Growth
Revised 2Q21 real GDP grew at a 6.7% q/q seasonally adjusted annual rate. Increases were broad based and were partly offset by decreases in inventories, residential fixed investment and government spending. Real output has now surpassed its previous peak in 4Q19. Weaker inventories weighed heavily on growth, and as businesses restock in upcoming quarters, inventories could be a significant contributor to GDP growth. The September PMIs signaled that the U.S. recovery is still on track despite the recent slowdown. The ISM manufacturing PMI strengthened more than expected to 61.1 from 59.9 in August, and the ISM services PMI strengthened more than expected to 61.9 from 61.7 last month.
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 kicked off, with early reporters in the door (4.6% of market cap). Our current estimate for 3Q21 earnings is $48.25, representing y/y EPS growth of 27.3%. On a quarter-over-quarter basis, we expect an earnings contraction of 7.3%, which can be attributed to macro headwinds such as renewed COVID-19 fears, slower economic growth, continued supply bottlenecks and rising wages. Despite these headwinds, oil (+73.4%) and the U.S. dollar (-1.4%) should act as decent tailwinds to earnings.
Inflation
Inflation has now well surpassed the FOMC’s 2% target, as the headline PCE price index rose +0.4% m/m and +4.3% y/y in August. The core PCE deflator also rose to +0.3% m/m and +3.6% y/y, with the latter slightly above market expectations. The August CPI report showed inflation moderated across a few major categories that have been most impacted by supply shortages and pent-up consumer demand, such as used cars, airlines, and hotels. Headline CPI for August rose +0.3% m/m, from 0.5% in July, and +5.3% y/y, while consumer prices excluding food and energy rose +0.1% m/m and +4.0% y/y.
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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