With a disappointing US employment report for the month of August, we see higher odds of our base case scenario that the Federal Reserve is likely to announce a tapering of its asset purchases only in November.
The August non-farm payroll data released on Friday (3 September 2021) disappointed significantly relative to market expectations.
The US economy added 235k jobs in the month of August, a big miss compared to consensus estimates of 733k. The main factor for the disappointment was the rise in the number of Covid-19 infections from the Delta variant. This is evident from the fact that no jobs were added in the leisure and hospitality sectors in the month of August, after averaging 377k additional jobs per month over May to July.
The decline in travel spending and increase in remote working reported in the latest survey likely drove this. Furthermore, the gradual reopening of schools only led to an additional 14k jobs in the education sector, which was much lower than expected. The gains were entirely in the private education sector, with the public education sector losing 26k jobs. As schools are practising a hybrid model and not returning to full in-person learning, the back-to-school dynamics this year are expected to be different from that before the pandemic. Employment in the education sector remains ~500k lower compared to pre-pandemic levels.
Despite weak job creation, the US economy continues to face a labour supply issue. Average hourly wages in the leisure and hospitality sector actually continued to rise through August (1.3% MoM). As a result, we can expect some of these weaknesses to dissipate once the number of Covid-19 cases start to moderate.
While the significant jobs miss took investors by surprise, markets remained relatively supported in the aftermath. The S&P500 ended Friday’s session 1.52 points lower than Thursday’s close (a decline of less than 0.1%), while the 10-year US Treasury yield stayed mostly flat, as investors assessed that the Fed is, as a result, more likely to stay gun-shy at its FOMC meeting in September with a taper announcement to come only in November or later.
Looking ahead, we expect US fiscal developments and the Covid-19 situation related to the spread of the Delta variant to form two key drivers of markets ahead.
The month of September is anticipated to be a busy month in the US political calendar, as we will obtain critical color on the fate of the Democrats’ ambitious USD3.5 trillion budget resolution and President Biden’s infrastructure bill. The USD3.5 trillion spending plan experienced a setback last week as Democrat Senator Joe Manchin, one of the moderate Democrats vocally critical of the scale of the Democrats’ spending plans, published a letter in the Wall Street Journal last Thursday (2 September 2021) stating that he “won’t support a USD3.5 trillion bill, or anywhere near that level of additional spending, without greater clarity about why Congress chooses to ignore the serious effects inflation and debt have on existing government programmes”.
Given the razor thin majority that the Democrats hold in the Senate, dissent by Manchin or any other Democrats will likely generate significant uncertainty over the ultimate size of the fiscal spending that can be expected.
The committees working on the budget resolution have until 15 September to submit the details of their spending plans and we expect that more information on tax increases would be closely watched over the coming week.
Although risks related to the Delta variant remain a wildcard for markets, our base case expectations remain that, notwithstanding a temporary negative impact on economic growth in the fourth quarter of the year, the global economic recovery remains broadly intact. In developed markets, the Delta variant continues to contribute to a rise in infection rates. The number of new confirmed cases remains on an uptrend in countries like the US, Canada and UK.
Hospitalisation rates are also on the rise, although still ~20% below the peaks experienced at the start of this year. Death rates, however, remain well below that (approximately 50%) at the start of this year.
We also see nascent signs of improvement amongst countries with low vaccination rates that have been hit hard by the pandemic.
For instance, the number of cases in Indonesia has fallen by ~80% from the peak of over 50k cases in mid-July to under 10k last week, in spite of the low rates of vaccination (~24% of the population has received at least 1 vaccine dose, ~14% fully vaccinated).
The hospital occupancy rate due to Covid-19 for the country has fallen from 77% in mid-July to 23%, and the rate in Jakarta has fallen from 93% in late June to 15%. This bodes well for the reopening of the local economy and the equity market – restrictions in capacity for malls and factories have been lowered starting last week.
Considering the supportive policy stances of major central banks (including the Fed, which is likely to begin a gradual exit from its quantitative easing program only in December or later) and our view that the trajectory of the global economic recovery remains broadly intact, we continue to hold a moderately risk-on stance in our view.
We hold an overweight position in US equities and 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 remain underweight in both Developed Market and Emerging Market Investment Grade bonds.Disclaimer applicable to recommendation
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