Monday Morning Quarterback (03/08/2021)

March 8, 2021

U.S. Economy

Powell’s Speech

Job growth has sputtered for the past few months, while inflation has been stagnant for many years, as the U.S. economy has lost momentum, which has led to over a decade of disinflation. To counter the disinflation, the Federal Reserve has shown little concern with raising inflation above 2% for a few years. Although not concerned with raising interest rates, the Federal Reserve Chief, Jerome Powell, has expressed concern that the rates are raised strategically and not too quickly in anticipation of rising prices. During Mr. Powell’s forum with Congress last Thursday, he remarked that the central bank would raise rates and curb asset purchases once the following three objectives occur:

  1. Inflation has hit or exceeded the Fed’s goal of 2%.
  2. Forecasters see inflation remaining at or above 2%.
  3. An array of statistics indicate that employment is at maximum strength.

Currently, the Fed plans to maintain monthly asset purchases of $120 billion and keep the federal funds rate between 0 and 25 bps. Following the video conference, the 10-year Treasury yield rose to 1.55% – the most since the pandemic began – up from 1.46% earlier on Thursday and 92 basis points from the start of the year. On Friday, the 10-yr yield closed at 1.56%. With a slightly improved economic outlook, investors and economists have pulled forward their forecast for the first Federal Reserve rate hike to early 2023.

Chart of 10-year U.S. Treasuries Increases Following Powell's Comments

Money Supply vs. Money Velocity:

Over the past few months, financial news pundits have elevated concern about inflation and the money supply. While the supply of money has recently seen unprecedented growth, money velocity (the frequency with which currency changes hands) has been on an accelerating downward trend since the beginning of the millennium. Like the money supply, money velocity also made an unprecedented move last year. From 1Q20 to 2Q20, velocity plummeted from 1.4 to 1.1.

LIBOR

As expected, on Friday, the U.K. Financial Conduct Authority (FCA) called for a formal halt to almost all LIBOR (London Interbank Offered Rate) rates by the end of 2021, pressuring markets to hasten the overhaul in LIBOR, used in roughly $260 trillion of financial contracts across the globe. In 2012, several bulge-bracket banks, including JP Morgan, Bank of America, and Credit Suisse, were caught colluding. From at least 2005 to 2012, these banks profited illegally by reporting artificially low or high-interest rates for profit. After much deliberation, the United Kingdom agreed to phase out LIBOR in 2017. Britain’s Financial Conduct Authority, which regulates the benchmark rate, made it clear back in 2017 and again on Friday that they would not guarantee LIBOR’s publication past 2021. Check out SkyView’s blog on the LIBOR transition to learn about LIBOR’s U.S. replacement, the Secured Overnight Financing Rate (SOFR), as well as its potential impact on commercial real estate.

February Unemployment

In February, the U.S. economy gained 379 thousand jobs, surpassing consensus estimates and bringing U-3 unemployment down to 6.2% – only a 10 bps drop from January. However, this figure understates the labor market’s weakness (The unemployment rate grows 330 bps to approximately 9.5% once individuals who have quit looking for employment are factored in). Additionally, roughly 6.1 million Americans are employed part-time but prefer full-time work. These part-time individuals make up approximately 160 bps of U-6 unemployment. In February, the U-6 measure remained at 11.1% from January.

While the U.S. labor market has been broadly improving, the nation is still down by over 9 million jobs since March 2020. Despite this slower recovery, last month’s job market does show signs of further acceleration. Since pandemic restrictions shut down a lot of business activity in early 2020, particularly in the service sector, the leisure and hospitality segment gained 355 thousand jobs, comprising ~94% of February’s new employment. Roughly 80% of the hospitality sector increase derived from food services, which rose by 286 thousand.

Chart of COVID-19 Jobs Recovery Pauses at a low Plateau

Manufacturing PMI

On Monday, the Institute for Supply Management (ISM) reported that February manufacturing activity rose to 60.8 from 58.7 in January – the fastest expansion in three years. A gauge of factory activity, the Purchasing Manager’s Index (PMI), exceeded the 58.9 median forecasts from Bloomberg’s economists’ survey. Amid lean inventories and robust, growing demand, producers struggled with higher raw material costs, inflated shipping rates, and disruptions in the labor force. According to ISM’s Chair Timothy Fiore, “labor market difficulties at panelists’ companies and their suppliers continued to restrict manufacturing-economy expansion and will remain the primary headwind to production growth.” Last month’s strongest manufacturing index was the “Prices Index,” which hit 86, up from January’s reading of 82.1. Material costs reflected rising inflation and accelerated to the highest level since July 2008, as supply shortages mounted. While production, orders, and factory employment measures all increased at faster paces in February, unfilled orders sky-rocketed to a 16-year high, as delivery times sunk to their second-lowest level since 1979. Additionally, backlogs for orders rose to 64 last month, the most elevated since 2004.

Chart of U.S. Manufacturing and Prices paid

Services PMI

On Wednesday, the February ISM Services Index reported a 55.3 dip, from a near two-year high of 58.7 in January. Reflecting moderate growth in new orders, employment, and business activity, last month’s performance was weaker than the most bearish forecast in Bloomberg’s economist survey. Like manufacturing, the “Prices Index” surged to 71.8 in February, the highest since September 2008. Both the manufacturing and services PMI reports indicated that labor constraints and supply shortages continue to be a problem across a broad range of industries.

Chart of U.S. Services and Materials

Economic Calendar

The Bureau of Labor Statistics will release February’s Consumer Price Index (CPI) on Wednesday. We expect the CPI to show higher gasoline prices; however, core inflation should remain low because of a modest incline in homeowners’ equivalent rent. Compared to CPI, pipeline inflationary pressures should be more evident within the Producer Price Index (PPI). But only a significant gain in commodity prices can begin to impact inflation at the consumer level.

COVID Update

Coronavirus cases have continued to fall, week-over-week, for the past seven out of eight weeks. Considering that the U.S. hit its peak number of new cases during the first week of the year (1.7 million), we are now only seeing ~400 thousand new patients a week. More importantly, the amount of coronavirus casualties has dropped significantly, falling 20% from January to February. As of March 7, the pandemic death toll sits above 524 thousand, while cases stand at nearly 29 million.

Chart of New Coronavirus Cases Reported per Day

Chart of New Reported Coronavirus Deaths per Day