Will Delta Variant Slow Economy as Much as Treasuries Expect?

Relying on anecdotal information can be dangerous, especially when trying to extrapolate the impact to an economy as vast and diverse as the US, but we can’t help ourselves. Much of the recent multi-month rally in Treasuries has been conditioned on the belief that the delta variant and its rise in virus cases will slow second half growth as consumers and employers hesitate to more fully reopen. So far, in our experience, we aren’t seeing a lot of that. Rather, we are seeing consumers continuing to vacation, shop, dine, and be entertained in droves. While there is no doubt some curtailing of activities, to us it seems to be at the margins at this point and not wholesale shifts in behavior. It seems most vaccinated individuals see the statistics of new cases overwhelmingly affecting the unvaccinated and have decided to continue on with their lives. In addition, the delta variant seems to have a rapid burnout aspect to it regardless of mitigation strategies when looking at the experience in India and the UK.  Just this week several of the hardest hit areas in the US are starting to see plateaus in case numbers. That implies to us the expected economic slowdown may not be as significant as once thought, which obviously has implications for yield levels and Fed policy. We explore in more detail below other aspects of the economy that will also bear on Fed policy and the future direction of rates. Please read on.

Finally, in our podcast this week we talk with Mark Bryant, Director of Government Lending for SouthState. We discuss what is next for SBA lending as we come out of the PPP process. The iTunes link can be found here and the Spotify here.


Where are Those Labor Supply Bottlenecks?

Much has been made of the tight labor market and the impact that generous supplementary unemployment benefits may have had on that outcome. With those supplementary benefits unwinding by the end of September the expectation is that many of the labor bottlenecks will ease. Approximately 8.7 million people are receiving supplementary unemployment benefits and the thinking is that when those benefits expire many if not most of those 8.7 million will be sending out employment applications to various employers and the tight labor market will ease and many of the 10 million unfilled jobs (per latest JOLTs survey) will be filled. It may not be as simple as that given the graph below, courtesy of Matthew Klein.


Source: Matthew Klein

The graph highlights monthly hires per posted job opening for various sectors of the labor market over a two-year period before the pandemic and most recently in the first and second quarters of 2021. Manufacturing and construction have seen the biggest lags in post-pandemic hiring followed by business services, and state and local governments. Many of those categories tend to be pay above minimum wage and are not thought of as front-line workers that might be worried about contracting the virus from the public. Thus, it seems the tightness in those sectors may well continue after the supplementary benefits expire.  Meanwhile, the sector many would think would see some easing in labor tightness, Retail, has already nearly recaptured its pre-pandemic hiring levels. So it really remains to be seen what those expiring benefits will mean across the labor market in the coming months. If labor market tightness indeed continues into the fourth quarter continued wage gains are likely which may keep pressure on inflation, and keep pressure on the Fed.

Labor Participation by Age Reveals Damage Done by Pandemic to Older Workers

Now that we’ve scared you into thinking wage pressures may persist through 2021 and into 2022, and keep an upward bias to the inflation numbers, and consequently what that means to future Fed policy, let’s add to that by looking at the other Fed mandate: full or maximum employment. We mentioned last week that one metric the Fed will want to see improve is the Labor Force Participation Rate (labor force/population), and while it improved slightly to 61.7% from 61.6% in June it remains far below the pre-pandemic level of 63.4%. Is it realistic, however, to think it can get back to that pre-pandemic level in a reasonable period of time?

Source: Bloomberg

After the July jobs numbers the latest participation figures are shown above, but this time divided into age cohorts and one can quickly see the damage done by the pandemic to the 55 and older group. The 16-24 age cohort (white line), and 25-54 age cohort (orange line), while not recovering to pre-pandemic levels are at least nearly 50% of the way back. The older cohort (blue line) remains well below its pre-pandemic levels with little sign of improvement in 2021.

A couple things can be gleaned from this information: (1) it might be the Fed remains patient with its accommodative policy stance until those older workers are enticed back into the labor market.  Or (2), and more likely, the Fed concludes those older workers are never coming back regardless of wage gains, etc., and to keep accommodative policies in place is foolish given what is happening to the price side of its mandate. Thus, don’t expect the labor force participation rate to return to pre-pandemic levels before the Fed starts hiking.

Agency Indications — FNMA / FHLMC Callable Rates

Maturity (yrs) 2 Year 3 Year 4 Year 5 Year 10 Year 15 Year
0.25 0.11 0.39 0.65 0.97 1.75 2.2
0.50 0.10 0.36 0.59 0.87 1.61 2.1
1.00 0.09 0.33 0.56 0.82 1.52 1.9
2.00 0.32 0.50 0.74 1.40 NA
3.00 0.69 1.34 NA
4.00 1.29 NA
5.00 1.26 NA
10.00 NA

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Published: 08/12/21 Author: Thomas R. Fitzgerald