Reasons for Stocks to Rally Back

The stock market has a window to rally back now that the Democratic spending/tax bills are on hold, the coronavirus infection rate is receding, and seasonal weakness is behind us.  /1/ Stocks risked being hurt by the bills, either because of tax hikes or to crowd out private spending to make room for the infrastructure investments.  /2/ A receding virus means the fear of the Delta variant will soon stop weighing on consumer spending.  /3/ The S&P 500 rose in October in 8 of the past 10 years.  This week's September Employment Report is expected to show a speedup in Payrolls and a decline in the Unemployment.  Even if Payrolls are not as strong as consensus expects, which is the risk, they should not stand in the way of a stock market bounce-back -- particularly if Treasury yields decline on the news.

Consensus expects Nonfarm Payrolls to speed up to +460k m/m in September from +235k in August.  But, the Claims data don't support a speedup.  Both While Initial Claims fell between August and September, showing fewer layoffs, Continuing Claims did not fall as much in September as they did in August.  The slower decline in Continuing Claims suggests a softer pace of re-hiring between the two months and argues for a smaller Payroll gain than in August.  A wild card, however, is the speed at which people who lost their extended Unemployment Benefits in early September found jobs.  The Claims data do not argue against the consensus estimate of a dip in Unemployment Rate to 5.1% from 5.2%.  So, even if Payrolls are softer than consensus, they still should be viewed as being above-trend.

Potential problems for the US economy and stock market further ahead are beginning to be apparent in Europe and Asia.  Energy shortages, stemming from weather-constrained alternative energy sources or policy-induced shifts away from fossil fuels, are showing up in parts of Germany, UK and China.  They could be precursors of what will happen in the US in coming years (having happened in Texas already).  In addition, the coronavirus has resulted in shutdowns in Viet Nam.  These developments will result in shortages that could exacerbate inflation.  

These supply effects have curious implications for monetary policy.  /1/ A supply-constrained US economy means the pre-pandemic low of the Unemployment Rate (3.5%) may not be the right target for Fed policy.  The non-inflationary level of the Unemployment Rate is substantially higher.  Policy should rein in demand to fit the slower capacity of the economy to increase production.  (To be sure, the lags and imprecision of monetary policy's impact mean the correct degree of restraint is not guaranteed to be achieved. A tighter policy could overshoot.)  /2/ If shortages abroad have little impact on US production, but result in higher import prices, monetary policy still may have to tighten to prevent spillover to prices of US-produced goods and services.  /3/ If some of the supply constraints ease, such as the chip shortage, monetary policy could ease to allow demand to move up with supply.