Good news is good news
As cautious as we are about the medium-term economic outlook, there’s plenty of positive news in Friday’s May jobs report that should be fully incorporated into everyone’s U.S. economic outlook. In short, it does make us more bullish about the near-term economic recovery.
In our view, we’re now firmly in the first phase of the recovery—an initial V-shaped rebound that will play out over the next three months. Like a beachball breaking free from being held underwater, we may very well see the economy post a series of best-ever economic data as it recoups most—but not all—of its COVID-19-related losses.
"Crucially, market reaction to Friday’s data—rates rose, stocks surged, but the U.S. dollar (USD) did not strengthen—sends a bullish signal about risk appetite in the short term, in our view."
During this period, it’s likely that many more economists (including us) will be caught out by the ferocity of the initial rebound; however, be warned that the next stage of the recovery will be—in our humble opinion—decidedly more challenging when reacceleration slows significantly and begins to pressure financial markets. No, it isn’t quite the sunny outlook we’d all prefer but, for now, let’s bask in the sunshine for as long as it lasts.
That said, unemployment peaking at 13.3%¹ is undeniably better than the U.S. unemployment rate hitting 19.0%, as had been expected, and it should absolutely be acknowledged as such. Crucially, market reaction to Friday’s data—rates rose, stocks surged, but the U.S. dollar (USD) did not strengthen—sends a bullish signal about risk appetite in the short term, in our view.
But there are still serious problems in this labor market
In hindsight, it’s worth trying to understand how economists collectively misread the U.S. labor market by such a huge margin and what we could learn from it. This is what we think: While recent data indicated that the worst of the month-over-month declines had taken place by mid-April, none of the traditionally reliable leading indicators of labor market activity (e.g., ISM subindexes, NFIB small business surveys) suggested that we would see job gains in June, much less in May.
This basically underscores how challenging it can be to rely on traditional data in such turbulent times. Even the U.S. Bureau of Labor Statistics highlighted their methodological challenges in categorizing those who were employed versus unemployed. The agency stated that if “workers who were recorded as employed but absent from work due to ‘other reasons’ had been classified as unemployed on temporary layoff, the overall unemployment rate would have been about three percentage points higher than reported.”¹ All things considered, even when taking the headline numbers at face value, we continue to believe there are indeed reasons to be cautious.
The U.S. economy added (back) 2.5 million jobs in May, which represents roughly 11% of the total number of jobs lost in March and April.² However, to return to pre-COVID-19 levels, the United States still has to create another 19.6 million jobs. Put differently, even if hiring were to continue at the current breakneck pace, it would still take another 10 months to get the labor market back to where it was before COVID-19 struck—and that’s a big if. In our view, the hiring activities we saw in May are likely to be low hanging fruit—jobs that can be reinstated easily. Once that’s done, job growth is likely to slow dramatically in the second phase of the recovery.
"In other words, for every American who’s working, there’s one who isn’t."
It’s also worth noting that the employment-to-population ratio in the United States is 52.3.² In other words, for every American who’s working, there’s one who isn’t. This can translate into other kinds of problems in the future—for instance, if the federal government were to introduce a payroll tax cut as a form of stimulus, almost half of all Americans wouldn’t benefit from it. It’s also likely to have important social and political implications that should be carefully monitored.
Unemployment duration, or the length of time it takes an active job seeker to find work, is another metric that warrants investor attention. Data from April shows that 60% of the unemployed had been out of work for less than 5 weeks. May’s jobs report paints a rapidly deteriorating picture—71% of those who are unemployed had now been out of work for between 5 and 14 weeks.¹ The point here is one that many of us can relate to: The longer a job seeker stays out of work, the harder it becomes to find work. At some point, a downward spiral takes shape; confidence shocks and disenchantment set in, a development that could lead many able workers to drop out of the labor force. We’ve seen this happen before—in the aftermath of the global financial crisis—and there’s no reason to think why it wouldn’t happen again.
Where do we go from here?
In light of the latest jobs report, we think it’s most prudent to focus our attention on three issues in the coming weeks:
- Rising U.S. interest rates
The stock market appears to have learned to stop worrying about boring fundamentals and decided instead to coast on historic levels of U.S. Federal Reserve (Fed) liquidity and rock-bottom interest rates; even we economist folks understand the rationale behind this approach. It’s also easy to see how a relatively weaker USD is likely to add more fuel to the risk-on fire. Naturally, surprisingly positive economic data helps, too; however, it’s worth noting that the 10-year U.S. Treasury yield has been sharply rising since June 2.² While we aren’t overly concerned about the impact that higher yields can have on the stock market at this stage, we believe it’s likely to leave the Fed in a slightly awkward situation.
In our view, the main question that Fed officials will need to answer in the coming months is this: Can the Fed justify keeping interest rates at ultra-low levels when the economy seems to be staging a robust recovery much earlier than expected? While it’s entirely reasonable for the Fed to reference existing macroeconomic challenges and continue to telegraph its intention to keep rates low for a very long time through forward guidance, it’s unlikely to be able to build a convincing case for introducing yield curve control. More than likely, the monetary hawks will become more vocal in their opposition to additional easing policies as economic data improves, triggering further rises in yields.
- Fiscal disappointment
While there can be little doubt that monetary policy has gone a long way to reducing the tail risk for financial markets, we believe fiscal spending is what will ultimately facilitate an extension in upside risk, but there’s a more than reasonable chance that we won’t see much development on this front in the coming weeks.
Like most of our peers, we believe that the U.S. government will eventually agree on an additional fiscal package of some kind; however, fiscal hawks are likely to get louder as economic data improves, potentially limiting the size and scope of new packages. Meanwhile, policymakers could soon find themselves racing against time to agree on new measures before unemployment insurance benefits run out at the end of July.
On May 29, Senate Majority Leader Mitch McConnell said that Congress could decide on whether to proceed with a final coronavirus relief package in the next few weeks3; a delay is now looking likely as the federal government devotes resources to calm nationwide protests. In addition, disagreements over the size and scope of relief required remain wide among key players.
- Old-skool macro factors to monitor
Traditional fundamentals may seem to be taking a back seat at the moment, but we’d like to highlight the following macroeconomic issues that could drive market movements in the coming month.
In truth, these tensions never really went away, but this issue has been relegated to the back of our minds as the trauma related to the COVID-19 outbreak unfolded. Headlines in the past week suggest tensions have been escalating. No macro issue worries us more than the potential for U.S.-China trade disruption.
COVID-19—a second wave
We’re still in pandemic territory—we may be emerging from lockdown rules, but we’re not out of the woods yet. A second wave of outbreak will no doubt prolong the economic pain.
The upcoming U.S. presidential election will become an increasingly prominent feature in investment commentary as we get closer to the main event in November. While the election will undoubtedly draw the most attention, we think it’s just as important to keep an eye on the composition of the entire government. Election outcomes are rarely predictable, and given the current context, could be even more difficult to forecast. As we approach November, certain segments of the market could begin to react to opinion polls in a more pronounced manner—something that investors should bear in mind.
1 “Employment Situation Summary,” U.S. Bureau of Labor Statistics, June 5, 2020. 2 Bloomberg, as of June 4, 2020. 3 “Next coronavirus stimulus bill will be the ‘final one,’ Mitch McConnel says,” cnbc.com, May 29, 2020.
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