August folds into September, and the high-frequency cycle begins anew. The initial estimate of consumer inflation by the ECB and the US jobs data are the highlights. The preliminary PMI estimates have already been released for many countries and are often good enough for investors.
China's PMI is an exception. Beijing does not publish a preliminary estimate. There is little doubt that the world's second-largest economy has slowed. It was already slowing before the lastest virus-related lockdowns, port closures, and foul weather. However, it seems that policy is more important than the economy's cyclical performance. While Beijing continues to press with its regulatory and social reforms, economic policymakers are eschewing large-scale fiscal or monetary initiatives. Instead, the "cross cyclical" slogan, seemingly emphasized at the recent National People's Congress session, looks for smaller and more nuanced policy- such as the PBOC cut in reserve requirements last month and the tightening of property restrictions to stabilize prices.
The bull case for the yuan has weakened. At the start of the year, China's 10-year bond yield offered 220 bp more than the US. It stands near 160 bp now, having bottomed three months ago near 145 bp. Nor have China's shares done particularly well. The CSI 300 is off 7.8% year-to-date, making it the worst performer among the large markets. Policy risks and those that stem from the opaqueness have increased. The yuan has been nearly flat against the dollar in August (-0.15%), leaving the greenback mostly rangebound between CNY6.45 and CNY6.50 (since mid-June). However, the yuan's relative stability should not distract from the fact that it is near its strongest level in five years on a trade-weighted basis (China's measure, CFETS).
Outside of some schadenfreude, it does not seem obvious what China gains with recent developments in Afghanistan. Islamic fundamentalism is on their borders. It does not need purposeful encouragement to spread, as the Arab Spring demonstrated. Pakistan has been the center of several attacks that have killed Chinese nationalists. Xi's Belt Road Initiative is networked throughout the region. It, not the US, is often the face of modernization and secularism in the region. China's own treatment of its Muslim minority (Xinjiang) may also come under more scrutiny. Of course, Beijing did not like having a US military presence on its borders either, but it was hardly threatening.
The eurozone's initial estimate of August consumer prices is due on August 31. Most of the CPI's 2.2% year-over-year gain is coming from food and energy, without which, euro area consumer inflation is up less than 1.0%. Last August, consumer prices fell by 0.4%. When this drops out of the 12-month measure, the year-over-year rate will tick up. The headline rate may jump toward 2.7% on a modest 0.2% month-over-month increase. The core rate may double to 1.5% from 0.7%. The market's reaction function is shaped by its perception of the reaction function of the central bank.
The August CPI is unlikely to feature prominently at the ECB meeting (September 9). More importantly, the staff will update its forecasts. In June, it saw CPI at 1.9% this year, 1.5% in 2022, and 1.4% in 2023. The two variables that the ECB seems to put emphasis on are oil prices and the exchange rate. Brent oil was near a peak when the ECB met in June, and the four-week moving is little changed since then. However, optimism spurred by the FDA approval of the Pfizer vaccine, upgraded from emergency approval, and by China's claim to have got the virus back under control saw a powerful rebound in oil prices in recent days (11.5% last week, the biggest jump since June 2020).
For its part, the euro broke down shortly after the June 10 ECB meeting. It traded mostly between $1.21 and $1.2250 in the first half of June before falling to around $1.1850 by the end of the month. It was rangebound in July, though unable to re-establish a foothold above $1.1900. This month, the euro was sold to a new low for the year (~$1.1665 on August 20). In fact, since the ECB's June meeting, the euro has fallen by 3% through the end of last week. While the euro has depreciated against the other major currencies and the Chinese yuan, it has appreciated against the Scandis and central European currencies. A weaker euro on a trade-weighted basis tends to be associated with upward pressure on prices. Still, the sensitivity varies considerably among members depending on several variables, including the openness of the economy (imports plus exports from outside EMU as a percentage of GDP).
The key issue at next month's ECB meeting is about the pace of the asset purchases. It boosted the pace in March and reaffirmed the decision in June. Here is the rub: the Pandemic Emergency Purchase Program as currently conceived is to end next March, which would seem to be ahead of the conclusion of the Fed's tapering by most reckoning. However, given the emphasis the ECB recently placed on the symmetry of the inflation target, officials may seek a compromise that extends the emergency purchases may slowing them under the current envelope.
While there is no requirement that the decision is made in September, slowing the purchases to sustain them for nine months or longer may be helpful soon rather than later. At the same time, the ECB's chief economist Lane suggested that with the Asset Purchase Plan still in operation, its balance sheet expansion will continue. The problem is that it is not nearly as flexible as the PEPP and may quickly run into the self-imposed limits on country exposure.
The Fed's Powell has explained that for inflation, there is one number, the headline PCE deflator, that best captures the inflation that the central bank wants to target. For all the talk in the press about the Fed's favorite or preferred inflation measure, the fact is the Fed does not target it. The labor market is more complicated, and Powell explicitly rejected the idea that there is one number that the Fed can target. Nevertheless, it has not stopped other Fed officials and market participants from emphasizing the monthly non-farm payroll report. The Fed has redefined its full employment mandate to be maximum and inclusive employment. Some observers object and claim that distributional issues are outside the purvey of monetary policy, but this is exactly the terrain being challenged. Similarly, there has been an objection to central banks trying to incorporate climate change into their regulatory and supervisory functions, let alone the conduct of monetary policy proper.
In March and April 2020, as the pandemic struck the US, 22.3 mln people could not work. Since then, and through July, roughly 16.67 mln have returned or nearly 75%. After rising by more than 900k in June and July, nonfarm payroll growth is expected to have slowed in August. The median forecast in Bloomberg's survey sits at 750k. However, government hiring flattered the July employment growth, which added 240k people to the payrolls. This appeared to be primarily state and local governments preparing to re-open schools. The slowing headline growth expected in August reflects a slower expansion of government payrolls. Private sector growth appears to have held up better. Private payrolls added 703k in July and likely another 700k in August.
The four-week average of weekly jobless claims fell 5% since the June FOMC meeting. Near 366k, the four-week average is still elevated from the end of 2019 when it was closer to 235k. The federal government's emergency unemployment compensation for $300 a week expires next week. Around half the states dropped out of the program early, but the impact on work, unemployment, etc., seems minimal at best.
The unemployment rate surged to 14.8% in April 2020 and stood at 5.4% in July. It is expected to have fallen to 5.2% this month. Recall in the first two months of 2020, it stood at 3.5%, a generational low. It had not fallen below 5.2% until August 2015, five years after the recession associated with the Great Financial Crisis ended. Part of the reason the unemployment rate has fallen so quickly is that the participation rate has fallen. It was at 63.4% on the eve of the pandemic. It stood at 61.7% in July. The participation rate peaked more than two decades ago at 67.3%. It was around 66% when the GFC hit and never recovered.
In his testimony before Congress last month, Powell noted how the US participation rate lags behind its peers. Macroeconomists will talk about the shrinking population of workers and how technology is making some jobs redundant, but those structural factors are shared by other high-income countries. That said, the working-age population in the US (ages 15-64) fell in 2019 and 2020. Retirement did quicken during the pandemic as baby boomers (born 1946-1964) continued to move out of the labor market. Surveys suggest some left earlier than planned, helped, perhaps, by rising equities and house prices. Others may have left under duress. That said, a recent study found that another change that has taken place is that the percentage of retirees that re-enter the workforce has fallen. It is too early to know if this is a structural development or whether it too is just transitory.
Oxford Economics estimated that almost half (45%) of the seven million jobs that were "missing" in June were vulnerable to automation (think of food services, retail sales, and manufacturing). Moreover, the technology has been around for a decade or more and is now being adopted. Perhaps, the famed flexibility of the workforce, and other considerations, including the pace of depreciation allowances, may encourage US employers to invest in labor-saving technology ahead of what is expected to be the next upswing in the business cycle. Powell told US Senators that they will see more technology and maybe fewer people.
The ADP report may be the pigeon in the coal mine and provide an alert about a potential surprise. The caveat is that the monthly deviation can be large, but the ADP does a good job tracking private sector employment. For example, consider that year to date, ADP estimates that private-sector employment has risen by 3.41 mln, while the government's reports shown a cumulative gain of 3.72 mln.
Barring a significant downside surprise and overlap of personnel and education suggest the Fed's models will generate the same estimate as Wall Street's models, the Fed's gradual movement toward tapering can continue. The most likely scenario is for the tapering to begin before the end of the year and be completed around the middle of next year. We have suggested working backward to deduce the pace, with an allowance for front-loading a bit to allow a proper taper to avoid a hard stop.
Two other considerations may also be particularly relevant because of America's political economy. First, there was a 30% increase in overdose deaths in the US last year to more than 92k. Three-quarters were related to opioids and primarily afflicts men. An earlier study (2018) by the Cleveland Fed found nearly half (44%) of the decline in men's labor force participation rate may be traced to prescription opioids.
Second, owing to the way the US addresses childcare and the gender pay gap and traditional values, more mothers than fathers took over the childrearing duties, including education, during the work-from-home era. As a result, the women's labor force participation rate fell from 57.4% in January 2020 to 56.2% in July. Many observers who are critical of the central banks taking into account how monetary policy impacts climate change and income disparity don't see any problem for a central bank considering the participation rate, which also looks more a product of social conditions than monetary policy.
Disclaimer
Reviewed by Marc Chandler
on
August 28, 2021
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