Cautious Market This Week?

The stock market will likely trade cautiously this week for two reasons. /1/ It will continue to digest the risks highlighted by the August Employment Report -- a slowdown in economic growth, possibly resulting in part from the Delta virus variant, and higher wage inflation.  /2/ Threats of increased taxes to pay for the Democratic spending bills.  But, these risks are not a foregone conclusion.  So, a market pullback would probably be modest.  

Not all the components of the August Employment Report pointed to slower growth.   Total Hours Worked in August are 4.7% above the Q221 average, the same as their q/q growth in Q221, but are only modestly above the July-August average.  They need to climb by more to point to good-sized growth in Q421.  The Atlanta Fed Model's estimate of Q321 Real GDP Growth was lowered to 3.7% from 5.3% after the Report, but the new estimate seems too low relative to THW.  So, the risk now is for upward revisions to the model estimate after it was to the downside before.  Indeed, the 0.2% pt decline in the Unemployment Rate to 5.2% in August raises doubt about a sharp slowdown in growth.  And, the latest Unemployment Claims data keep alive the possibility that the Rate will fall further in September.

The composition of August Payrolls sheds light on the driving forces in the economy.  Hotel jobs were essentially flat while restaurant jobs fell in the month -- after both had rebounded sharply in the prior few months. Fears of the Dela variant could have undercut the recovery of these sectors.  Or, there could have been a natural pause to "take stock" of the situation after having recovered so sharply.  In contrast, motor vehicle jobs jumped, suggesting the chip shortage is abating somewhat, despite news headlines to the contrary.  The dichotomy fits with the Fed staff's outlook (as reported in the July FOMC Minutes) -- "in the second half of 2021, an easing of the surge in demand seen over the first part of the year was expected to be largely offset by a reduction in the effects of supply constraints on production, thereby allowing real GDP growth to continue at a rapid pace." 

The August Employment Report did highlight the risk of a speedup in wage inflation.  The 0.6% m/m jump in Average Hourly Earnings follows 0.4% increases in the prior two months.  Moreover, about half the sectors saw speedups in the month.   But, of the three major measures of labor costs -- AHE, Employment Cost Index and Compensation/Hour -- AHE is the narrowest.  And, speedups in all of them can be offset by faster productivity growth thereby reducing their import for price inflation.  For example, in Q221, most of the 3.4% increase in Compensation/Hour (q/q saar) was offset by a 2.1% increase in Productivity.  Besides wages, final demand pressures could impact price inflation.  And, the risk is that softening demand for hotels, airfares and restaurants because of the Delta variant fear could result in price declines.  This week's report on August PPI will provide evidence on airfares.  

The decline in the Unemployment Rate and higher wage inflation in the Report should keep a Fed tapering at year-end in play.  But, with the Black Unemployment Rate having risen and Payroll gains slowing, the stock market could be supported by an increased possibility of a delay in the tapering.