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Dow Future stumbled almost -759 points from 3rd September (Friday) closing levels around 35359.60 to 34607.50 early European Monday (13th September) for multiple reasons. Dow Future was already under stress on Goldilocks progress of U.S. employment and elevated inflation, which may prompt the Fed to announce the inevitable QE tapering by Dec’21. Apart from taper tantrum concern, the risk trade was also affected by China’s ongoing regulatory crackdown, especially on techs, deleveraging effort, and trade/cold war suspense with the U.S. (as per respective domestic political compulsions).
Also, lingering suspense over Biden’s $4.7T fiscal stimulus and tax hikes plan is affecting the stimulus savvy Wall Street. Biden’s Democrat colleagues led by Manchin & Co (moderate Democrats) have serious objections over the huge fiscal stimulus, which will inevitably cause hotter & persistent inflation, negative for the U.S. economy, low earners (vote bank), and Biden’s 2022 mid-term election prospect. Biden’s popularity is sinking amid the allegation of inflation, economy, COVID vaccinations as well as Afghanistan mismanagement (economy, COVID, and foreign policy).
Last week Dow Future tumbled more after a WSJ report indicated that Fed may announce QE tapering by Nov’21, which will start from Dec’21 to end by June’22. And then Fed will go for liftoff from late 2022.
The WSJ report said:
“Federal Reserve officials will seek to forge an agreement at their coming meeting to begin scaling back their easy money policies in November. Many of them have said in recent interviews and public statements that they could begin reducing, or tapering, their $120 billion in monthly purchases of Treasuries and mortgage-backed securities this year. While they are unlikely to do so at their meeting on Sept. 21-22, Fed Chairman Jerome Powell could use that gathering to signal they are likely to start the process at their following session, on Nov. 2-3.”
The WSJ report (floating balloon) was also coincided with falling levels of U.S. jobless claims and elevated PPI/inflation data. Effectively, Fed is now preparing the market for Dec’21 QE tapering and Dec’22 liftoff.
Last Thursday (10th Sep), the market focus was on U.S. jobless claims after Aug’s terrible NFP headline job addition. The U.S DOL flash data shows the number of Americans filing initial claims for unemployment benefits (UI) fell to 310K in the week ending 4th Sep, from a downwardly revised 345K in the previous week, lower than the market expectations of 335K and a new low since Mar’20, just before the COVID lockdown 1.0. The total number of initial jobless claimants remained on a downward track amid an imminent expiry (6th Sep) of extended PUA benefits and mandatory vaccinations requirement to join the physical workplace.
The continuing jobless claims in the U.S., which measure unemployed people who have been receiving unemployment benefits for a while (more than a week under UI), dropped to 2783K in the week ending 28th Aug, from an upwardly revised 2805K a week before and above expectations of 2744K, at fresh post-COVID low.
The number of Americans applying for help from the Pandemic Unemployment Assistance (PUA) scheme, which covers uninsured workers that do not qualify for initial claims (UI), slips to 96.198K in the week ending 4th Sep, from the previous week's downwardly revised level of 102.521K.
Overall, at a glance, as per average jobless claims coupled with NFP reconciliation, the U.S. unemployment rate should be around 5% (depending upon the actual number of labor force participants and NFP reconciliation factor assuming all the unemployed persons are filling continuous claims). Also, continuing unemployment claims (DOL) and a nominal number of unemployed persons (BLS) may now converge to pre-COVID levels as extended PUA has expired on 6th Sep’21, although there may be some backdoor PUA in some states even after the expiration.
Fed may target around 155000K employed persons as a primary standard (substantial further progress) for its maximum employment mandate for the QE tapering condition. Till Aug’21, the actual number of employed persons was around 153154K against pre-COVID (Feb’20) levels of 158735K and an expected QE tapering milestone of 155000K. Thus Fed may look for at least 1846K more employed persons from Aug’21 levels as a primary condition for QE tapering.
The U.S. economy may continue to add around 500K jobs per month in the next few months on an average amid the expiry of PUA benefit, and the progress of COVID vaccinations. Thus in that scenario, around 1850K jobs may be gained by Dec’21, translating nominal U.S. employed persons around 155000K, paving the way for QE tapering announcement by Dec’21.
Further, the Fed may target 160000K employed persons as standard for maximum employment compared to pre-COVID (Feb’20) levels of 158735K as U.S. real GDP already surpassed pre-COVID levels. In that scenario, the U.S. economy would have to produce another 5000K jobs (from Dec’21 levels) to attain the 160000K milestone. If the U.S. economy continues to add around 500K jobs on an average per month in 2022, it may take another 12-month; i.e. by Dec’22, the U.S. economy should attain the Fed’s standard of maximum employment, paving the way for liftoff.
On last Wednesday (8th Sep), BLS’s JOLTS (Job Openings and Labor Turnover Summary) data shows that the number of job openings in the U.S. rose by +749K sequentially to a new high of 10934K in July. Job openings increased in several industries, especially the consumer-facing service industry like health care and social assistance; finance and insurance; and accommodation & food services.
JOLTS Job Openings
Nominal U.S. Unemployment (NFP)
The normal gap between U.S. job openings and nominal unemployment was around 1295K in Feb’20 (Pre-COVID) and the unemployment persons/job openings ratio was around 82%, which is now around 1467K and 86% respectively. The current gap between U.S. job openings and unemployed persons should reduce drastically from September’21 after the expiry of extended PUA benefit, which was providing almost equivalent or even more than minimum wage payments. Also, the progress of herd immunity (COVID vaccinations) along with the gradual reopening of schools should help in U.S. employment going forward.
Although Fed/Powell has already acknowledged ‘substantial further progress on inflation front for QE tapering condition, for the sake of the record, on Friday (10th Sep), the U.S. DOL data shows that U.S. core PPI (producer price index) surged +0.6% in August against +1.0% in July (m/m). On yearly basis, the U.S. core PPI jumped +6.7% in August (y/y), the largest increase on record.
The further fine print shows that in CY21, the U.S. core PPI is increasing by around +0.62% sequential (m/m) rate on an average; i.e. annualized rate around +7.44%. In CY20, the average sequential core PPI rate was around +0.08%, translating to an annualized rate of +1.0%. In CY19 (pre-COVID), the average sequential core PPI rate was around +0.11%, translating an annualized rate of +1.29%, which helped the core PCE inflation to stay below +2.0% and Fed’s price stability mandate. If U.S. core PPI continues to increase even by +0.50% on an average sequential rate in the coming days (persistently), then core PCE inflation may also surge proportionately as the U.S. producers have now pricing power (higher demand, lower supply) unlike in prior years.
Fed may go for QE tapering announcement by Dec’21. The QE tapering may start from Jan’22 at around $12B on an average ($6B each for UST and MBS) to complete the same by Oct’22 (total $120B). Fed may complete the $40B MBS QE tapering by June-July’22 and then increase the UST tapering pace to $12B/M to finish the same by Oct’22. And then after complete QE tapering (reinvestment will go on during QE tapering process and also after that), Fed will go for liftoff (gradual rate hikes) from Dec’22 with a moderate increase of +0.25% in Dec’22 and Dec’23, followed by two hikes in 2024 and four hikes in 2025 to hike cumulatively by +2.0% to +2.25%.
And Fed may go for QT (quantitative tightening) also from 2025 (after the 2024 U.S. election) and hike once more in 2026 to +2.50% to prepare itself for the next cycle of the financial crisis- usually every 10-12 years after a major GFC. The combination of elevated inflation, higher borrowing costs, and subdued tax revenues (amid subdued employment/wage gain) may cause another wave of GFC after 2025-26, even if there is no COVID-like pandemic in another 100-year. The transition to green energy is impacting the oil capex, resulting in lower oil production, but the demand may remain elevated during the transition phase. This may cause oil even above $100, resulting in uncontrolled inflation. Thus policymakers need to balance the green aspiration and reality of the world so that oil stays below $80 in the medium to long term.
The Fed has to control rising inflation and inflation expectations by effectively using its available tools; i.e. tightening; otherwise, it will soon find itself well behind the curve and lose control over U.S. bond yields. If U.S. bond yield goes above 2%, then the ratio of U.S. borrowing costs in terms of tax revenue will be around 20-30% from the present level of 10%, which will trigger another GFC. In the short term, U.S. may even default on its debt service obligation, if the U.S. debt limit is not increased by Congress on time amid the yearly ritual of debt limit political drama.
Technically, Dow Jones (DJ-30) now needs to sustain above 34500-400 zone for any rebound; otherwise, expect more correction. Similarly the ‘do or die’ levels for SPX-500 (S&P-500) are now around 4430-15, while for NQ-100 (Nasdaq-100), it’s 15300-250.
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