Growth
Real GDP expanded at a 2% annual rate in 3Q21, lower than the 2.6% consensus estimate and a sharp slowdown from robust gains earlier in the year. Weakness was led by a marked deceleration in consumer spending, growing just 1.6%, along with slower home building and a wider trade deficit. Weaker auto sales alone detracted significantly from GDP, and the rotation to services continued at a slower pace. While supply chain issues may persist well into 2022, recent data confirms economic momentum is beginning to pick up. The October flash PMIs overall shaped up better than expected on a composite basis. Manufacturing fell more than expected to 59.2, but services bounced sharply to 48.2 from 54.9.
Jobs
The September jobs report was both weaker and hotter than expected. Nonfarm payrolls increased by a meager +194,000, well below expectations. However, this miss was mitigated by a 169,000 upward revision in payroll gains for the prior two months, a decline in the unemployment rate from 5.2% to 4.8% and a modest increase in the average workweek. Further, the miss in jobs was concentrated in the government education sector, while the important COVID-19-sensitive sectors added jobs. Importantly, wages continue to climb, rising by 0.5% m/m and 5.5% y/y.
Profits
The 3Q21 earnings season has been strong, with 280 companies reporting (73.9% of market cap). 82% of companies have beat on earnings expectations and 66% have beat on revenue expectations. Our current estimate for 3Q21 earnings is $51.61, which represents y/y EPS growth of 36.2% but a q/q contraction of 0.8%. Earnings have held up better than we previously anticipated, as companies seem able to defend profit margins despite higher input prices. Oil (+73.4%) and the U.S. dollar (-1.4%) have also been decent tailwinds to earnings.
Inflation
Inflation has well surpassed the FOMC’s 2% target, with the headline PCE price index rising +0.3% m/m and +4.4% y/y in September. The core PCE deflator also rose to +0.2% m/m and +3.6% y/y. The September CPI report showed consumer prices have resumed a faster pace of growth as more sustainable sources of inflation are now picking up. Headline CPI for September rose +0.4% m/m and +5.4% y/y, primarily driven by increases in the prices of food and shelter. Further increases in shelter costs, which make up a third of the overall index, could provide a more durable tailwind to inflation in the coming months.
Rates
At its September meeting, the FOMC delivered a slightly hawkish message to markets on its policy outlook, recognizing slower economic progress due to the delta variant, but also robust improvement in the labor market recovery and somewhat stickier inflation than it previously assumed. In the FOMC’s Summary of Economic Projections, growth estimates were downgraded from 7.0% to 5.9% for 2021, but increased for 2022 and 2023. The FOMC also increased its unemployment estimate to 4.8% for 2021 and PCE inflation to 4.2% for 2021 and 2.2% for 2022. Notably, the Fed signaled that tapering could “soon be warranted,” raising the likelihood of a November announcement.
Risks
- The delta variant and global vaccine delays could slow the economic reopening.
- Inflation could spike in the medium term.
- Extremely accommodative monetary and fiscal policies could lead to a boom-bust recession.
Investment Themes
- U.S. equity investors may use earnings as a guide in a rising rate environment.
- Fixed income investors may underweight bonds and maintain short duration in a rising rate environment.
- Long-term growth prospects, a falling dollar and cyclicality support international equities.
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