Slowing, from top speed
It looks like the US economy hit a speed bump lately, as the Delta outbreak escalated. Some early signs suggest this has spilled over into economic activity, for example with consumer confidence cratering in August and the composite Markit PMI taking a sharp hit.
As such, Fed chief Powell hedged his bets last week. He said that the tapering process could still begin this year, although that would ultimately depend on how much the virus impacts the economy. Investors interpreted his caution as diminishing the chances of a September announcement.
That said, the US economic engine is still strong. The economy is already much larger than it was before the crisis, there are now more open jobs than people unemployed, and Congress is about to unleash another multi-trillion spending spree to power up growth.
Meanwhile, inflation might not cool as quickly as the Fed thinks. Supply chain problems are getting worse with shutdowns in Asia, causing shipping costs to skyrocket and lengthening delivery times. And with the US Supreme Court abolishing the ban on evictions, rents could now start to play catch-up with soaring house prices, allowing inflationary pressures to broaden out.
Therefore, the Fed will almost certainly dial back its asset purchases. Markets are debating whether the central bank will signal tapering in September and start the process in November, or whether it will be pre-announced in November and implemented in December. The upcoming jobs data could go a long way in settling this debate.
Solid report expected, but mind the risks
Nonfarm payrolls are forecast to have risen by 750k in August, pushing the unemployment rate down another two ticks to reach 5.2%. If the actual numbers meet the forecasts, that would leave the US economy some 5 million jobs away from a full labor market recovery.
Subtract from that around 2.5 million people that retired early because of the pandemic and aren’t coming back to the labor force, and it is entirely possible that America returns to full employment by the turn of the year. It would only take a few more months at this pace.
With the economy overflowing in open jobs and the generous federal unemployment benefits ending, this seems like a high-probability scenario as millions of people begin to actively look for jobs again.
As for the risks surrounding the upcoming employment data, there is some scope for disappointment. The ADP report showed only 374k jobs being added in August, the Markit PMI surveys signaled that employment growth fell to a one-year low, and the employment sub-index of the ISM manufacturing report fell into contraction.
Dollar looks promising overall
A disappointment this week could hurt the dollar, as it would further lower the chances of a September taper announcement by the Fed. Taking a technical look at euro/dollar, a soft jobs print could push the pair towards the 1.1900 region.
That said, the bigger picture for the reserve currency seems positive. Whether the Fed announces tapering in September, November or even December doesn’t matter much. That will only affect short-term trading, not the overall trend.
What’s important is that the Fed is getting the tapering process rolling and ultimately plans to raise interest rates, whereas the European Central Bank and the Bank of Japan aren’t. Over time, this central bank divergence could allow American yields to rise faster, making the dollar more attractive against the euro and yen as it begins to benefit from carry trades.
That could allow euro/dollar to fall back below the 1.1800 zone and aim towards the recent lows of 1.1665.
Finally, the ISM services PMI for August will also be released on Friday, ninety minutes after the employment report.
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