for overnight reverse repurchase agreement was raised from $80 bil to $160 bil. Some may see that as an ominous signal of a financial system flushed with too much cash, but the NY Fed insists it's essential for smooth monetary policy implementation. Using the reverse repo market to stabilize interest rates is not a new strategy and was used in 2013 in previous periods of normalization.

The biggest news came from the FOMC projections which saw some pretty large shifts from the June numbers. Here are the three most important changed:

  • Fed members are a lot more bearish on growth in 2021 with the median GDP growth forecast for the full year down to 5.9% from 7.0%. Instead, the growth that was originally projected in Q3 and Q4 2021 was pushed off to the beginning of 2022. The median full year GDP growth projections for that year is up from 3.3% to 3.8%. Overall, this does confirm that the Fed sees the current disruption in activity to be a temporary factor with the recovery to resume sooner rather than later.
  • With supply disruptions persisting, the Fed has no choice but to acknowledge inflation will run rampant in 2021. The median PCE inflation projection for 2021 is now 4.2%, well up from 3.4% in June. Despite elevated expectations this year, the Fed remains rooted in the thought that inflation will moderate substantially in 2022 and 2023. The median projection for both is at 2.2%, pretty much unchanged from the June numbers. There is a slight acknowledgment of upside risk in prices in the members' range for 2022. The bottom side estimate is up just 0.1% to 1.7% while the top side estimate is up 0.5% to 3.0%. There is at least one FOMC member that sees inflation as more than temporary.
  • The Fed does not give a schedule on rate hikes, but it does hint at timing in its projections and dot plots. Since June 2020, the median projected Federal funds rate (FFR) for 2022 was set at the lower bound 0.1%. That has finally changed. With more FOMC members forecasting a rate hike in 2022, the September projection of the FFR was raised to 0.3%. More specifically, June projections had 5 members seeing 1 hike and 2 members seeing 2 hikes in 2022 while September projections have 6 members seeing 1 hike and 3 members seeing 2 hikes. With rate hikes likely to come sooner than previously expected, many believe that tapering will begin in the November meeting since that will need to begin first.

The projections also pointed to an increase in uncertainty surrounding the growth outlook. As downside risks emerge. Cue the Evergrande crisis. With the large Chinese property development firm seeing major cash flow issues, investors are sensing that the overleveraged firm could spark more trouble in China's financial system because of its size (over $300 billion in liabilities). Relief may come from a very hands-on Chinese government that can choose how it defuses the situation. However, Xi's government, which has previously indicated that "deleveraging" is one of "five major tasks" in 2021, may not choose a friendly route.

Many major financial institutions see the Evergrande crisis as a risk to Chinese growth through the end of the year. RBC Capital Markets sees any kind of outcome being a "meaning headwind to domestic growth" and by extension having "global implications." Wells Fargo voiced similar concerns suggesting a resulting slowdown in China could "have material impacts on global growth that could weigh on the United States." The bank should be publishing its monthly international outlook report, and it will be interesting to see whether it updates its China growth forecast. Danske Bank does see some volatility stemming from the situation as its middle case sees the Chinese intervening "really late" and that "financial markets and global economy will take a big hit before things turn around again." Commentary from CIBC suggests that the banks is now expecting slower growth from China following the events, admitting that Beijing is "clearly willing to risk some slowdown to the economy as a whole" to use this situation to help stamp out excess debt.

Indeed, that could be another issue for the Fed to consider going into the November meeting as the large Chinese economy reacts. The setback to growth would combine from weakness in Japanese and Indian growth to make a for a very weak 2021 end in the Asia Pacific region. And of course, many of those countries are at the heart of supply chain disruptions that are causing inflation. This is just one factor of many that go into monetary policy decisions. It would take a disastrous outcome to really put pressure on normalization by developed market central banks. Nevertheless, some think that disaster is a potential end to the Evergrande story.

Chart of the Week

From Federal Reserve

Mentions of "inflation" and "transitory, temporary" in Jerome Powell's press conferences following the FOMC meetings have been low in the last two meetings. Is the Fed shying away from the "transitory inflation" narrative? Or do members assume it has already sent that message to the markets successfully?

The Week Ahead

Next week brings the close of September and the beginning of a new month of economic data. The PCE Price Index reports on Friday as the month of October opens, bringing into focus how supply chain disruptions have affected prices in August. Additionally, throughout the week, markets will be watching Beijing to monitor how the Evergrande debt crisis will play out. It could have implications for Chinese and global growth.

Review the Fed Previews

Jacob Hess
September 20, 2021

The Week Behind (& The Week Ahead)

We've had a few central banks reports so far in September, but they've all been warming us up for the one of the bigger FOMC meetings in recent time. We'll be combining the "Week Behind" and "Week Ahead" sections to spotlight some top commentary previewing the Fed meeting. Some think that tapering is still an option in September despite the trouble that has come with Delta, but the conesensus has become more ambigiuous as uncertainty has risen. New projections also introduce another level of anxiety as inflation expectations could see major adjustments if the Fed indicates that year-end inflation is set to be higher than previously forecasted. There certainly is a lot to unpack, here are some thoughts:

ING: A no change decision at the upcoming FOMC meeting looks a foregone conclusion. The Fed funds target range will be kept at 0-0.25% and monthly asset purchases maintained at $120bn per month despite decent activity data and elevated inflation readings that are running at double the Fed’s 2% target. Just six weeks ago this wasn’t necessarily going to be the case. Several regional Fed presidents were openly questioning the need for quantitative easing stimulus, including St. Louis Fed President James Bullard who argued “it’s not clear to me that we’re really doing anything useful here”. Dallas Fed President Robert Kaplan agreed, stating “these purchases are not well suited to the environment we’re in now… I think the best thing to do is, early, begin weaning off that medication”. Several others spoke of it being at least “appropriate” to start the discussion of “dialling back” the stimulus

Danske Bank: The Fed is in a difficult position amid slower growth and still high inflation. Given the weak jobs report and lower-than-anticipated inflation in August, we expect the Fed will refrain from providing more details at this meeting, as the Fed has already made it clear that tapering is set to begin before year-end. We believe the tapering pace is more important than the timing. We continue to expect that tapering will be concluded in mid-2022. We expect the Fed to raise the ‘dots’ by signalling the first rate hike in 2022 (up from 2023 currently). We still expect the first rate hike in H2 2022 in either September or December.

Wells Fargo: The Federal Reserve is currently purchasing $80 billion worth of Treasury securities and $40 billion worth of MBS every month, and many market participants look for the FOMC to commence a "tapering" of its asset purchases in the near future. In our view, the disappointing labor market report for August and the uncertainties imparted by the recent surge in COVID cases on the economic outlook mean that an announcement of tapering at the upcoming meeting is quite unlikely. However, it is important not to miss the forest for the trees. Progress continues to be made toward the Committee's goal of "maximum" employment. Unless the economic recovery is completely derailed over the next few months, we believe a taper announcement will be forthcoming at either the November or the December FOMC meetings. The Committee could potentially use its statement to signal the timing of tapering commencement. For example, changing the first sentence of the statement and/or characterizing the risks to the economic outlook as more "balanced" could signal that the FOMC believes that tapering is imminent. That said, we believe that the Committee will refrain from making substantive changes to the wording that it uses in the September 22 statement. Will the "dot plot," which shows the expected pace of rate hike among the 18 Committee members, shift? A downgrade to GDP growth forecasts could cause some dots to shift lower. But forecasts of lingering inflation next year may lead some members to conclude that the pace of tightening that they expected three months ago is still warranted.

TD Bank: The Federal Open Market Committee meets next week to deliberate on the course of monetary policy. Importantly, the Fed’s statement will come alongside renewed projections for economic growth, unemployment and inflation. Economic growth projections are likely to be downgraded, but to rates that are still well above trend. The pace of improvement in unemployment is also likely to be slowed, but still make progress. The inflation forecast is also likely to see an upgrade in the near-term, marking to the data. With these economic views, the Fed is likely to communicate that in order to ensure inflation remains transitory it must begin preparing to withdraw policy support. The first step is to slow the pace of asset purchases, which is likely to happen this calendar year. The Fed’s statement is likely to emphasize that this does not mean that policy rate hikes are around the corner, but as long as growth continues, they may not be too far on the horizon.

CIBC: Quantitative easing, at least at its current pace, may still have outlived its usefulness. Bond yields are so low that the case for maintaining the current pace for Fed purchases isn’t obvious. Each time the Fed takes bonds off the market in exchange for reserves that pay a floating rate, it shortens the term structure of federal debt held by the public, as those overnight reserves are also a government liability. With that debt now much higher than pre-pandemic, it might be prudent to curtail such term shortening if the economy doesn’t need it. But the market will still see a tapering announcement as a sign of increased confidence in the economic outlook. Given the recent clouds from both Delta and the last payrolls data, the Fed could well decide to wait one more meeting before setting its plans in stone. That ties into one other power that Jay Powell doesn’t have: the ability to predict the course of the pandemic. The Fed’s headquarters, and each regional office, are flush with economists, not epidemiologists. The FOMC will publish its economic outlook, one likely dented a bit in the near term, but full of confidence about both dampened supply-shock pressures on prices, and an improving jobs market, as we move through 2022. It might even bring forward some of the rate hikes that lie further out in the future.

Pictet Wealth Management: The main message from the Federal Open Market Committee (FOMC) meeting on 22 September will likely be that the Fed will announce QE tapering at the following meeting, on 3 November. This would be in line with the well-telegraphed schedule; we think Chairman Powell, who is seeking re-nomination, is mostly in ‘do-no-harm’ mode for now.

Chart of the Week

From FRED

No Tapering Yet

Jacob Hess
September 13, 2021

The Week Behind

The rebound in global economic growth has brought central banks in the spotlight as they look to unwind from accommodative positions. The situation is tenuous and has been made complicated by volatile public health conditions as various countries face troubles from resurging COVID infection rates. It has become a delicate balancing act for the mouthpieces of monetary policy trying to acknowledge the renewed risks while ensuring markets to stick to the plan. Last week, three central banks from developed nations took the stage to do just that: the Reserve Bank of Australia (RBA), the Bank of Canada (BoC), and the European Central Bank (ECB).

The RBA finds itself in grappling with normalization as Australia sees its worst wave of COVID infections since the pandemic began. The most recent 7-day case growth rate of 1,739 beats the previous high of 552 on Aug 2020. Regional lockdowns have been reinstated and have already started to restrict activity. The RBA acknowledges that strong growth is set to be interrupted: "GDP is expected to decline materially in the September quarter and the unemployment rate will move higher over coming months." However, in a bid to maintain optimistic, it assures of the "temporary" nature of the setback and emphasizes that only some regions are facing contraction while others are "continuing to grow strongly."

Despite the uncertain conditions, the RBA moved ahead with its reduction in government security purchases from $5 billion to $4 billion, but it extended the length of the program from "until early September" to "at least mid-February 2022." Tapering in number only. In reality, the cumulative effect of the changes indicates an increase in quantitative easing if this pattern holds through early 2022. The change also contradicted a quote from the July meeting where the RBA looked to move away from a "commitment to a specific rate of purchases over an extended period of time." This detail shows how disruptive the new restrictions have been in advancing towards normalization. As a result, the RBA remains on the offensive.

A day later, the BoC's monetary policy announcement was released. Canada's recent rise in COVID infections has not been as bad as previous waves and, consequently, has not forced lockdowns in the same way. However, that has not stopped growth from stalling. GDP fell by about -1% in Q2 2021 and shorted the BoC's July projections as supply chain disruptions and a housing activity pull back weighed. On a positive note, the bank pointed out that "domestic demand grew at more than 3%." Indeed, employment and consumption avoided contraction despite the spike in COVID, and elevated inflation continued. These positive factors led the BoC to say that "the Canadian economy still has considerable excess capacity."

Regardless of that assessment, Canada's central bank held firm on policy rates and the pace of asset purchases. This was largely expected, and in fact, with Delta risks materializing, it was thought the BoC could go either way in its decision. Instead, the Governing Council remains in wait and see mode. Tapering remains on the table later this year if the recent contraction proves to be temporary, and inflation stays elevated. The BoC acknowledged "CPI inflation remains above 3 percent as expected" and is still monitoring the inflation and labor market releases. Like the Fed, it will use the jobs recovery to guide its decision making regarding tapering. According to Statistics Canada, "Employment is within 156,000 (-0.8%) of its February 2020 level, the closest since the onset of the pandemic." It would not be a surprise to see a reduction in asset purchases next meeting or two.

Finally, the ECB took the stage to end the week. Its monetary policy decision is the 2nd after it shifted its monetary policy strategy to adopt a "symmetric 2% inflation target over the medium term" in order to acknowledge that inflation over the target 2% is equally undesirable as inflation below 2%. The most recent measure of inflation came in at 3.0% YoY in Aug, up from 2.2% YoY in Jul. However, core inflation (ex-unprocessed food, energy) was closer to the target at 1.6% YoY. Combine this with a solid rate of GDP growth, and the ECB is looking at a solid euro area recovery that is relatively undisturbed by the new Delta cases. Like the previous two central banks, tapering was definitely on the table.

And we got the smallest taste of that tapering. The ECB maintained policy rates and APP purchase rates while choosing to reduce PEPP purchases to "a moderately lower pace of net asset purchases under the PEPP than in the previous two quarters." While the ECB is not known for tapering, this change was mostly expected and acted as a signal to markets that the Governing Council sees the increase in inflation and that it is impacting their deliberations. This was also evident in the release of the Sept economic projections where growth and inflation projections increased over June. In fact, the ECB now admits that it expects to see 2.2% HICP inflation at the end of the 2021, up from 1.9% projected in June. It is likely that this will set the stage for further tightening of the APP and PEPP purchases by early next year. Of course, there will be consideration of near-term economic conditions, but they aren't expected to change: "Real GDP growth is expected to increase again vigorously in the third quarter."

Three developed market central banks, three passes on tapering. This sets the stage for the Fed to decide whether it wants to take pole position in tapering among advanced economies. Recent soft economic data could delay that, but there are still some expectations that the September decision will come with reduced asset purchases.

Chart of the Week

From FRED

Tapering remains on the table for Australia, Canada, and the euro area as their central banks take a pass in their September meetings.

The Week Ahead

Inflation reports for the US, the UK, and the eurozone will come out this week to set the stage for the Fed next week. We'll also see the initial reading of September consumer sentiment on Fri after it took a sharp negative turn in August. There should be a bit of a bounce there as Delta risks have settled but likely not a large one. Elevated input prices finally falling through to the consumer continue to weigh on the personal finances of consumers.

Labor Day on Labor Day

Jacob Hess
September 06, 2021

The Week Behind

It’s Labor Day and it's time to look at labor day. That's right, last week we got an update on the labor market that followed the Fed's central banking conference in Jackson Hole, and with tapering still on schedule, many were wondering if the newest employment gain would get in the way. In addition to that, the report would give an idea of what kind of effect that the Delta variant would have on hiring. According to last week's CotW, August PMIs suggested that the effect might not be that much. However, the generally disappointing report might be evidence to the contrary.

Total nonfarm payroll employment grew by 235,000 in August and the unemployment rate fell -0.2% to 5.2%. While gains were made, the number was well off expectations, short of expectations by about 500,000. Wells Fargo was thoroughly disappointed, calling the report a "major miss at a critical time." For TD Bank, the steep decrease in hiring suggesting that "the risks in the coming months are firmly to the downside" as Delta continues to run rampant in the US. Those risks were made more material for CIBC which stated that it would now more than likely decrease its forecast for H2 GDP growth in the US. These were just three voices of the many that were sharing their disappointment. Many of them are also less sure of a tapering announcement in September.

While the consensus seems to be that the report was a major downer for the outlook of the US economy, we're here to provide a few counterpoints:

  • While the number of job additions was low, there was still a solid drop in permanent job losers. In August, permanently unemployed fell -443,000 compared to -257,000 in July. This was the largest drop since December 2010, larger than all of the declines in permanent unemployment during the pandemic recovery.
  • On the other hand, temporary layoffs were essentially flat in August and remain at 1.3 million. Recovery in this category has been quicker than the permanent category, and therefore, acts as the "low hanging fruit" in the labor market. Permanent unemployment can be a more chronic condition.
  • While the leisure and hospitality employment gain (the most sensitive to COVID factors) was 0, it wasn't negative. When infections rose at the end of 2020, the leisure and hospitality sector lost -525,000 jobs in two months, and that effect wasn't visible in the August report. This does provide evidence for the efficacy of vaccines in protecting the economy from further decline.
  • July and June data was revised upward by a significant amount. The Establishment Survey data for July was revised up from 943,000 to 1.1 million in July and from 850,000 to 962,000 in June. With revisions in these months, there might be reason to believe that August could also get an upward revision. However, it is unlikely the revision would come near expectations.

For all the disappointment that came with the jobs report, it seems unlikely that tapering is going to be delayed. The Fed might be inclined to label the Delta effects at "transitory" just like it did in discussing inflation. The market did not see the Fed getting more dovish as yields were unchanged in trading on Friday of last week. It all kicks off at the September Fed meeting.

Chart of the Week

Data from FRED

Temporary layoffs have skyrocketed during the COVID pandemic but were also quick to recover. Permanent job losers have recovered at a slower rate.

The Week Ahead

The Reserve Bank of Australia, the European Central Bank, and the Bank of Canada announce this week representing developed market central banks. These announcements precede the long awaited Federal Reserve meeting in September with tapering expected.

With That, We Carry On

Jacob Hess
August 30, 2021

The Week Behind

The Federal Reserve's Jackson Hole conference closed out the previous week with central bankers gawking over monetary policy research and updates. Chair Jerome Powell opened the proceedings with a speech titled "Monetary Policy in the Time of COVID." As many expected, he guided on tapering and how it should be expected in the latter half of 2021. However, he was very keen to separate the coming asset price reductions from rate hikes in the future: "The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test." The development of the effects of the Delta variant have brought about different conditions than were felt in Q1 and early Q2. In fact, the new peak in infections manifests the risks and uncertainties that the Fed had mentioned before.

The UMich consumer sentiment indicator showed the disruption the most in its most recent edition of the survey. The indicator fell -13.4% on a monthly basis in August dropping it -5.1% below the level from a year ago. Consumers' expectations worsened the most, a -17.6% drop, as the Delta variant caused them to be more cautious. There almost certainly will be a ripple effect in personal consumption that the Fed will heed in its review of economic conditions. Jobless claims also took a step back with an increase of (just) 4,000 to 353,000 in the third week of August adding to the stalling of the recovery there. However, the states with the highest infection rates aren't necessarily acting as one would suspect, so we are unlikely to see another capitulation to subsidized joblessness. This is good news for hawkish Fed members patiently waiting for the labor market that the central bank has clearly prioritized.

The biggest release of the week came at the end when the Bureau of Economic Analysis reported on personal income and outlays for July. The 1.1% monthly increase in personal income made a case for a strong summer as growth in jobs and wages bolstered consumer's financial prospects. However, in the same month, personal consumption growth slowed to just 0.3% MoM after a 1.1% gain in June, possibly showing the early effects of the Delta variant. Expect more disappointment in August. In addition to data on income and consumption, we got an update on the PCE Price Index and the Core PCE Price Index, the measures that the Fed use to track inflation for monetary policy. Both gained on a monthly basis, but at a slightly lower pace. The headline PCE Price Index yearly gain was 4.2%, quicker than June at 4.0%, and the Core PCE Price Index remained up 3.6% YoY. Both have been above the 3.0% level for 4 months now and show little signs of slowing. At face value, they also seem to be consistent with how the Fed envisioned post-pandemic inflation would run.

In the end, nothing groundbreaking seems to have come from the Jackson Hole meet-up. Expectations of tapering have been majorly updated with most commentary from banks and investors maintaining the view that tapering will begin in H2 2022. And because the Fed has warned of risks to their outlook along the way, there doesn't seem to be a huge surprise in the rise of Delta. And with that, we carry on.

Chart of the Week

Data for Dallas Fed, NY Fed, Phiadelphia Fed, NY Times

Employment indexes in many Federal Reserve manufacturing surveys have remained strong despite the recent rise in the COVID-19 infection rate. This suggests that the impact from the recent wave of Delta variant infections on the labor market is likely to be much weaker than the initial wave of the pandemic was. This should will allow the Fed to continue as planned on tapering.

The Week Ahead

Several more indicators of supplier activity in the US will be revealed as manufacturing orders data for July comes out. Personal income and consumption comes out after that. These reports follow the flurry of Flash PMI reports from IHS Markit that will give a glimpse of August business conditions. From Jackson Hole, the Fed will be watching these reports and hoping they will show some easing in the supply constraints. The solid industrial production from last week should give us hope that these economic releases will tell a similar story.

Supply Pressures Looking to Peak

Jacob Hess
August 22, 2021

The Week Behind

It's been some time since we saw some choppiness in markets, and we finally got some this week. The S&P 500 fell -0.59% and the Nasdaq fell -0.73% after a solid Friday offset some losses early on in the week. Asian stocks performed worse with China's regulatory crackdown lingering. In the week, the Shanghai Composite fell -2.5% and the closely related Hang Seng index (in Hong Kong) fell -5.8%. Risks are making themselves known especially as US equities sit near all-time highs and the VIX ready to jump from its coiled position. The volatility also expressed itself in a major move lower in the price of oil. WTI futures started the week above $68 and fell towards $62 a barrel, reportedly, on worries that growth would slow due to Delta and tapering. Combine the downward move in oil markets with other commodities staggering lower (Bloomberg Commodity Index down -3.7% last week) and you've got a nod to the "transitory" inflation narrative.

Updates on business activity in the US came through retail sales and industrial production early on in the week. Retail sales stumbled to a -1.1% decline in July after a small gain of 0.7% in June. Motor vehicles & parts sales was the major factor in the decline (total retail sales ex-motor vehicles at -0.4%) with a -3.9% drop. The other sectors saw mixed movements but most were still 10-15% above a year ago. Food service & drinking places sales continued on its reopening path, up 1.7% in July and up 14.7% in the May-July 2021 period over the February-April 2021 period. The days of surging retail sales are over, and the summer spending bump was slightly disappointing. May-July 2021 retail sales were just 2.8% higher than the February-April 2021 period. There has been discussion of slower goods spending shifting to stronger service spending as the recovery continues in the latter half of 2021, and the sour July report provides evidence of this shift. The latest Quarterly Services Report has also been supportive of that narrative with service revenue growth up 4.0% in Q2 2021, up from 2.5% Q1 2021. Ceteris paribus, the trend will likely continue with goods sales returning back to a pre-pandemic path, and service spending strong in Q3. However, Delta virus risks remain.

Auto production up in July, but still sluggish.

While the demand front faltered in July, the supply side stepped forward with a solid industrial production number, up 0.9% month over month. The solid gain was mostly broad-based with end product growth up 1.6% (consumer goods up 1.0% and business equipment up 2.8%). Construction supplies bounced 0.9% after three straight declines. The short-term cooling of the real estate market likely led to these later spring early summer drops, but consistently high homebuying demand and the end of inflated lumber prices will keep construction production near and above peaks. Most importantly, we saw a large monthly spike in motor vehicle and part production, up 11.2% in July, that will help assuage fears of persistently high prices in the auto market. Primary metals and machinery production gains of 1.2% and 1.0% will also play into a "transitory" inflation narrative. Overall, observers can take the strides suppliers are making as a sign that constraints from low input inventories, high costs, and labor shortages began to peak in July. Total industry capacity utilization sits at 76.1%, well off the lows of 71.5% from a year ago, but still below the long-term average around 80%. The next round of stimulus through infrastructure spending is sure to heat industrial production even more, but could it prove to be too much? That remains to be seen and could depend on how much accommodation the Fed decides to keep in its monetary policy.

Chart of the Week

Data for US, Euro area, Canada, Japan, UK, Australia

Where's the inflation? The US leads the developed world in all CPI categories. Canada and Australia are close behind while the EU and the UK are seeing moderate price pressures. Japan's deflationary struggles continue as COVID makes a reappearance.

The Week Ahead

Several more indicators of supplier activity in the US will be revealed as manufacturing orders data for July comes out. Personal income and consumption comes out after that. These reports follow the flurry of Flash PMI reports from IHS Markit that will give a glimpse of August business conditions. From Jackson Hole, the Fed will be watching these reports and hoping they will show some easing in the supply constraints. The solid industrial production from last week should give us hope that these economic releases will tell a similar story.

Cars are Still Expensive, Workers are Still Needed

Jacob Hess
August 15, 2021

The Week Behind

US economic news last week gave us a lot to digest with several reports continuing to document the pace of the recover. Notably, the JOLTS and productivity and costs reports gave another glimpse of the labor market (after the booming jobs report) and CPI and PPI prints updated the inflation scoreboard. It was more of the same theme: demand from reopening continued to outstrip the ability of businesses to satiate it. However, last week the discussion of the economy felt less centered on these key indicators as concerns over the Delta variant dominated the headlines. Indeed, Wells Fargo downgraded its outlook for Q3 and Q4 GDP (projections down -1.9% and -2.0%) and even its full year view (projection down -0.8%). Regardless, let's dive in anyways.

The JOLTS report showed another record high in job openings as it surpassed expectations. Hires took off while separations rose only on increased quits. Evidence continued to point towards workers moving around and taking advantage of the tight labor market. The largest jump in openings was in the professional and business services sector (227,000) which almost doubled the struggling accommodation and food services sector (121,000) that is still bouncing from COVID lows. The sectors were flipped in the July jobs report with the former adding just 60,000 jobs while the latter added 380,000. The dynamics in these sectors represent the two labor trends present in the post-COVID economy:

  • Businesses posting new job openings for jobs that were unfilled previously due to depressed activity. These businesses are seeing large positive employment changes due to low quit rates (accommodation and food services: 40k quits vs 122k hires in June).
  • Businesses posting job openings for newly vacant positions. Job gains are mostly net neutral here because it involved a quit and a hire (professional and business services sector: 106k quits vs 246k hires in June).

With job openings at all-time highs, one would expect wages to be tracking high as well. That does not seem to be the case. The Productivity and Costs report for Q2 2021 showed that unit labor costs for all firms were up just 0.1% YoY as hourly compensation grew 2.0% YoY, just barely above productivity up 1.9% YoY. Manufacturing unit labor costs actually fell -5.8% YoY as output surged 16.5% YoY while hourly compensation was only up 0.6% YoY. However, the comparison was at least partly affected by low bases in Q2 2020 when government support (ex PPP program) was put in place to preserve the paychecks of workers despite lower output (and therefore productivity). This report suggests that inflation is not being driven by labor costs directly. Instead, it's possible that the disappointing growth in compensation (see negative real hourly compensation in Q2 2021) is discouraging potential workers from entering a very tight labor market.

Speaking of inflation, we got a double dose of it this week with the PPI and CPI releases. Businesses continued to see hot prices with another monthly gain of 1.0%. That makes 7 straight months of monthly gains over 0.7%, a truly robust period of consistent price increases. Core PPI is now up to 6.1% YoY, the highest since August 2014. There was an interesting divergence between core processed goods and core unprocessed goods. Nonfood unprocessed materials less energy were flat 0.0% MoM in July and 0.9% MoM in June after a 9.3% MoM jump in May. Processed goods less foods and energy, on the other hand, remained hot, notching another monthly gain above 1.5%. It seems that commodities are rotating away from their extreme rise in prices while propagations of those previous price increases are still lingering in processed intermediate goods. A good step towards "transitory" inflation is input prices peaking and beginning to level off. Lumber was the first commodity to do that, and more could follow. For now, inflation persists.

Has inflation peaked?

And of course, the report that everyone was watching (including Chair Powell), the July CPI report. We've peaked? We might have peaked. Headline CPI recorded its lowest monthly gain since Feb at 0.5% and, notably, used car prices grew just 0.2%. While it's a good step toward easing, there really is still no actual easing in auto prices yet. Transportation commodities still grew 1.0% and were up 19.8% over a year ago. While the movement in auto prices may support the narrative that inflation is here for longer, moderate Services (less energy) CPI growth of 0.3% MoM to just a 2.9% YoY move suggests inflation from reopening is a lot tamer than we think. Service spending has been the category of spending most sensitive to the pandemic, so it should see larger price increases as consumers start ramping up service spending again (as they have in the summer). Service inflation has actually been more in line with the framework set by the Fed which has said it is pushing for inflation above 2.0% to make up for periods below the target. This is probably what has the Fed leaning more dovish despite good shortages pushing the headline index up.

Chart of the Week

From FRED12

Inflation, as measured by Core CPI and Core PCE Price index, is streaking above 2.0%. A comparable period of short-term inflation following a recession occurred in late 2011 and early 2012 and lasted 10 days (as measured by Core CPI).

The Week Ahead

Retail sales and industrial production for the US come out this week alongside some real estate indicators in NAHB Housing Market Index and housing starts. More current developments on the Delta variant will also be observed as many are still waiting to see if the outbreak will be "transitory" like it was in the UK. Meanwhile, equity indexes remain near all-time highs and VIX at a near-term low.

Recovery Continues, but Delta Looms

Jacob Hess
August 08, 2021

The Week Behind (Aug 2nd - Aug 6th)

Last week was PMI week revealing the state of the global recovery in July. Developed nations in the US and Europe saw manufacturing and service activity growth peaking in Q2 2021. There, robust growth continued in July but was slowed slightly by supply constraints and surging input prices. Growth slowed even more in Asian nations where COVID was making a comeback. The chart below shows how vaccination rates have shielded economies from restrictions that weigh on manufacturing. The same narrative remains: herd immunity through immunization is the only way to get back to economic normality.

From IHS Markit

Countries in the bottom left corner weighed on the JPMorgan Global Composite PMI which fell to 55.7 in July from 56.6 in June. Germany, Spain, and the US were bright spots offset by slow growth in China, Brazil, and Russia and contraction in Japan and Australia. Despite the Delta variant rising in July, output from the Tourism & Recreation sector led all 21 sectors as reopening effects continued to bolster economic growth. Notably, new order growth trumped output growth in the Machinery & Equipment, Automobiles & Auto Parts, and Chemicals sectors. The Metals & Mining sector was pretty much flat. In Q3 2021, global supply chains will be playing necessary catch-up with the reopening economies. Developed economy central banks will be watching with much anticipation, maintaining accommodative policy to allow this to happen while developing economy central banks tighten to cool adverse pricing affects. It is a fragile balancing act that will define what "transitory" means for inflation.

Not only was it PMI week, but the jobs report for July also came out with a very positive 943,000 jobs added. The unemployment dropped to 5.4% (down -0.5%) and total unemployed persons fell -782,000 to 8.7 million. A majority of the drop in the unemployed were temporary layoffs which now sit at just 1.2 million, just 489,000 above pre-pandemic levels, suggesting that most of the easy job gains that were a result of restrictions easing. Could we see some reversal here in Q3 if the Delta variant continues on its current trend? It seems unlikely. Restrictions will likely be directed towards the unvaccinated which would allow vaccinated workers and consumers to continue as normal. Hopefully, the number of unvaccinated individuals drops in the next two months allowing the economy to return to normal for everyone.

Going forward, eyes are fixated on where the labor market will go from here. The Fed has maintained that full employment is its main objective in determining the course of monetary policy as it continues to label the current movement in inflation as "transitory." Where is there slack to get to that level of full employment? Right now, in leisure and hospitality. The sector added 380,000 jobs and is still off February 2020 levels by 1.7 million (even farther off what the sector would be if employment grew at long-term growth rates). These jobs also go towards lower skilled, lower income workers, those that took the hardest hit during the pandemic. Since it was most sensitive to the effects of COVID-19, it would make sense that it be a good general indicator about whether the labor force has shrugged off the pandemic. It would also be the first sector to feel the effects of restrictions from the Delta variant.

Chart of the Week

From FRED

Supply chain issues persist in metals and machinery. The total level of unfilled orders in these industries vs total shipments is elevated by historical standards. However, it is still below the peaks experienced during the Global Financial Crisis and the beginning of the pandemic.

The Week Ahead

Next week is a big week for inflation. A whole host of nations including the US will report CPI and PPI for the month of July. In addition to that, the JOLTS report will show how job openings are moving off of its record levels. At the moment, the forecast sees openings rising even higher. The equity market remains teetering at elevated levels, but economic news might not be as much of a factor as the Delta variant headlines.

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