11.08.21

U.S. job market warms up, and equities stay hot

Brian Nick

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 Fourth-Quarter Outlook:
 
  • U.S. economy: Stimulus wearing off but growth remains solid. More workers needed.
  • Global economy: Slowing from its fastest pace in decades even as parts of Asia and the emerging markets are set to reopen.
  • Policy watch: Policy is shifting from “extremely accommodative” to merely “quite accommodative.”
  • Fixed income: Income generation remains a challenge as rates rise gently from very low levels.
  • Equities: Valuations have come down but remain high relative to history; earnings growth will be key to returns.
  • Asset allocation: Balance the risk of hotter inflation with that of slower growth.
 

Quote of the week:

“Patience is a form of wisdom. It demonstates that we understand and accept the fact that sometimes things must unfold in their own time.” – Jon Kabat-Zinn
 

October’s U.S. jobs report: Better, but still not great

U.S. employment reports are always closely watched, but October’s was subject to added scrutiny because the labor market had tailed off in August and September after creating more than a million jobs in in July.7 With employers struggling to fill vacancies for much of the third quarter, the question became whether the fourth quarter would start on a stronger note.
 
As it turns out, October’s report was quite good — but not quite good enough to assuage our concerns about a too-tight labor market heading into 2022.
 
Breaking down the details:
 
  • Total nonfarm payroll employment rose by 531,000, while August’s and September’s totals were revised upwards by a combined 235,000.8

  • The unemployment rate dropped to 4.6% amid stable overall labor force participation, with a slight uptick among prime-age (25-54) workers.9

  • Manufacturing jobs registered their biggest gain of the year, and leisure and hospitality jobs got a post-Delta bump. On the down side, government jobs fell for the third straight month (though last month’s drop was much smaller than originally estimated).10

  • Average hourly earnings for all employees decelerated on a monthly basis, but the year-on-year growth for nonsupervisory workers (5.8%) continued to climb.11
 
Despite this mostly upbeat news, there’s still a cloud on the horizon. The U.S. labor force grew by only 104,000 workers in October, indicating there are fewer and fewer unemployed people available to fill open positions.12 If 2021 has taught us anything, it’s that high demand combined with inadequate supply leads to higher prices — which in this case means wages.
 
Also, based on weekly jobless claims data, more than 9 million people who had been receiving unemployment assistance at the end of August were no longer doing so by the middle of October, when the monthly employment data was being collected.13 Yet fewer than 1 million net new jobs were created during the past two months despite more than 10 million job openings. How could this happen?14
 
We surmise that labor force participation is being depressed by some combination of (a) ongoing fears of the virus, (b) a large number of people unable to work due to family commitments and (c) potential employees staying on the sidelines and continuing to live off excess savings accumulated during the pandemic. To varying extents, all three of these factors should be fading. If they don’t — and quickly — the current worker shortage could become more acute, with wage pressures leading to broad-based price increases and narrower profit margins for businesses. Fortunately, that hasn’t occurred yet, but the clock is ticking.
 
Businesses have also had to deal with a sharp rise in unit labor costs, a measure of how much they spend on workers, adjusted for their productivity. Last quarter, compensation rose and productivity declined, meaning businesses suffered. Third-quarter earnings results for S&P 500 companies haven’t reflected this dynamic, but it’s likely that smaller businesses (which don’t report earnings) are being disproportionately affected by shortages in both labor and supplies. This is one of the most important areas to keep an eye on for the global economy in 2022: Do enough workers return, and can firms make those workers productive enough through investments to forestall a wage-price spiral?
 
You know who’s watching this closely? The folks at the Federal Reserve. So let’s talk about them next.
 

It’s officially time to taper

As anticipated, the Federal Reserve announced last week that it will begin tapering its $120 billion/month quantitative easing (QE) asset purchases by $15 billion/month, starting in November and lasting until the process ends in mid-2022.
 
This round of QE, launched to add liquidity to markets at the outset of the COVID-19 pandemic in March 2020, was kept intact to ensure financial conditions remained accommodative to foster a strong economic rebound. Having met that objective, the Fed now believes the risks of continuing to add large amounts of liquidity to the system roughly offset any further benefits.
 
Inflation was also in focus last week. The Fed still regards the current period of higher prices as transitory, largely the result of supply and demand imbalances related to COVID-induced lockdowns and the economy’s subsequent reopening. In his press conference, Chair Jerome Powell noted that the Fed’s tools “cannot ease supply constraints” but expressed optimism that those constraints would abate on their own. Also noteworthy: the Fed subtly changed the language of its policy statement, indicating that inflation is now being driven by factors that are “expected to be transitory” while in July, it stated that inflation “largely reflect[ed] transitory factors.”
 
Regardless of the Fed’s nuanced explanation, we continue to believe the second quarter’s burst of inflation qualifies as transitory. In fact, its effect is already fading as consumers rotate away from expensive goods and toward services, whose prices have largely not returned to their pre-pandemic levels. However, there is also a risk that a more permanent form of inflation will take root, driven by a shortage of workers, rising wages and increasing rents.
 
Should these factors become the driving forces of inflation in 2022, the Fed may be forced to raise interest rates faster than it might like to. Indeed, the markets have recently been pricing in such a scenario, with fed funds futures now anticipating a rate hike by next July. (Fed funds futures are used by traders to bet on the direction of interest rates.) If that earlier rate increase were to occur, tightening and the end of tapering could coincide, although the Fed emphasized that its tapering decision “does not imply any direct signal regarding our interest-rate policy.”
 
Key to the Fed’s willingness to accept inflation well above its 2% threshold has been the current composition of its voting members, who have been exceedingly tolerant of higher prices as they have attempted to foster strong and broad-based wage growth in the early stages of this economic cycle. And while the Fed’s makeup could change dramatically in the coming months as vacancies are filled (Governor Richard Clarida’s term expires on January 31, 2022, for example), the new configuration is likely to be even more accepting of moderately high core inflation (2.5%-3%) to persist next year.
 
The primary determinant in terms of tightening versus standing pat on rates will be the labor market. Although the unemployment rate has fallen quickly, labor force participation among prime-age workers is still languishing well below its January 2020 level. If more workers stream into the jobs market, the pressure will likely come off the Fed to raise rates quickly to forestall a wage-price spiral. If large numbers of potential new hires remain on the sidelines, the market’s current expectations for a mid-2022 rate hike may end up looking prescient.
 
Markets took last week’s news on tapering and tightening in stride. The S&P 500 Index rose in the immediate wake of the Fed meeting and kept rallying. It finished the week with a healthy gain (+2.2%) and hit a fresh all-time high on Friday. As for bond markets, the U.S. Treasury yield curve flattened modestly on the week, with yields on longer-dated (10+ year maturities) dropping following Friday’s jobs report. In our view, this indicates less of a fear in markets that the Fed will need to take steps to contain inflation. That would be a positive for risk assets. On the other hand, if the Fed were compelled to raise rates early and quickly – possibly in error – the resulting investment environment would certainly be unpleasant.
Sources:
  1. S&P 500 via Haver, Marketwatch, Bloomberg
  2. Bloomberg
  3. Marketwatch, Bureau of Labor Statistics (BLS), Eurostat via Bloomberg
  4. Federal Reserve via Haver
  5. Institute for Supply Management (ISM)
  6. ISM via Bloomberg
  7. BLS via Haver
  8. BLS 
  9. BLS, Bloomberg
  10. BLS, Bloomberg
  11. Bloomberg
  12. Bloomberg
  13. Bloomberg
  14. BLS via Haver
 
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
 
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