A Step on the Path Towards Tightening – August 6, 2021

A Step on the Path Towards Tightening – August 6, 2021
Morgan Lewis Posted on August 7, 2021

Weekly Hard Asset Insights
By David McAlvany

A Step on the Path Towards Tightening

The big news of the week came late when, on Friday, the US Labor Department released the July jobs report. The numbers were strong, and beat official Wall Street estimates. New jobs came in at 943,000 vs. average analyst estimates of about 860,000–880,000. This jobs report came with added significance, as many market participants believed the report to be a crucial data point in shaping expectations for when the Fed will announce, and eventually start, a process of tapering its asset purchases.

In recent weeks, HAI has highlighted the volatility on display in many areas of the market. It might fairly be said, however, that real volatility junkies need look no further for a fix than the volatile swings of FED policy interpretations offered by the armies of FED policy tea leaf readers. No disrespect intended, at MWM we eagerly and enthusiastically engage in the practice ourselves. That said, the rapid seesawing of FED watchers’ interpretations of events have been rather extreme of late. The June FOMC was a hawkish shock, July a dovish surprise, and now this latest July jobs report seems to be whipsawing market sentiment all the way back to hawkish again.

While some held that this jobs report was pivotal, and that good numbers would spell the end of continued policy accommodation, another view suggests that many of the key factors driving monetary policy and timing will not be resolved with the release of this single jobs report. Nevertheless, the markets reacted in volatile style. This was the best week for the dollar since June, erasing all the post-FOMC weakness of the prior week. Commodities were all ugly, with oil posting its worst week since October and closing back below $70 per barrel. Major market indexes reached new all-time highs, and bond yields rallied sharply on Friday.

The hawkish framing of the jobs report started prior to the data’s release. Earlier in the week, Fed Governor Christopher Waller stoked high expectations for both a strong payroll print and for the FED policy significance of a strong print. FED Governor Waller indicated that if the July report were to post a gain of one million jobs, and if numbers come close to another million in next month’s August report, the labor force will have recovered enough of the losses suffered during the pandemic to constitute Chairman Powell’s “substantial further progress” criteria sufficiently for the FED to initiate tightening. Within that context, Friday’s 943,000 jobs number was strong enough to prompt the notably hawkish recalibration of market attitude reflected by Friday’s market movements. So the market reaction to the data point is understandable, and the logic is tidy. With that said, however, there may well be much more complexity to the story of the FED’s ultimate policy path forward.

For one thing, this week, JP Morgan updated its economic model tracker, and, according to the latest results, the next monthly payroll number is expected to tumble. The bank released projections from two different models that, if they verify next month, would put the FED tightening narrative firmly back on ice. JP Morgan’s “Difference model” now projects 322,000 jobs, while their “Levels model” now projects a shockingly low 53,000 new jobs in August. These numbers are nowhere near Waller’s one million new August jobs benchmark for initiating tightening.

These are just one bank’s projections, but they illustrate the fact that there is more to the story of a now clarified and tidy path forward to FED tightening in the wake of the July numbers. Indeed there is more to the story, and, in fact, this story’s plot appears to be thickening.

One complicating factor may be broad economic growth. Last week’s HAI pointed out the significant GDP miss for the second quarter, as well as the possibility that GDP growth rates may have already peaked and may well be turning notably lower ahead of expectations in the second half of the year and beyond. There is also the very valid possibility that the Covid Delta variant will build into enough of a disruption to complicate even the best laid plans.

A global surge in Delta variant cases has already started to cast a shadow over the global growth outlook. In the US, according to Reuters, Covid cases this past week hit a six-month high, with more than 100,000 infections reported. News out of China this week has also sparked renewed Delta variant fears. According to CNN, “The country now has 144 medium- and high-risk areas, the most since the initial outbreak in early 2020….” “The speed and scale of the spread has spurred mass domestic travel restrictions, with all inter-city coach, taxi, and online car hailing services suspended in medium- and high-risk areas. Chinese immigration authorities have also vowed to ‘strictly restrict non-urgent, unnecessary cross-border travel,’ including tightening the issuing of passports for Chinese citizens.” Developments on the Covid front are, of course, a wildcard, but some of the recent news is justifiably increasing concern for a resurgence of significant Covid problems and of the implications that might bring.

Interestingly, on the topic of growth, the oil market may also be chiming in with some indicative signals. Earlier in the year, on the back of the surging growth of the recovering economy, numerous oil analysts were forecasting huge crude oil weekly inventory drawdowns of 20+ million barrels to be commonplace by August and through the remainder of the peak summer demand season. We have seen fairly strong numbers so far this summer season, but now into August, when demand was really expected to take off, the inventory data is disappointing.

The first inventory report for the month of August not only didn’t match the lofty drawdown expectations, but inventories for crude actually reported a 3.6 million barrel build. Gasoline and distillates did report drawdowns, but the net inventory results were nowhere near expectations, and represent the second straight week of significantly missed estimates. While it’s still too early to know exactly what to make of the disappointing numbers and what they may or may not be saying about economic growth, it is an interesting development to keep an eye on. The resulting demand concerns in the oil market were no doubt a big contributor to the 7.67% decline in oil prices this past week.

Despite the market reaction to a perceived “hawkish” jobs number, only time and hindsight will fully reveal the ultimate significance of Friday’s job release. While July job numbers were a solid positive step on the path towards FED tightening, it is hard to argue that anything close to solidified clarity was attained this week. What remains clear is that the FED’s dizzying tightrope walk remains fraught will peril.

As for weekly performance: The S&P 500 closed the week down 0.37%. Gold was down 2.98%, and silver lost 4.77% on the week. Platinum was clubbed to the tune of 7.27%, while palladium was lower by 0.98%. The HUI gold miners index lost 5.13%. The IFRA iShares U.S. Infrastructure ETF was up 0.70%. Energy commodities were all over the place this week. Oil was crushed on the week, down 7.67%, while natural gas prices had a big week, up by 5.87%. The CRB Commodity Index was down 2.74%, while copper was down 2.90%. The Dow Jones U.S. Real Estate Index ended the week up 0.35%, while the Dow Jones Utility Average Index added 2.13%. The U.S. Dollar Index was up 0.64% to close the week at 92.78. The yield on the 10-year Treasury had a very volatile week, adding 7 bps to close the week at 1.31%.

Have a great weekend!

Best Regards,

David McAlvany
Chief Executive Officer

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