Will Jobs Stutter Delay Fed Tapering?

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What You Missed: Long-term interest rates rose as equities advanced to record territory amid wobbles on economic gauges stemming from the Delta variant. The yield on the benchmark 10-year US Treasury note rose three basis points to 1.33%, while short-term rates, like 1-month LIBOR, SOFR and BSBY continued to bounce close to zero. The price of a barrel of West Texas Intermediate crude oil rose to $69.68 from $69 following the disruptive impact of Hurricane Ida. The US Dollar weakened, and Gold strengthened. Treasury yield volatility, a key driver of the cost of rate caps and swaptions, drifted lower through the week.

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America’s job engine sputtered last month – what does it mean for our tapering timeline? Falling significantly short of expectations, America’s job creation engine coughed last month. Breaking a string of robust job gains in the last two months, August only saw the addition of 235k new jobs. High contact, Covid-sensitive sectors of the economy drove the shortfall, with leisure and hospitality job gains coming to a screeching halt, even as wages in that sector accelerated rapidly last month (1.3% month over month). For some perspective, total jobs are now 5.3 million below February 2020 levels. The economy lost 22.4 million jobs over the March-April period last year; it has netted 17.0 million since then.

On whole, even with an unprecedently high level of job vacancies and more attractive wages, the weakness shows that worries over public-health conditions due to the delta variant continues to cause many workers to stay out of the workforce. Strong wage growth in August suggests that the supply of labor, not the demand for it, drove the weakness in new jobs.

Our take: In what is historically the most impactful piece of economic data on interest rates, the significant miss in job creation last month adds a new risk to our view that the Fed will start the tapering process – easing off the stimulus throttle – at the end of the year. While it looks bad on the surface, one month’s worth of jobs data certainly doesn’t make a trend and there’s a silver lining of sorts in the data: positive momentum for workers rejoining the work force across a broad spectrum of demographic groups in the coming months.

Skeptical? Here’s some reasons to consider: 1) The looming expiration of extra unemployment benefits – the largest impact will be seen in the hard hit, pandemic sensitive leisure, and hospitality sectors.  2) Most states are keeping school reopening plans on track.  3) Hospitalization and the Covid positivity rate both fell in the last week of August, suggesting the current infection wave may have peaked, and 4) The availability of vaccine booster shots, and perhaps inoculations for young children, are likely right around the corner.  All told, we see the job creation weakness as just a bump in the road and the prospects for improvement in September are good.

Soaring COVID-19 infections dented consumer’s confidence in the future.  The survey showed consumers – who’s spending alone drives 70% of the US economy – weren’t as upbeat about the jobs market and were less inclined to buy a home or big-ticket items over the next six months. The gauge, conducted by the Conference Board, dropped 11.3 points in August to 113.8, lower than most expected and the lowest since February. It was also revised 4.0 points lower in July, following gains in each of the prior five months. It’s a troubling signal for economic momentum heading into the fall. On the positive side of the coin, consumers’ lukewarm attitudes appear to be more the result of virus fears rather than a souring of employment or income prospects.

Our take: As long as the jobs market is improving, household spending patterns should remain resilient. Consumer demand is critical to the economic outlook. While we expect consumer spending habits to moderate in the coming months, we still expect solid spending toward year-end. Ever wonder why we keep saying that the Fed’s #1 priority is helping create new jobs? Now you know why. It’s all about jobs, and now a strong showing in September and October’s jobs data is more important than ever.

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What to Watch: As we said last week, Fed Chair Powell has and will continue to work hard at divorcing a taper from a rate hike in the minds of markets. This, coupled with delta variant-driven weakness in recent economic data, resulted in a near shrug of the shoulders by financial markets – rates barely moved – after last week’s disappointing jobs report.

The Fed will do its best to hammer the message home this week via a raft of scheduled speeches by officials, who’ll likely comment explicitly on the job numbers, hoping to keep the economic optimism alive.

On the economic data front, scheduled releases will remind you of the other side of the Fed’s mandate – stable prices – which continue to rise. Another acceleration in producer prices (Friday) lies ahead in August data. Shortages were less intense in last month’s inflation gauges, but auto production woes and the approaching holiday season are set to create logistical headaches. Potential pass-through to inflation readings are probable and cannot be ignored.

Elsewhere, the Fed’s Beige Book will offer clues into how Fed officials are seeing price, wage, and labor market dynamics (Wednesday).

Big Picture: As a reminder, the Fed’s stimulus programs, aka “quantitative easing”, work by depressing long-term yields. As yields fall, and overall “easier” financial conditions show up, investors are nudged toward riskier assets. At present, a roaring U.S. recovery, the highest inflation since 2008 and a historical low for real yields (yields stripped of their inflation component) make strange companions, implying that the Fed’s stimulus programs may be working almost too well. Robust demand and limited supply would normally drive yields higher, but the Fed’s relentless asset purchases are more than beating back the surge.

What happens next? The combination of the looming Fed taper – which will be a long, slow, incremental process of easing off the stimulus gas pedal – and an end of pandemic-era uncertainty will change the dynamic.  Initially long-term yields, like the 10-year Treasury yield, will likely be driven closer to 1.50% by year’s end, assuming that economic growth  and inflation cooperate, while short-term rates, like 1-month LIBOR or SOFR, remain anchored near record lows. That’s the definition of a steeper yield curve, which itself will revert near the end of 2022 as the markets prepare for Fed interest rate hikes in 2023.

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Source: Bloomberg Professional

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Source: Bloomberg Professional