Bassanese Bites: RIP YCC – November 01 2021

Global markets

Generally solid earnings results continued to support Wall Street over the past week, as did an easing back in long-term bond yields. Hopes that President Biden’s infrastructure package might get over remaining Congressional hurdles was also a positive.

U.S. economic data was somewhat mixed, with a softer than expected 2% annualised gain in Q3 GDP (market 2.7%), but another notable drop in weekly jobless claims. The core PCE inflation indicator was thankfully a bit weaker than expected, with the annual rate easing to 3.6% from 3.7%. More worrisome was a chunky lift in the Q3 wage cost index of 1.3% (3.7% over the year) reflecting strong wage gains in sectors such as leisure and hospitality where staffing shortages remain acute.

All up, after a Delta-induced Q3 growth slowdown, the U.S. economy appears to be ramping up again but with tentative signs that the logjam in goods supply is peaking out, helped by a shift back to services. That said, stronger service demand appears to be making lingering labour constraints – with millions still not having returned to the labour force – more of a concern. The key question for the U.S. economy in the months ahead is whether labour force participation finally begins to rebound – easing labour constraints. If not, persistent wage pressure could force the Fed’s hand with tightening as early as mid-2022 (immediately after the end of bond purchases), which would likely involve a growth slowdown and potential market drop of 20% or more.

If labour supply does rebound, by contrast, 2022 could see a return to the ‘Goldilocks’ scenario of easing inflation and still good growth – which means the Fed likely won’t tighten until late 2022 or more likely in 2023. I still think Goldilocks will slay the bears in 2022 but it’s dependent on an easing in labour market pressures. And of course, when we do eventually get closer to Fed tightening, history suggests upward pressure on bond yields may well cause a PE-valuation induced market correction of around 10% or so.

In terms of the week ahead, the Fed looms large – though the formal announcement of bond tapering (with likely reductions of $US15b per month, ending the QE program by mid-2022) has been well-telegraphed and seems largely priced by the market. The other global highlight will be October U.S. payrolls on Friday. with a solid employment gain of 413k expected. As noted above, also worth watching will be labour force participation and strength in average hourly earnings.

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