Back to Pre-Covid Normal? Not Quite…
At the start of the 2nd quarter, the economic re-opening trade was on full-force with the 10yr Treasury at 1.74% and rising fairly fast due to massive amounts of fiscal and monetary stimulus and on course to take out the low 1.90’s range, its pre-Covid level. Almost three months later and the 10yr is at about 1.53% and has been essentially chopping sideways in a range between 1.60% and 1.50%. This price action in the 10yr would seem to indicate at least that there’s some uncertainty about just how robust this economic re-opening really is. But you could argue that the full re-opening has yet to even happen, which provides an optimistic backdrop for the continued rally in equities.
The 10yr’s gradual move lower in yield this quarter seems to be the collective wisdom of the crowd getting ahead of the Federal Reserve’s mid-June meeting news. From that meeting, we learned that inflation has moved somewhat higher than Federal Reserve officials had anticipated and consequently they moved up very gradually their plans to eventually raise rates. And they acknowledged that they have begun discussing plans to start tapering their monthly bond purchases. In that light, the 10yr’s rally in price makes sense – market participants have purchased longer dated Treasuries in anticipation of the Federal Reserve moving faster on inflation, which would mean slower growth and lower long rates. But is 1.74% on the 10yr the peak for this economic cycle? Are we really already past peak re-opening and peak reflation?
9.8 million Americans remain unemployed and you could argue that the Federal unemployment and state unemployment benefits have made the financial trade-off of returning to work less attractive. The extra Federal unemployment benefits will be ending on Sept 6th. This also will be when schools will reopen, allowing parents an easier transition to return to the workforce. 25 states have announced that they’re ending the Federal enhanced benefits early (in June and early July). That’s obviously half of the 50 states, however those 25 states account for about 40% of the U.S. population. The remaining 60% of the population remains eligible through Sept 6th. Employers across the country have been raising hourly wages, but have found workers very reluctant to fill empty job openings.
Federal Reserve Chair Powell has been clear in his comments regarding the Federal Reserve’s analysis that the move higher in inflation will be transitory. The Federal Reserve believes the inflation surge will eventually subside as workers will likely return to the workforce in the fall as those enhanced unemployment benefits run out, slowing the upward pressure on hourly wages. And supply chain bottlenecks have hampered production, but will prove to be temporary. Those supply bottlenecks were directly related to the pandemic, but will get worked out over time.
As mentioned above, some workers have been slow to return to the workforce. The two charts below show that workers right now have quite a bit of leverage regarding wages and are using that leverage. Job openings are at the highest on record, yet employers are having a very difficult time finding employees. And job quits are also at their highest on record, reflecting worker confidence they can find a better paying job and that they won’t remain unemployed for long.
Job Openings
Job Quits
The move lower in yield for the 10yr has meant that the spread between it and the 2yr Treasury has fallen by about 32 basis points since the start of the 2nd quarter. A flattening yield curve is commonly thought to be a sign of a slowing economy. But 2nd quarter GDP growth is forecast to be 13% by Bloomberg (with 58 contributors). Full year growth is forecast to be 6.6% in 2021vand 4.1% in 2022 (we averaged a mere 2.3% in the 10 years prior to 2020). As well, we’ve seen the S&P 500 and Nasdaq making new all-time highs in the last few days. So, how do we have a booming economy and strong equity markets and the 10yr is only at 1.53%? Investors believe the Federal Reserve will be proven correct that the rise in inflation will recede. That remains to be seen.
In the meantime, we think that the that full economic reopening is yet to happen. Once we get into September and the fall months, we should see job hiring pick up due to people returning to work. Schools will be reopening. People will be going to college football games and restaurants will be full. Life should look more and more normal as we’re moving into the 2nd half of 2021. That pickup in economic activity likely carries into 2022 and sustains equity markets, but that’s also when the Federal Reserve’s inflation thesis will be tested for real.
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