Friday's Market Minute: The Labor Market Is Key To Monetary Normalization

U.S. equities once again made fresh record highs ahead of today’s August employment report. The monthly data release will be closely scrutinized by traders, as U.S. employers are expected to have added approximately 725,000 jobs in the month. With inflation running at year-over-year levels not seen since 1991, the labor market is key in setting the path of monetary policy that has undoubtedly shored up equity markets during the pandemic. Anything around this level is something that markets would be comfortable with, as it would support a popular narrative that the U.S. economy is recovering strongly from the pandemic while the Fed may be willing to continue its crisis-era stimulus.

The unemployment rate will continue to fall as extraordinary pandemic-related unemployment stimulus designed to boost household consumption comes to a halt. The U.S. unemployment rate reached 5.4% in July and is expected to continue a downward trend to 5.2% in August. A labor market print far beyond consensus estimates could tilt the scales to support Fed taper, while any disruption to economic activity is just another reason on why it will take longer to satisfy the Fed’s substantial further progress goal.

Growth in the U.S. economy is coming off a scorching pace in the first half of the year as stimulus spending and a reopening-fueled burst of spending begins to normalize in the back half of the year. In recent weeks, there have been times when financial markets showed growing concerns about the Delta variant and its potential to dent the global recovery. However, supply chain frictions, and not the coronavirus, may be the biggest risk for the economy in the second half of the year. Ongoing supply constraints are crimping key high value-add industries such as motor vehicles. Yesterday, Ford Motor Co. F reported August new vehicle sales declined by 33.1% compared to last year due to an ongoing global shortage of semiconductor chips.

Supply chain bottlenecks have made inflation linger for longer than most expected and are potentially slowing the global recovery. Despite slower growth, the economy is expanding, and the Fed continues to focus on reaching substantial further progress toward its goal of maximum employment. The Fed sees no need to tighten policy, but rather it is nearly time to take its foot off the gas pedal by growing its balance sheet at a slower pace. All else equal, it is to be expected that at the FOMC meeting this month, the FOMC could solidify a November or December announcement of the Fed’s intent to trim back bond purchases which could begin at the end of the year, if not the beginning of 2022.

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