Growth

Revised 2Q21 real GDP grew at a 6.6% q/q seasonally adjusted annual rate. Increases were broad based and were partly offset by decreases in inventories, residential fixed investment and government spending. Real output has now surpassed its previous peak in 4Q19. Weaker inventories weighed heavily on growth, and as businesses restock in upcoming quarters, inventories could be a significant contributor to GDP growth. The September flash PMIs pointed to a slowing pace of economic expansion although more concentrated in services than manufacturing. The Markit manufacturing PMI fell to 60.5, from 61.1 in August, while the services PMI fell to 54.4 from 55.1 in August.

Jobs

Hiring momentum in August slowed sharply as the delta variant curbed in-person consumer activity and businesses continued to grapple with chronic labor shortages. Total nonfarm payrolls increased by a meager +243,000 in August, falling short of consensus expectations by a large margin, as the leisure and hospitality sector saw a striking zero net job creation. However, despite the slowdown in hiring, robust wage growth suggests the weakness is primarily supply-side driven, with wages spiking +0/6% m/m and 4.3% y/y. This was further corroborated by the July JOLTS report, which showed a record 10.93M job openings.

Profits

The 2Q21 earnings season was spectacular, with 491 companies having reported (98.8% of market cap). Our current estimate for 2Q21 earnings is $52.29. Thus far, 86% of companies have beaten on EPS estimates, and 83% have beaten on revenue estimates. Following blowout 1Q21 earnings, many companies have now recovered to the revenue/EPS levels of 2019 and are setting fresh highs. Oil prices (+143.4%) and the U.S. dollar (-7.6%) have continued to be tailwinds to earnings.

Inflation

Inflation has now well surpassed the FOMC’s 2% target, as the headline PCE price index rose +0.4% m/m and +4.2% y/y in July. The core PCE deflator also rose to +0.3% m/m and +3.6% y/y, with the latter slightly above market expectations. The August CPI report showed inflation moderated across a few major categories that have been most impacted by supply shortages and pent-up consumer demand, such as used cars, airlines and hotels. Headline CPI for August rose +0.3% m/m, from 0.5% in July, and +5.3% y/y, while consumer prices excluding food and energy rose +0.1% m/m and +4.0% y/y.

Rates

At its September meeting, the FOMC delivered a slightly hawkish message to markets on its policy outlook, recognizing slower economic progress due to the delta variant, but also robust improvement in the labor market recovery and somewhat stickier inflation than it previously assumed. In the FOMC’s Summary of Economic Projections, growth estimates were downgraded from 7.0% to 5.9% for 2021, but increased for 2022 and 2023. The FOMC also increased its unemployment estimate to 4.8% for 2021 and PCE inflation to 4.2% for 2021 and 2.2% for 2022. Notably, the Fed signaled that tapering could “soon be warranted,” raising the likelihood of a November announcement.

Risks

• The delta variant and global vaccine delays could slow the economic reopening.
• Inflation could spike in the medium term.
• Extremely accommodative monetary and fiscal policies could lead to a boom-bust recession.

Investment Themes

• U.S. equity investors may use earnings as a guide in a rising rate environment.
• Fixed income investors may underweight bonds and maintain short duration in a rising rate environment.
• Long-term growth prospects, a falling dollar and cyclicality support international equities.