Federal Reserve Chair Powell accomplished his objective at the virtual Jackson Hole conference last week. As expected, Powell punted on the question of timing to start a reduction in asset purchases, also known as tapering. He noted that it could be appropriate for tapering to begin this year. However, he disconnected the beginning of tapering from the initial rate hike, which is likely still over a year away. Powell still sees “substantial slack remaining in the labor market and the pandemic continuing.” While he believes that the “substantial further progress test has been met” regarding inflation, he thinks the pandemic and reopenings caused much of the recent inflation pressures.
With markets worried about a premature reduction in Fed accommodation smothering the economy, Powell stating that an “ill-timed” policy mistake could be “particularly harmful” was extremely important. The yield curve, which has accurately predicted most recessions when the yield on the 10-year U.S. Treasury has fallen below the 2-year, applauded the Jackson Hole conference. The difference in these yields fell to a low of 1.02% during the week but ended the week at 1.09%. This yield curve steepening lifted bank stocks, as measured by the KBW Bank Index (BKX), by 5.2% for the week and 1.7% on Friday alone. The U.S. 3-month Treasury yield 18 months forward continues to indicate just one rate hike over the next year and a half.
As outlined last week, the negative impacts of the increase in the Delta variant infections are being seen in the economic data. Last week, the August Purchasing Managers’ Index (PMI) data for the U.S., Eurozone, U.K., and Japan showed a reduction in the economic momentum due to Covid. The services component, which has tended to be more vulnerable to increased infections than the manufacturing piece, declined for all four regions. With the continuing supply chain disruptions, manufacturing PMIs for all four areas took a hit as well. The August PMI readings from China this week will be watched closely to gauge the extent of the economic slowdown there.
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There continues to be evidence of a decline in consumer mobility in the U.S. showing up in airline travel, mass transit usage, and dining demand. No day last week had more than 2 million people passing through TSA checkpoints, which indicates some impact from rising infections. Southwest Airlines (LUV) and American Airlines (AAL) announced increased cancellations and slowing reservations due to rising infections and a limited boost from business travel.
Especially after Powell mentioned slack in the labor market at Jackson Hole, the August jobs report will be crucial this week. Nonfarm payrolls are expected to increase by 750k after a strong 943k in July, while the unemployment rate should fall to 5.2% from 5.4%. If economic growth continues as expected, tapering should be officially announced in the fourth quarter, most likely November. Third-quarter annualized GDP growth should easily remain above 5% annualized, despite the international headwinds, supply chain disruptions, and some reduction in consumer mobility. With the increase in uncertainty due to the rising Delta variant infections, markets will be highly tuned to changes in the pace of economic growth and expected Federal Reserve policy.