Firm US jobs report, CCP’s 100th year and the delta variant

The much-anticipated US non-farm payrolls report that came out on Friday did not disappoint, indicating that 850,000 jobs were added to the US market in the month of June, the highest since August 2020.

This exceeded market expectations of ~700,000 jobs according to various polls, and the total number of jobs lost in the US economy since February 2020 has fallen to 6.8 million, representing a still sizeable 4% of total employment prior to the pandemic. Other details of the June report also reveal a still-weak employment picture, and considerable uncertainties of the dynamics of the US labor market coming out of the pandemic.

The labor participation rate for June of 61.6% remains at 1.7 percentage points below the pre-pandemic level, and prime age participation at 81.7% is 1.2 ppt below the pre-pandemic rate. The headline unemployment rate was 5.9%, close to 5.8% for May and the participation-adjusted unemployment rate still stands at 8.6%, almost twice that of February 2020.

In response to the labor market report, US equities rose slightly while the 2Y and 10Y treasury yields both fell slightly by ~3bps. The absence of major shifts in risk asset prices and inflation expectations signals that the pace of recovery and expectations around the Federal Reserve’s policy trajectory remain largely in line with expectations after the Fed’s hawkish pivot in June.

An analysis of US market labor history shows that the decline of the unemployment rate after recessions tends to take some time to reach pre-recession levels, as there is a limit on the pace at which workers can be drawn back into employment. The size of the aggregate labor force is also a factor; even as job growth is strong, if workers are re-entering the labor force, this will drag on the unemployment rate decline.

With this in mind, given the Fed’s goal of seeing “substantial further progress” in reducing slack in the labor market before tapering its quantitative easing, we expect the Fed to wait until December before announcing a gradual exit from quantitative easing over 2022, and see this overall dovish stance remaining supportive of risk assets throughout 2021.

The past week also marked the celebration of the Chinese Communist Party centenary on 1 July. In his televised speech, in addition to highlighting the significant progress that China has made over the past hundred years, President Xi Jinping also touched on the message of self-reliance, strengthening national security, deepening reforms, promoting “high quality development” and building up China’s strength in science and technology.

Chinese policymakers continue to normalize monetary policy which has unsurprisingly triggered a phase of consolidation in Chinese equities, and this has been exacerbated by a series of regulatory actions in the technology space as policymakers seek to rein in Chinese tech giants.

Over the long term, we remain broadly positive on Chinese markets given the world’s second largest economy’s solid economic momentum. This is reflected in our macro-economic team’s GDP growth forecasts of 8.7% in 2021 and 6.0% in 2022 and expectation for further CNY appreciation ahead (12-month forecast is 6.25 versus the USD). As shown in the exhibit below, a strong CNY has historically fueled an appreciation of Chinese equities as well.

After a relatively lackluster 2021 for Chinese equities, we believe that foreign investor positioning appears to be fairly light as well, as can be seen in the subdued cumulative equity fund flows into the China market in 2021 – especially versus the strong flows seen into US equity funds. This divergence – if sustained for a period – can be dry powder for Chinese risk asset performance ahead.

As the re-openings in the US and Europe go into full swing, anxiety over the rise in cases due to the delta variant are on the rise. Portugal announced that it will reimpose nighttime curfew, and Israel with the highest vaccination rate in the world is seeing a rise in pockets of infection of the delta variant.

In Asia, we saw new lockdowns in several cities in Australia and Indonesia announcing new restrictions for parts of Java and Bali island. Latest data from the WHO indicated that for the week ending 27 June, the delta variant had spread to 11 new countries compared to a week ago and was found in a total of 96 countries. WHO warned that this was “likely an underestimate” given the sequencing capacity to identify variants would be limited in several countries.

Dr Anthony Fauci – the chief medical adviser to the US president – also sounded warnings on the danger of the rise of delta variants cases in the US, as the US narrowly missed President Biden’s target of a 70% vaccination rate for adults by 4 July. As at 2 July, 67% of adult Americans have received their first dose.

The low rates of vaccination in developing countries continue to be a source of major concern amidst the spread of the delta variant, and points to the urgency needed to support lower income countries in order to get the pandemic under control globally.

For the week ending 27 June, the highest number of new cases were reported from Brazil (521,298), India (351,218), Colombia (204,132), the Russian Federation (134,465) and Argentina (131,824). The sharpest rise in the infection rate and mortality was in the Africa region.

Globally, Covid-19 incidence remains very high with an average of over 370,000 cases reported each day over the past week. The one silver lining is a decline in the number of weekly deaths with more than 57,000 deaths reported in the past week, a 10% decrease as compared to the previous week.

While the delta variant remains a wild-card for markets, it has been reported that several existing vaccines, including Moderna’s, are effective against the delta variant.

Given that 1) the vaccination rollout continues at a consistent pace in major developed markets, 2) that policy makers are much more prepared at this stage of the pandemic, and 3) that there is very limited political will to reimpose mobility restrictions in a significant manner, our base case is that the delta variant is unlikely to derail global risk assets significantly.

Within our asset allocation strategy, we maintain an overall overweight position in equities with a preference for US equities. In fixed income, we remain overweight in Emerging Market High Yield bonds, where valuations still look relatively attractive and should offer a buffer against the adverse impact of rising rates compared to other fixed income segments. We stay underweight in both Developed Market and Emerging Market Investment Grade bonds, where historically rich valuations leave little buffer against rising rates.