‘Nothing So Bad That It Couldn’t Get Worse’

Headlines in the new week will revolve mostly around the final days of America’s chaotic exit from Afghanistan and the aftermath of Hurricane Ida, which was expected to damage nearly a million homes on the Gulf Coast with rebuilding costs running to nearly a quarter trillion dollars.

“The central Louisiana coast is at risk of bearing the brunt of Hurricane Ida’s extreme storm surge potential, with a total of 941,392 homes in the Louisiana, Alabama and Mississippi coastal areas exposed to storm surge damage,” CoreLogic said, in a risk analysis ahead of landfall. “These homes have a combined reconstruction cost value of approximately $220.37 billion,” the same release added, warning of a “trifecta event,” with severe wind, surge inundation and extended heavy rainfall all set to devastate coastal properties.

You can be sure the federal government response will be mishandled at some point, and that will become political ammunition, just as the 13 US servicemembers killed in last week’s bombing in Kabul were immediately exploited by some of the very same lawmakers who, over the past two years, variously insisted the US should exit the war posthaste. So too will whatever human tragedy unfolds in the storm’s wake be cause for partisan rancor. And at a time when Democrats are attempting to push the two pillars of Joe Biden’s economic and social agenda through Congress, a house not just divided along party lines, but also within party lines on both sides of the aisle.

It’s a huge week for data stateside. The market is expecting to hear the US economy added 750,000 jobs in August (figure below). That would be a solid encore from July’s blockbuster.

If the report meets expectations, the shortfall versus pre-pandemic levels of employment would shrink to “just” five million.

There’s some risk associated with August NFP. Although Jerome Powell appeared to mostly rule out a September taper unveil during his Jackson Hole speech, it’s not totally out of the question. If the jobs report comes in strong and it’s accompanied by, say, a scorching-hot average hourly earnings print, the market could assign a higher probability to a taper announcement at next month’s FOMC. The leadership would clearly prefer to wait until November, and that remains the base case on Wall Street.

Powell and the Fed’s dovish contingent want more progress on the labor market front, so anything that suggests slack is being taken up rapidly would have hawkish undertones. “What we fear is that hesitation on the part of front-line service sector workers to reenter the labor force will continue to weigh on the aggregate participation rate – particularly in the <55-year-old category,” BMO’s Ian Lyngen and Ben Jeffery said.

“Whether this reluctance will be a function of the variant risk or more durable pandemic-inspired shifts will ultimately dictate its permanency,” they went on to write, adding that “in the event this dynamic contributes to labor shortages and drives up wages, the net result could be a period in which inflation appears to be self-perpetuating and would prompt the Fed into action sooner rather than later, thereby undermining the pace of the recovery at a particularly vulnerable moment for the real economy.” That’s the policy mistake risk. And risks abound. You know the story.

Also on deck is ISM manufacturing and services. Last month’s headline print showed marginal deceleration in US manufacturing activity, and some regional Fed gauges followed suit this month. To the extent you think it makes sense to plot the YoY change in an equity benchmark with the same for a PMI, the figure (below) isn’t particularly encouraging.

ISM services printed a record high last month. Markets will be looking for the usual anecdotes on price pressures and employment.

Treasurys are “in a definable trading range that we anticipate will remain in place at least into next month’s FOMC meeting,” BMO’s US rates team went on to remark, in the same note cited above.

It’s mostly impossible to formulate any kind of forecast for rates, given supply/demand dynamics, the lingering effects of the Delta variant, the still unknown impact on the labor market of expiring unemployment benefits and the coming wave of fiscal measures.

“The market is pricing in an overly gloomy outlook and, in that process, downplaying a possibility of an economic recovery despite the unprecedented fiscal and monetary accommodations,” Deutsche Bank’s Aleksandar Kocic wrote, in his latest. He noted that the curve-implied neutral rate is near where it was at the peak of the crisis last year, prior to the vaccines.

Speaking of gloomy outlooks, another read on the consumer is due, courtesy of the Conference Board’s gauge. The final read on University of Michigan sentiment was little changed from the disastrous preliminary print, and market participants will be watching for signs that the same pessimism found its way into another survey. “Consumers’ extreme reactions were due to the surging Delta variant, higher inflation, slower wage growth, and smaller declines in unemployment,” Richard Curtin, director of the Michigan survey, reiterated late last week.

The “disconnect” between consumers and that simplest of all market-based confidence measures is glaring (figure above).

Also up in the new week, a “fresh” update on home prices, where “fresh” is a misnomer given the Case-Shiller index comes on a two-month delay. While attempting to describe the last report, Craig Lazzara, global head of index investment strategy at S&P Dow Jones Indices, said simply, “I find myself running out of superlatives.” Indeed (figure below).

And then there’s the virus. It was mentioned in passing above, but addressing it specifically, Deutsche’s Kocic wrote that, “We are one foot in a new territory of the pandemic defined by an aggressive wave of infection by a mutated virus that is threatening to pull the rug under everything that has been done so far and potentially invalidate initial optimism created by stimulus and medical advances.”

He wasn’t necessarily describing his own view, but rather the dour market mood as manifested in falling long-end yields and the accompanying bull flattener, which belie record-highs on equity benchmarks. The US is averaging nearly 150,000 new COVID cases per day. That’s more than double the seven-day average from last year’s summer wave.

“The market’s logic,” Kocic said, is that “nothing is so bad that it couldn’t get worse.”