The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveens 2021 Midyear Outlook :
- U.S. economy: The growth rate has peaked but will remain high throughout 2021.
- Global economy: The economic recovery will spread to Europe and eventually Asia as more countries achieve herd immunity from COVID-19.
- Policy watch: Policy is becoming marginally less accommodative as the recovery takes hold.
- Fixed income: Even with rates subdued, credit-sensitive parts of the market should lead.
- Equities: The best opportunities may now lie outside the U.S.
- Asset allocation: Continue to allocate toward assets poised to benefit from economic reopening and recovery from the pandemic.
Quote of the week:
“Due to temporary supply chain constraints, we are currently experiencing issues getting our vanilla ice cream. Please understand if this limits your options temporarily.” – Posted in the window of a Carvel in Forest Hills, NY.
Where did the workers go?
U.S. employers added just 235,000 jobs in August, a whopping 500,000 below forecasts.2 Partly offsetting the headline miss were upward revisions (a combined +134,000) to June and July payrolls.3
Other key highlights from the jobs report:
- The unemployment rate fell to 5.2% in August, as expected.4 We continue to expect it to slip below 5% by December and return to its pre-pandemic low of 3.5% by the end of 2022.
- Workers actively looking for jobs are finding them, but the size of the labor force (those employed plus those seeking employment) is still down almost 3 million since January 2020.5
- Average hourly earnings rose 0.6% – double expectations for 0.3%. That sharp increase is consistent with labor supply constraints.6
But last month’s weaker-than-expected job growth was not due only to a lack of available workers. Industry-level data clearly suggests that the Delta variant slowed hiring in COVID-19-sensitive industries such as leisure and hospitality, which reported zero net increases in employment gains after averaging 350,000 over the previous six months.7
Let’s take a step back and assess the overall situation. The total number of employed workers is still 5.5 million below its pre-pandemic peak.8 Some of those workers have dropped out of the labor force altogether, and a large portion have retired and will never return.
This somewhat muddles what had seemed like fairly straightforward implications for monetary policy based on the Fed’s recent assumptions and rhetoric. In particular, it could be that labor market slack is not as plentiful as the Fed thought. Job creation over the past six months — 650,000+ on average — suggests that this is not a huge risk.9
But more reports like August’s would likely have Chair Jerome Powell and his colleagues worrying that the labor supply shortage is not a transitory concern, perhaps forcing them to recalibrate their economic outlooks and change their forward guidance that has, for now, kept investors calm. That said, we believe last month’s underwhelming payrolls release closes the door on a former taper announcement at the September 21-22 Fed meeting. The committee will instead wait to formally announce it in the fourth quarter after receiving more data from September and October. That’s been our call all along.
September’s employment report will be our first look at a quasi-“clean” labor market in which broader and more generous unemployment benefits will have run out. October’s release will be even more important. Studies analyzing states that have already cut off the extra federal assistance have generally found this action had almost no impact on overall employment in those states. But a large majority of unemployed workers reside in states that are still paying out the maximum benefits. With schools reopening, Delta hopefully on the wane and vaccinations continuing to rise, October’s payrolls could get a big boost — perhaps to the tune of several hundred thousand more workers rejoining the labor market.
What’s on our mind for markets and global economies?
Damaging heat and volatile storm systems were the norm this summer, but the same can’t be said of financial markets, where seas were generally calm and sailing mostly smooth. Since early July, U.S. Treasuries have traded in a narrow range, with the bellwether 10-year yield hovering around 1.25% - 1.35%.10 In equity markets, the S&P 500 Index continued to climb, notching one record high after another. In fact, on only two occasions over the past two months did the index lose more than 1% in a single trading day.11
Against that benign backdrop, we’re monitoring a number of issues, including the following:
- The Fed’s next move. Chair Jerome Powell and his colleagues appear primed to start scaling back their $120 billion per month asset purchases before the end of the year. In contrast, the Fed is not yet considering raising interest rates — Powell said as much during his speech at the virtual Jackson Hole summit on August 27. (We don’t expect the Fed to tighten policy until 2023.)Even Powell’s assurances probably won’t stop markets from focusing on when the Fed will begin “rate liftoff.” For now, investors are enjoying the easiest financial conditions the U.S. has ever seen, which are supporting credit, equity and real estate markets. That said, the Fed’s ability to separate its tapering plans from its eventual pivot to higher rates will be key to maintain a continued low-volatility environment — much less avoid a repeat of 2013’s taper tantrum.
- Wage gains versus dwindling government transfer payments. While U.S. household income is still above pre-pandemic levels, its rate of growth has slowed thanks to the expiration of a number of emergency stimulus measures. This month, for example, federal supplements for unemployment insurance expire nationwide. At the same time, many households are now eligible for the expanded child tax credit — part of the American Rescue Plan Act passed in March —which likely helped boost income growth in July. In a strong, albeit slower, economic expansion like the one in the U.S., government transfer payments can be pared back as take-home pay increases. But because the COVID-19 fiscal aid packages were so massive over the past 18 months, even heftier wage gains are needed to ensure that total income continues to grow and consumer spending — the most important input into GDP — remains robust.
- The potential toll of virus mitigation measures on economic progress. Take China, for example, whose recent data releases have not been encouraging. The latest “downer” due to COVID-19 related restrictions: The country’s non-manufacturing PMI (Purchasing Managers’ Index) fell from 53.3 in July to 47.5 in August, marking the first time in 18 months that it registered below the 50 mark separating contraction from expansion.12 Although the Chinese government is likely to reverse mitigation measures soon, it’s not certain how quickly the economies of China and other countries (such as Singapore, New Zealand and Australia) that have reinstated lockdowns will bounce back.
- Effect of the COVID-19 Delta variant on the global economic recovery. The sequential global economic recovery we anticipated in the second half of 2021 is being pushed into 2022 because of the Delta strain. Chinese imports, in particular, are a major driver of GDP for economies throughout Asia, Europe and Latin America, so even a brief contraction in its economy will reverberate worldwide. Such a downshift may already be priced in to some asset classes. For example, the MSCI Emerging Markets Index is up 3.4% for the year compared to a 20.9% advance for the S&P 500 Index.13
- Some mixed messages for stocks. U.S. equity market resilience has been the key story for investors in 2021, just as it was in 2020. However, at least some of the sources of that resilience — policy stimulus, rapid vaccination deployments, better-than-expected economic data — are all but gone. The good news is that year-over-year corporate earnings growth has easily topped forecasts in recent quarters, helping to bring last year’s sky-high valuations down significantly.