The challenge for market participants as December approaches is do you get lost in the near-term pessimism stemming from the Covid-19 surge or keep focus on the other side? I understand it is a difficult to think past the immediate suffering, but from a market perspective I believe it is important to maintaining a focus on the medium- and long-terms. Beyond the current surge awaits a solid if not surging economy.

In the near term, there will likely be some downward pressure on services spending, particularly in leisure and hospitality, as behavior changes and state and local restrictions on activity intensify in response to the rising number of Covid-19 cases, hospitalizations, and deaths. Still, there are four important points to remember when considering the outlook. The first is that the downward pressure will be less severe than the indiscriminate shutdowns of this past spring. The second is that, like it or not, now that we are well beyond the possibility of suppression, there is a tradeoff between the pandemic and the economy. That means that when the current pandemic surge levels off and starts reversing, behavior and restrictions will shift again and activity in impacted sectors will pick back up. The third point is that after we are on the downside of the current surge, a vaccine looks almost certain, so there most likely isn’t another large surge lurking in the future. This feel like the last month or two of the worst of the pandemic, hopefully. And, finally, the fourth point is that the U.S. economy is on a better economic footing than commonly believed.

I suggest avoiding the fiscal fetish trap and recognize that fiscal support is far less important for the macroeconomy than it was earlier this year. Yes, fiscal support was very helpful support. But the support was far more than needed to fill the pandemic hole:

The obsession with the fiscal stimulus has forecasters focused on that top line falling whereas they should really be focused on the bottom line, income excluding transfer payments, rising. More specifically, watch wages and salaries, which have made a V-shaped recovery:

A recovery of wages and salaries means that fiscal stimulus is less important for sustaining aggregate spending. That’s what forecasters missed this summer when we predicted disaster from the end of enhanced unemployment benefits. Indeed, note also that the decline in wages and salaries is still in aggregate less than the decline in spending since the beginning of the pandemic:

So how does saving fit into this story? The fiscal support overshoot coupled with the decline in spending relative to wages and salaries pushed saving rates dramatically higher:

Importantly, as of October the saving rate is still almost twice pre-pandemic levels. Households are not drawing down on the saving cushion. They are still increasing the cushion. By my estimates, relative to the pre-pandemic saving trend, households have accumulated $1.4 trillion of excess (forced) savings this year:

Note that commentary such as this from NBC news is just dead wrong:

Income and spending moving in opposite directions indicates that Americans are drawing down on the money many socked away early in the pandemic. It also shows the extent to which the recovery has been supported by the government, because much of the reduction in income was associated with a drop in pandemic assistance.

The idea that households are already drawing down on savings in aggregate is a common misperception. To be sure, it is happening on an individual level. Consider this, for example, from the November FOMC minutes:

However, several participants expressed concern that, in the absence of additional fiscal support, lower- and moderate-income households might need to reduce their spending sharply when their savings were exhausted. A couple of these participants noted reports from their banking contacts that households appeared to be rapidly exhausting funds they received from fiscal relief programs.

This is undoubtedly true on a micro level. The micro stories are real, but they don’t necessarily add up to the macro story. The fact that the saving rates remain positive (and above pre-pandemic levels) means that savings are growing not shrinking. In aggregate, the stockpile of savings accumulated since the pandemic began hasn’t been touched and is still growing. A decrease in the saving rate does not mean that households are drawing down savings. Drawing down savings in aggregate means a negative saving rate. The possibility of a negative savings rate is actually an under-discussed possibility for next year. Look for my Bloomberg column this week on that topic.

Separately, even though we can expect services spending to soften with the pandemic surge, watch for other sectors to help compensate. Notably, the housing market is red hot. New home sales are at levels last seen during the housing bubble:

That graph is mind-boggling but consistent with the demographics; Millennials are aging into their home-buying years and then the high-earning years will follow. That is a multi-year trend you should be ready to ride. And importantly for the macroeconomy, the number of homes sold but not yet started has doubled:

This is literally months of higher construction activity in front of us, not to mention the durable goods spending needed to fill those houses when they are occupied. Traditionally, housing is a good leading indicator and it is hard not to be positive about the economic outlook with numbers like these.

Also note the V-shaped recovery in capital spending continues:

Watch for this to show up in this week’s ISM numbers.

This is a jam-packed week. In addition to the ISM manufacturing numbers Tuesday, Federal Reserve Chair Jerome Powell will testify in the Senate on CARES act. We should expect him to reiterate that the Fed has pledged to use all of its tools to support the economy and advise that Congress authorize additional aid. On Wednesday Powell repeats his performance at the House while the ADP report on private job growth (400k expected) helps focus our attention on the labor market. Thursday brings the initial claims report; claims have been ticking higher and should continue to do so given the pressure of the resurgent pandemic. Also on Thursday is the ISM non-manufacturing numbers. The November employment report comes Friday. Expectations are for a 500k employment gain, but it’s a tricky report. Supporting a solid report is that the most recent pandemic restrictions most came about after the reference week. Supporting report on the softer side are seasonality issues. Retailers are adding fewer seasonal employees than in past year while some, such as Amazon, likely pulled forward seasonal hiring in the form of permanent hiring earlier in the year. Consequently, the seasonal factors might depress the report. Job growth outside of the trade and transportation sectors might paint a more accurate indicator of the health of the job market.

Good luck and stay safe this week!

President-elect Joe Biden continues to build his team and today it was announced that former Fed Chair Janet Yellen will be nominated for Treasury secretary. What can you say? It’s not like Yellen is unfamiliar to us; she has decades of proven policy making and management experience and is well-respected by her international counterparts and can hit the ground running. She is an excellent choice and consistent with Biden’s methodical, experience-based approach to picking advisors. One interesting place to watch is her views on fiscal policy. In the near term, she will support fiscal stimulus to help lift the economy out of the pandemic hole. Note though that she has a track record as a deficit hawk. Such views would be consistent with my expectation that a Biden administration will eventually pivot toward deficit reduction, but maybe that instinct has been tempered in the last few years.

The housing market remains red hot heading in the fourth quarter. Builder confidence pushed to a new record high in November:

The strong showing follows on the back of new cycle highs for single family housing starts:

Housing is traditionally a solid leading indicator and talk of a double-dip recession is wildly inconsistent with the strength the sector continues to exhibit. Meanwhile, in another blow to the narrative that the U.S. economy is struggling under the weight of the Covid-19 resurgence, the flash IHS/Markit PMI report for November indicates the economy is gaining momentum:

U.S. private sector business activity rose sharply in November, as growth momentum picked up further. The overall expansion was the fastest for over five- and-a-half years, as both manufacturers and service providers indicated a steeper upturn in output. The month also saw a survey record rise in employment and an unprecedented increase in prices, the latter in part linked to a record incidence of supply chain delays

And also despite the Covid-19 resurgence, Americans are traveling in post-pandemic record numbers. Via CNN:

Warnings from public health officials not to travel for Thanksgiving didn’t stop passengers from packing US airports and planes this weekend.

From Friday to Sunday, more than 3 million people passed through airport security checkpoints in the United States — a record weekend for air travel since the pandemic hit in March. Sunday was the biggest day for air travel since March 16, with 1.05 million people screened.

Covid-fatigue is real and many people feel the benefits of traveling outweigh the risk This is “lockdown lite.” If you are using the spring shutdowns as the model for your macro forecast, you are doing it wrong. People will shy away from food services and gyms, but much other activity will proceed will little disruption. The current situation lacks the novelty of the spring and will not induce the same degree of response. Importantly, equity markets refuse to buy into the double-dip recession story in sharp contrast to the rapidity in which they quickly incorporate the economic implications of the pandemic into prices:

Also regarding the Covid-19 resurgence, watch out for a narrative shift:

The good news is that many of the worst-hit states for the US pandemic have started their descent.
Nebraska, New Mexico still on a sharp ascent pic.twitter.com/L05QJZPTt6

— Eric Topol (@EricTopol) November 22, 2020

Keep an eye on follow through from the bigger states like Illinois and Wisconsin; as behavior changes those numbers will turn. The bigger picture is that Biden will be riding on the downside of the surge and the upside of the vaccine. Beware of too much near-term pessimism on the economic outlook that obscures the long-run view.

Bottom Line: Lots of moving pieces but they are generally pointing toward a brighter future if you can look past the current wave of the pandemic.

The Fed has positioned itself in such a way that its next move seems obvious and that it will ease policy further by some means sooner than later, with sooner being the December FOMC meeting. Expectations are moving in the direction of the Fed shifting asset purchase toward the longer end of the curve. Not to be outdone, some shops are expecting the Fed to increase the pace of asset purchases.

I am not terribly comfortable with this narrative yet. I could get comfortable with it under certain circumstances, but I have some nagging doubts. Here I am going to outline those doubts and hopefully provide some context for thinking about this issue.

I think we can consider these six facts as central elements to the growing narrative:

1. As in the last cycle, the Fed’s forecasts predict that inflation will remain belong target for a protracted period of time. This suggests that the Fed should take further action to support the economy and accelerate the return to target. They have so far opted not to do so but presumably could.
2. Fed officials have repeatedly expressed concerns about the dual downside risks of a Covid-19 surge and insufficient fiscal support. Both of those events look more like reality than risks.
3. The Fed has repeatedly expressed concerns about inequalities and permanent job loss arising from the pandemic recession. Federal Reserve Chair Jerome Powell reiterated these points in remarks yesterday. There seems to be no point in complaining about such issues yet still hold policy steady.
4. The Fed believes their tools remain effective. On Monday Federal Reserve Vice Chair Richard Clarida used the strength in interest rate sectors of the economy as evidence that monetary policy was as effective in this cycle just as it has been in past cycles.
5. Federal Reserve Governor Lael Brained said in October that “in the months ahead, we will have the opportunity to deliberate and to clarify how the asset purchase program could best work in combination with forward guidance to support achievement of maximum employment and 2 percent average inflation.”
6. With interest rates at zero and the Fed dismissive of yield curve control, the primary tool available to the Fed is the asset purchase program. The Fed discussed possible extensions of the asset purchase program at the November FOMC meeting.

The path from that set of facts to some type of action at the December meeting seems straightforward. So what’s eating at me?

First, I don’t know entirely how to interpret Powell’s dovishness. I think Powell is rightly concerned with saying anything that can be interpreted as optimistic out of fear that doing so will lead market participants to erroneously conclude that the Fed is closer than expected to hiking rates. He is genuinely committed to sustained accommodative monetary policy because even if the U.S. recovery remains intact this winter, the economy will still be in a hole with excessively high unemployment. I don’t think he wants to accidentally blunder into a “taper tantrum” and slow any progress toward meeting the Fed’s goal.

That said, if Powell is indeed concerned about things like inequality or long-term labor market damage, why hasn’t he already pushed his colleagues into expanding the pace of asset purchases? The situation now is no different than two or three months ago. I can really only conclude that he views monetary policy as a poor substitute for fiscal policy at this point in the cycle and to achieve his desired goals. A very poor substitute. When Powell says the Fed has reviewed the asset purchase program and concluded that it is providing the appropriate amount of accommodation, he may really be saying that increasing it will neither accelerate the recovery nor deal with the structural issues that concern the Fed. Why then would they do something in December that they have already concluded won’t help?

While Powell may be suppressing optimism, Clarida, let the optimism fly as he revealed that the good news on the vaccine gave him:

 “…more conviction in my baseline for next year and more conviction that the recovery from the pandemic shock in the US can be potentially more rapid, potentially much more rapid, than in was from the Global Financial Crisis…there is an enormous quantity of pent-up saving….so you combine the good news on the vaccine with north of a trillion dollars of accumulated saving, the there is a very, very attractive right tail to this distribution.”

Could Powell see more upside risk than he is willing to admit?

Second, the Fed has not identified how the asset purchase program interacts with the Fed’s new strategy. The path of the asset purchase program and its relation to economic outcomes has not been tied down as has the path of interest rates. This is what Powell said at the November press conference:

EDWARD LAWRENCE. Thank you, Mr. Chairman, for taking the question. So what would cause the Federal Reserve to shift more of its asset purchases towards the long-term securities and Treasuries and change the amount of spending there also? And as a second point onto that, you know, would — if there’s no fiscal stimulus package, would that then trigger buying of more long-term assets or change the asset purchases?

CHAIR POWELL. So I don’t really have a specific hypothetical I would put to you. I would just say that we understand that there are a number of parameters that we have where we can shift the composition, the duration, you know, the size, the life cycle of the program. All of those things are available to us as ways to deliver addition — you know, more accommodation if we think that’s appropriate. Right now, we like the amount of accommodation the program is delivering. And it will just depend on the facts and circumstances. We may reach a view at some point that we need to do more on that front. Today’s meeting was about analyzing the — one of the things it was about was about analyzing the various ways and having a, you know, good discussion about how to think about those various parameters, which I thought was quite a useful discussion.

What are the “facts and circumstances” that were discussed? We don’t know. We are falling into the assumption that the “facts and circumstances” include addressing the negative impacts of a Covid-19 surge, but we don’t know that. Again, it appears the Fed already concluded that increasing the changing the asset purchase program would not accelerate the recovery, so why would they believe it could offset fresh pandemic weakness?

There is one obvious set of “facts and circumstances” that would prompt the Fed to alter the asset purchase program: A financial disruption. And that gets me to my third concern. I am pretty sure that a financial hiccup would get the Fed’s attention and provoke a response. As of yet, however, there has been no financial disruption despite the surge of cases across the nation.

The financial situation appears very different from this past spring. Then the markets quickly discounted the implications for the economy and the stocks crashed while credits markets nearly froze. This time no such thing has occurred. Why? A number of possibilities. First, this is “lockdown light” that will have less significant economic impacts. Second, selling off is foolish because we know there will be a rebound on the other side. Third, market participants are looking through the short-term problems to the long-term solutions.

Whatever the reason, financial markets are not tightening. Now, to be sure, longer term interest rates are edging higher, but that increase could be consistent with improving economic conditions, so it is not readily obvious the Fed would need to push back. This from Clarida this week was illuminating:

We are buying a lot of Treasuries, we’re buying $80 billion a month, that comparable to the path of QE2 and it’s roughly the duration pull…with long-term yield at historically low levels and below both current and projected inflation, financial conditions are accommodative…not concerned about the rise in Treasury yields and it is still in an accommodative range.

Those are not the words of someone interested in expanding asset purchases or changing the duration of the program to sit on the long end of the curve.

Bottom Line: I don’t know that the Fed’s behavior with regards to the asset purchase program to date argues for change in the composition of purchases as a response to feared renewed pandemic weakness. If the Fed believed alterations to the program would have a meaningful impact on economic outcomes in the current environment, they should already have changed the program. That outcome though seems more likely than expanding the pace of asset purchases. Another possibility is that the Fed decides to clarify the length of the program to make is consistent with guidance on the interest rate. This seems like an easier call than other options. The most likely reason to alter the asset purchase program would be to offset a tightening in financial markets, but as of yet that doesn’t seem necessary. Hopefully the upcoming minutes of the November FOMC meeting will reveal new information and the Fed’s discussion of the asset purchase program.

My Bloomberg column this week listed six reasons to be optimistic about the Biden economy:

It’s fashionable to think that, just like his former boss, President Barack Obama, president-elect Joe Biden is inheriting a damaged economy that will struggle to recover, perhaps for years. The reality is quite the opposite, with Biden stepping into a dream scenario for economic growth on the other side of the battle with the Covid-19 pandemic.

Read more here.

I should add two more reasons. Number 7 is that the sector of the economy most impacted by the pandemic is fairly small:

A retreat in food services spending the winter from already depressed isn’t great but it also won’t have the same impacts as the hard shutdowns of this past spring. Number 8 is easier monetary policy. In the last expansion, the Fed was looking for reasons to tighten policy. This time, it is looking for reasons to maintain easy policy. Completely different policy emphasis.

Meanwhile, despite the pandemic resurgence, the economy continued to gain ground in November:

With the support of Alaska Senator Lisa Murkowski, the Senate is moving forward with a vote to appoint Judy Shelton to the Federal Reserve. The gold bug turned dove will almost certainly revert to her hawkish ways now that the Democrats have regained control of the White House. I don’t believe that Shelton is qualified to be on the Fed. That said, the potential damage she might cause is limited. She is no longer a contender for the Fed chair and she is being appointed to a term that ends in 2024, so she will be out the door soon enough.

As far as her potential impact on policy, I think her colleagues will treat her with respect publicly and largely ignore her privately. She will not be the first ineffective Fed governor nor will she be the last. Moreover, there is even some upside risk here. The only way to change her status would to do something constructive rather than destructive. I don’t expect that. I expect comic relief. But there is a path for her should she choose to take it.

The CPI report revealed that both headline and core inflation were flat in October:

The still solid gains in employment are great news for the economy but they don’t mean much for monetary policy as long as inflation is locked down. Under the Fed’s new strategy, it can both cheerlead the recovery and remain credibility committed to accommodative policy. It’s a good place to be.

Covid-19 cases continue to surge in the U.S. The issue has been kicked to the states as there is not national leadership nor will there be until January. U.S. local governments continue to avoid broad lockdowns with Chicago being the latest example of lockdown light. By lockdown light I mean it is a stay-at-home advisory not order, a limit of six non-household members for private gatherings, and apparently no changes to business already under restrictions. The general approach with lockdown light is that the key problem is the social gatherings and thus a hard lockdown is an excessive blow to the economy. In addition, I think there are reasonable concerns that people will ignore strict stay-at-home orders during the holidays. My anecdotal evidence is that the strong desire to spend the holidays with family and friends spans the political spectrum. In my progressive community I regularly talk with friends and acquaintances that are planning family and friends events despite the pandemic. Sorry to be a fatalist but pandemic-fatigue is real and will kill a lot of people this winter. Please try to keep yourselves and your loved-ones safe!

Bottom Line: Rate policy on hold for the foreseeable future. There is a lot of upside in the future but we will have to endure a hard winter to get there.

Joe Biden is the President-elect of the United States after have gained a solid lead in the electoral college over the weekend. President Donald Trump has not conceded the race and likely will always claim he actually won had there not been voter fraud. While some of Trump’s allies are dutifully following that line of thought, they unsurprisingly offer no evidence of widespread fraud. With the votes now counted, the odds of a successfully legal action of the scope necessary to change the election are very, very thin.

In Biden’s favor as he faces managing a pandemic-stricken economy, the October employment report indicates the job market retained substantial momentum heading into the fourth quarter. The private sector added 906k employees although the release of temporary Census workers and a loss of 65k state and local government jobs dragged the headline gain to 638k. To be sure, there remains a substantial hole of the million jobs relative to the pre-pandemic peak:

Still, the slowdown in job growth has been less severe than I expected. Importantly, October marks the third full month after the supposed fiscal cliff at the end of July and yet the economy continues to gain lost ground. Note that hours worked continued to grow at a solid pace in October:

Gains in jobs and hours worked means incomes are growing at a solid clip that that growth will support consumption.

The unemployment rate sunk to 6.9%, still high but already well-below the Fed’s projected year end rate of 7.6% as of the September Summary of Economic Projections:

The Fed has consistently underestimated the strength of the rebound but unlike in past cycles this does not impact the expected timing of a rate hike. The focus is not on the unemployment rate but instead on the inflation rate. Until inflation is at 2% and looks like to remain modestly above 2%, the Fed expects to hold interest rates at zero. Ongoing solid economic gains may however prompt the Fed to rethink its asset purchase programs. At last week’s press conference, Federal Reserve Chair Jerome Powell said this:

… today, you know, we had a full discussion of the options around quantitative ease — not quantitative easing, the asset purchase program and, you know, we understand the ways in which we can adjust the parameters of it to deliver more accommodation if it turns out to be appropriate. Right now, we think that this very large effective program is delivering about the right amount of accommodation and support for the markets, and so it continues.

The Fed will deliver more accommodation via the asset purchase program if appropriate but if overall economic conditions are such that unemployment rate keeps dropping quickly they won’t find more accommodation necessary. We also still lack guidance on the conditions that would induce the Fed to pull back on the pace of asset purchases.

Although he may have more momentum in the economy than many expected at this point, Biden faces the problem of surging Covid-19 cases. The virus did not, as Donald Trump fabricated, magically disappear on November 4. Instead, the U.S. is experiencing new records in cases on a daily basis. This is not exactly optimal, to say the least. Biden is already laying out plans to address the virus and is expected to announce a coronavirus task force Monday. That said, his options are limited until the inauguration. The Trump administration appears to have largely abandoned the issue.

If the U.S. follows the pattern of this past summer, the surge will peak in a couple of months as behavior changes and local jurisdictions tighten restrictions on activity. I don’t expect the extent of general lockdowns as seen in Europe. In the U.S. that issue is in the hands of states and many governors are either content to let the virus run its course or concerned about the impact of shutdowns on economic activity. The latter extends to even states held by Democrats; with suppression now not really an option, there is on some margins a tradeoff between the economy and fighting the virus. I also doubt that widespread shutdowns are politically possible in a Covid-fatigued population. Moreover, I think the lure of the holiday season will prove impossible for many to resist; no matter the danger, too many people will still visit with family and friends. And some of their family and friends are going to die from that decision.

Yes, I understand I sound fatalistic, but this is the reality I am seeing on the ground. The best-case scenario for Biden at this point seems to be that the surge is nearing its peak around the inauguration and he gets to ride the downtrend while implementing his program and benefits from the eventual vaccine. The case remains that the economy cannot fully recover until the widespread use of a vaccine. Until then, certain sectors, particularly in leisure and hospitality, will remain encumbered by the dynamics of the virus. I expect those sectors suffer through a challenging winter.

Rumors are flying about Biden’s potential cabinet. This from Bloomberg for example, although the piece as an odd lede:

As President-elect Joe Biden forms his cabinet, he will make it a top priority to assemble an economic team that can confront the surging unemployment and business slowdown touched off by the coronavirus pandemic.

Unemployment is no longer surging and is on its way down. Putting that aside, some notable possibilities are current Federal Reserve Governor Lael Brainard for Treasury Secretary and the possibility of replacing Powell with Atlanta Federal Reserve President Raphael Bostic. I am not really thrilled with the latter possibility. Not about Bostic being Fed Chair but that Powell would conceivably be replaced. I would rather return to the bipartisan tradition of re-nominating the existing Fed chair that was broken when Trump did not renew Janet Yellen.

Bottom Line: Biden might have been dealt something of a lucky hand with respect to the economy. As a general rule, it is much better to have the recession at the front end of your administration than the back end. Even though he will likely face a recalcitrant Senate, do not mistake the current situation for the last recovery. A vast stockpile of savings is sitting in the background to fuel the economy next year, giving Biden a massive economic tailwind. Moreover, there was nothing wrong with the economy at the beginning of the year; there were no structural problems that needed to be fixed. Biden also has the opportunity to ride the downside of the current Covid-19 surge and the upside of the coming vaccine. And he has a Fed that has already committed to holding rates zero; President Obama had a Fed that was always looking to unwind. Looking past the current Covid-surge, there is a lot to like here.

The U.S. presidential election has not been the swift victory anticipated for Democratic candidate Joe Biden as the race remains tight at the end of Wednesday. Biden has a path to victory with the trend in Pennsylvania indicating he will take the state and its 20 electoral votes.  Biden may even pull out a close win in Georgia as the counting of the final ballots in the Atlanta area are overwhelmingly in his favor. It is not yet certain but it appears likely that Biden will be the next president in a very divided country and government. So far, the Democrats have not been able to retake the Senate and the path to that outcome looks narrow, hinging on the possibility that Georgia will have runoff elections for both Senate seats.

Both stocks and bonds are rallying at the prospect of divided government; the S&P500 rebounded to 3443, just shy of the October 23 level, while the 10-year Treasury rate has slipped to 0.742%, down from a high of 0.916% on Tuesday. The logic here appears to be that divided government under a “normal” president will deliver more consistent economic policies at the executive level but will lack the ability to legislate large changes in tax and spending policy and produce a smaller Covid-19 support package. Steady albeit slower growth than optimal with less issuance of debt and longer zero rate policy from the Fed. We will see.

The ISM manufacturing data was solid with the employment component edging above 50:

The ISM services data however indicated some softening in employment:

This was consistent with the ISH/Markit report which although showed the strongest growth in services since April 2015, said this about employment:

Meanwhile, greater new order inflows encouraged companies to increase their workforce numbers in October. Employment growth nevertheless softened to a three-month low amid some reports of fewer requirements due to excess capacity.

Signs of softer job growth were consistent with the ADP report and its private payroll gain of 365k, much weaker than expectations of 643k. This bodes poorly with for 700k private gain expected for the upcoming employment report for October although the ADP report has been known to be a volatile predicter of the actual jobs numbers.

The Fed concludes its meeting Thursday. No policy change is expected as the Fed appears to lack consensus on next steps. I doubt they want to make news this week anyways. Federal Reserve Chair Jerome Powell will continue to sound the alarm on rising Covid cases and the importance of fiscal policy. He might show relief that the data remains firm so far but won’t want to say anything that gives the impression the Fed will hike rates sooner than anticipated.

Bottom Line: The election is still up in the air, the U.S. economy is still expanding although look for the expansion to settle into a subpar pace of job growth until the pandemic is contained, and the Fed remains committed to holding rates near zero until something interesting happens with inflation.

It’s election week in the U.S. and the whole world is watching. Democratic presidential candidate Joe Biden is anticipated to win. The polls suggest a decisive victory outside the margins that vote tampering is likely to be successful but obviously 2016 opens up the possibility that Trump wins. Assuming Biden wins, he will inherit an economy navigating a pandemic while still struggling to recover from last spring’s shutdowns.

If the Democrats carry the Senate, we should expect another round of substantial fiscal support out of Washington. If the Republicans hold the Senate, they will look to weaken a Biden presidency with all tools available including more paltry fiscal support. In either case, the early days of a Biden administration will be spent trying to mitigate the damage the current President Donald Trump will cause in his remaining months in power.

As anticipated, output rebounded sharply in the third quarter as GDP grew at a 33.1% pace. As also anticipated, this number is misleading as it hides the extent of the damage from the pandemic. Output is 2.9% below last year’s levels. Assuming the potential growth is around 2%, the true shortfall is closer to 5%. Not great, but not exactly a depression either.

Of course, growth will slow markedly in the fourth quarter. This isn’t rocket science. You can dress it up anyway you want, but the fact that the economy collapses if you close it down and surges after you open it back up isn’t particularly revealing. The pace of growth will obviously decline to something more toward normal after the initial stop-start dynamics have played out. Interestingly, the quarter ended with more momentum than anticipated. Consumer spending grew 1.2% in September, up from 0.7% in August:

Remarkably, the saving rate declined just a notch, falling to 14.3% from 14.8%. Even two months after enhanced unemployment benefits ended, the saving rate remains very high. That stockpile of pent-up demand just keeps growing:

In aggregate, the decline in spending still tracks the decline in income less transfer payments:

If spending is tracking income growth excluding transfer payments, that spending growth can be maintained as long as jobs growth continues. The explains why the economy can still grow without more fiscal support. Fiscal support is then not absolutely necessary for growth but there remains a powerful justification for support in hastening the recovery and alleviating the unequal impacts of the recession.

The pandemic remains the chief impediment to healing the economy. The services sector cannot fully recover until people are confident they can return to crowded venues. Until services can heal, demand will continue to be pushed into goods spending:

This will be unraveled at some point in the future. There will be an explosion in leisure and hospitality spending next year, assuming of course a vaccine and sufficient uptake of a vaccine.

Inflation remains muted:

If inflation settles into a 2% trend, the Fed isn’t raising interest rates for a long, long time.

Another sign that the quarter finished on a strong note was another gain in new orders for core capital goods:

An unexpectedly solid V-shaped rebound. As far as October is concerned, the Weekly Leading Index suggest the economy still has upward momentum:

The impact of the latest Covid surge remains a risk in the outlook. Europe has responded with a fresh round of national lockdowns despite the economic damage they will cause. The narrative that Europe will outperform the U.S. in virus control and have a stronger economic rebound looks to have fallen apart. I still don’t anticipate a nationwide lockdown for the U.S. Regional variations in the level of restrictions are more likely. I don’t think another nationwide lockdown has political support in the U.S. nor do I think a Covid-fatigued population will easily resist the pull of the holiday season regardless of government decrees. I do think heavily impacted regions will experience fresh weakness in services spending, something that was almost inevitable as winter arrives and the opportunities for outdoor dining in particular dwindle in much of the nation. I expect a long, hard winter.

The Federal Reserve meets this week. I don’t expect any substantial change in the statement other than to update the FOMC’s view of the economy; the recent surge in Covid cases will weigh on the minds of meeting participants. There isn’t a pressing need to adjust policy just days after a contentious election nor has there been a consensus reached about the next steps for policy. In the press conference, Powell will likely continue to identify the path of fiscal policy and Covid as the important factors in the forecast.

I sense it will be a struggle to pay attention to the data this week. It is though the first week of the month and that brings ISM and Markit surveys, ADP employment, the usual jobless claims report on Thursday, and, to cap off the week we get the employment report for October. The key issue is obvious. We are looking to the data for signs of how much momentum remains in the economy going into the final quarter of the year.  

Good luck and stay safe!

The U.S. housing market continues to steam along on the back of demographic trends and low interest rates. Single family starts rose in September, compensating for a decline in multi-family:

The primary support for this market is Millennials aging into their home buying years; the pandemic and low rates are just pushing the marginal buyers over the edge. Existing home sales also moved sharply higher:

Remember that even existing home sales create a downstream impact on durable goods consumption and residential investment (remodeling). With inventory tight (just 2.7 months of supply), prices continue to climb, up 14.8% over last year:

Household wealth will continue to rise. Speaking of tight markets, the Wall Street Journal has a fun story on the crazy contingencies in housing contracts now occurring:

In central Oregon, real-estate agent Chris Sperry has also played peacemaker. Ms. Sperry represented a buyer and seller in a transaction where the buyer insisted she wanted the seller’s cat along with the house. The seller balked.

“It really got into a heated argument on both sides,” she says. The seller finally agreed to leave her cat, and Ms. Sperry bought her a replacement kitten.

This week we get the third quarter GDP report. Expectations are high with Wall Street expecting a 31.9% gain and the Atlanta Fed expecting 35.2%. I am not inclined to agonize over the exact number as it is all too easy to lose sight of the forest for the trees. The wild swing in the data tell us that U.S. economy shut down in the second quarter and reopened in the third. This isn’t new information. The rebound in activity will still leave the economy operating below pre-pandemic levels. Part of this can’t be helped due to the nature of the pandemic, another part is self-inflicted due to lack of preparation on issues like opening schools. Presumably the latter could still be addressed but won’t be until (hopefully) after the election. We know this story at this point.

We have already turned the page on the third quarter. What we really care about is the pattern of recovery going forward as the after-effects of the start-stop dynamics play themselves out. Can the economy sustain upward momentum? Is the recovery self-sustaining even without additional fiscal stimulus? To get at those questions we need to start thinking about the October data.

One metric that has traditionally tracked year-over-year trends in GDP growth fairly well is the New York Fed’s Weekly Economic Index (WEI):

I tend to care about the year-over-year GDP trends more than the quarterly growth rates; the latter are subject to excessive noise that can overwhelm the underlying signal. The WEI regained its momentum in October. This is important for two reasons. First, it indicates that the general upward trend in the economy continues into the fourth quarter. Second, note that the index accelerated in October despite now going on the third full month since the end of enhanced unemployment benefits in July. This suggests that the expansion remains resilient to the reduction in fiscal support.

Similarly, the IHS/Markit PMI flash report for October indicates that the fourth quarter is getting off to a solid start:

U.S. output growth regained growth momentum in October, as business activity rose at the fastest rate for 20 months and business optimism improved markedly. The upturn was largely driven by service providers, though manufacturing firms also reported a further solid increase in production.

That said, watch for another trend: Slower job growth:

Reflecting softer pressure on capacity, firms increased their workforce numbers at a slower pace in October. The rate of employment growth was faster than the series average, but dipped to a three-month low…

… manufacturers registered a slower rise in employment in October. Some firms, however, stated that difficulties finding suitable candidates weighed on their ability to hire.

I am not going to start in on the lack of suitable candidates; from such random comments I can’t tell you what is firm specific, industry specific, a broader structural issue, or just a firm looking for a “unicorn” employee. I need more information. The slower job growth though is relevant and matches this from Ernie Tedeschi:

Meanwhile, my attempt to forecast payroll employment with UI claims as well as data from Homebase and Kronos suggests employment rose by +1.1 million in October not-seasonally-adjusted. That’s consistent with the HPS. That should be consistent with ~+360K seasonally-adjusted https://t.co/FDnQKPCCfV pic.twitter.com/mNK6oLiDHG

— Ernie Tedeschi (@ernietedeschi) October 23, 2020

The September job growth number was 661k overall, 877k private. The slowdown in job growth would be consistent with a baseline expectation that this recovery follows the patterns of recent cycles in which job growth settles into a pace that closer to 200k/monthly until the economy can be freed from the pandemic.

I find this particular interesting in light of the fiscal support to households this year. I am still in shock by the magnitude of the support:

My prior was that a fiscal shock of that magnitude would have had much longer legs; I would not have anticipated the dramatic accumulation of savings given the initial severity of the downturn. Seems like that prior was just wrong. This suggests to me that the support was not particularly well targeted (I would prefer state and local aid over tax rebates). That’s fine, we were faced with a unique event deserving of the kitchen sink. But the lack of effective targeting would explain why the economy seems to have weathered the July fiscal cliff.

And then there is the next big question. How well we weather the surge in Covid-19 cases?  There is no national leadership at this point. A new cluster of cases has been reported in the orbit of Vice President Mike Pence, the supposed head of the coronavirus task force. White House Chief of Staff Mark Meadows admitted the administration is no longer trying to contain the virus (my belief is the Trump administration is just hoping to leave Biden with as big a mess as possible). Cases are surging across the Midwest. Utah hospitals are close to rationing care. Europe is careening out of control. Remember when Europe was the model? Good times. Even China has a fresh outbreak.

In the U.S., the lack of national leadership suggests a national lockdown is unlikely; I anticipated rolling increases and decreases in the level of restrictions on a local level. I doubt indiscriminate lockdowns are politically feasible, especially for a population struggling with virus fatigue. My experience is that the fatigue cuts across political lines at this point.

We have a busy week ahead, even before the already mentioned GDP report on Thursday. Monday we get another reading on the housing market with new home sales for September; expectations are for 1,025k compared to 1,011k the previous month. Durable goods orders come on Tuesday; to date, core manufacturing orders have exceeded expectations and are expected to be up another 0.5% in September. Note that that the series has considerable monthly volatility; keep focused on the underlying trend. Friday we get some follow up to the GDP report with the September income and outlays report which also contains PCE inflation for the month. Also arriving is the employment cost index for the third quarter and the final Michigan consumer sentiment numbers. Blackout week for the Fed.

That’s it for this morning. Good luck and stay safe!

Monday I promised some detail on the shift of spending from services to goods. Via Bloomberg:

In the world of investing, self-storage properties are about as bland as it gets. Then again, U.S. consumers are going to need a place to store the mountains of stuff they bought during the pandemic. Retail sales soared 1.9% in September, more than doubling analysts’ estimates of a 0.8% gain. The surge came despite the end of enhanced unemployment benefits at the end of July. Although concern is rising that the absence of a new fiscal aid package will cause retail sales to falter, such worries give too much importance to fiscal aid in supporting retail sales and not enough importance to the changing composition of household spending.

The point is to not confuse retail sales with overall spending. The services sector captured in overall spending is larger than the goods sector. Overall spending is down in line with incomes less transfer payments, but the shift from services to goods boosted retail sales. I wouldn’t be surprised by a blowout holiday season for retailers not because the economy is great but because you can’t travel.

Separately, Federal Reserve Governor Lael Brainard spoke Wednesday. The theme:

Further targeted fiscal support will be needed alongside accommodative monetary policy to turn this K-shaped recovery into a broad-based and inclusive recovery.

This is a good sentence that I think highlights a key split in the commentary. One segment, of which I am a member, tends to emphasize that the recovery is likely self-sustaining at this point. Moreover, I argue that there is substantial upside risk in 2021 given the large stock of accumulated savings and the possibility or even likelihood of a vaccine. I don’t think we suffer through another nationwide shutdown as occurred this past spring even in the event of a surge in Covid-19 cases; more targeted and rolling shutdowns will be more likely. Overall, the economy will continue to grow around the virus.

Another segment of the commentary emphasizes the need for additional fiscal stimulus. This often sounds as if the recovery will reverse in the absence of that stimulus, an increasingly difficult position to hold given that the enhanced unemployment benefits ended in July yet the economy has not nosedived. Brainard gets it right though. The real risk from a lack of fiscal stimulus is not so much that the economy can’t recover but that the recovery will more likely be neither broad-based nor inclusive and thus slower than optimal.

Brainard on the recovery:

Targeted interventions, along with adaptations in the behavior of households and businesses, have enabled economic activity to recover. All told, after an unprecedented contraction in the first half of the year, U.S. gross domestic product appears likely to have reversed more than one-half of that decline in the third quarter.

I don’t think this is entirely accurate. What enabled the economy to recovery was reopening the economy. Fiscal policy helped, but it helped because it could help, because the economy began to reopen. There is only so much fiscal policy can do if you can’t open the doors.

More Brainard:

Overall, total consumer expenditures in the United States have recovered about three-fourths of their spring decline through August.

Yes this. Don’t be fooled by retail sales into thinking that consumer spending has recovered. Brainard is correct. This though needs some clarity:

Interest-sensitive sectors such as residential real estate and autos have rebounded strongly—a welcome reminder of the power of monetary accommodation, especially when coupled with necessary fiscal support.

Interest rates on auto loans are down just a notch, just 47 bps since January. And lower rates in housing help, but fundamentally the demographics are driving the train there. I think this points to some fundamental tailwinds the economy has now that it didn’t have in 2009 and that those tailwinds are not widely appreciated.

Brainard acknowledges easy credit conditions for large firms while seeing the core of the problem in lending markets:

Small businesses tend to be concentrated in sectors that entail high direct contact, operate with relatively tight cash buffers, and rely on bank credit rather market-based finance.

The key is “high-direct contact.” With the pandemic, many of those firms simply can’t get customers and if you can’t get enough customers you can’t get a bank loan. Brainard also highlights the particular challenges for minority-owned small businesses. She then proceeds through a discussion of the unevenness of the labor market. This is I think the most important long-term problem:

The recent decline in prime-age labor force participation has been due primarily to women. September marks the third consecutive monthly decline in the prime-age female LFPR since it bounced back in May and June. The decline in September, when many schools moved to virtual instruction, was especially pronounced for women ages 35 to 44. Indeed, the fraction of prime-age respondents to the Current Population Survey in September with children ages 6 to 17 who reported being out of the labor force for caregiving reasons was about 14 percent, up nearly 2 percentage points from a year earlier.⁵ If not soon reversed, the decline in the participation rate for prime‑age women could have longer-term implications for household incomes and potential growth.

I think we probably need some aggressive government intervention to revive the child care market to sustain the labor force participation of women. Getting a vaccine and K-12 schools open next fall thought would help too obviously. Brainard harkens back to the good old days of really just 9 months ago:

In the years before the pandemic, I was encouraged to see prime-age individuals in all demographic groups drawn into the strong labor market, reversing the previous decline in participation and boosting the productive capacity of the economy.

And then lays out what will happen if we can’t reverse current trends:

Persistent spells out of employment risk harming not only the prospects of these individuals, but also the economy’s potential growth rate.

We are in an uncomfortable situation. The more we pump up the economy, the more we shift the structure of the economy away from the services we will want next year. Next year then we will have to restructure the economy again. We can use more targeted aid to support those services now, but the resulting spending will still pump up the wrong sector of the economy. Getting this right might not be as easy as it seems. The key is targeted support:

The recovery will be broader based, stronger, and faster if monetary policy and fiscal policy both provide continued support to the economy. While monetary policy has helped keep credit available and borrowing costs low, fiscal policy has replaced lost incomes among households experiencing layoffs and businesses and states and localities suffering temporary drops in revenue.

The first round of stimulus was fairly broad-based with the tax rebates and PPP lending. A more targeted approach would be preferable in the next round to minimize remaking the economy in a direction we would won’t demand next year.

Brainard discusses the Fed’s new policy framework and concludes rates will be near-zero for a long time, which isn’t exactly news. This though is interesting:

In conjunction with the forward guidance on the policy rate, the commitment to continue asset purchases at least at the current pace over coming months is also helping to achieve our goals by keeping borrowing costs low for households and businesses along the yield curve. As noted in the September FOMC minutes, in the months ahead, we will have the opportunity to deliberate and to clarify how the asset purchase program could best work in combination with forward guidance to support achievement of maximum employment and 2 percent average inflation.

The Fed has committed to holding rates at zero until actual inflation is sustainably at 2% but has made no such similar commitment with asset purchases. Here she suggests that such guidance will not be coming anytime soon.

Bottom Line: We can believe both that the economic recovery will continue and that the recovery would greatly benefit from targeted fiscal stimulus.

September retail sales came in stronger than expected as the headline number pulled above pre-pandemic trend:

Core sales were down a notch but remain solidly above trend:

Food and drinking even gained although it still remains depressed:

Aggregate retail sales continued to gain in September despite now two months after the end of enhanced unemployment benefits at the end of July (otherwise known as the fiscal cliff that wasn’t; hey, I am as surprised as anyone else). I know this is going to be an unpopular opinion, but the fiscal stimulus may have been less important for retail sales than widely assumed. What we see inside the retail numbers – the shift in spending away from the services component – has happened in the economy overall. Spending on goods has remained strong largely because households were unable to spend on their typical basket of services and that extra money had to go somewhere. I will have more on that topic later this week.

The fiscal support was not unimportant, it was just important in different ways than expected. Consider this interesting story from the Wall Street Journal:

While the coronavirus was pummeling the U.S. economy, Americans’ credit scores—a metric used in nearly every consumer-lending decision—were rising. The average FICO credit score stood at 711 in July, up from 708 in April and 706 a year earlier, according to Fair Isaac Corp. , the score’s creator. Early estimates suggest the average score has held steady through mid-October at the July level, which is the highest since FICO began keeping track in 2005.

Surveys tells us the the vast majority of aid boosted household wealth via either direct savings or indirect savings (paying off debt). There is no question that this has bolstered the financial conditions of millions of Americans. Nor should there be any question that there exists a stockpile of spending power that will come into the economy when confidence improves.

Confidence is actually already improving, at least a little. The early October reading from the University of Michigan saw confidence edge up 80.4 to 81.2 as a gain in the expectations measure outweighed a loss in current conditions. Overall confidence remains well below its pre-pandemic levels but we should take comfort in the recent firming. We might haver expected by October confidence was collapsing due to the July fiscal cliff.

Disappointingly, industrial production edged down in September:

in part because auto production slowed a bit the strong post-lockdown rebound:

Still, even excluding autos manufacturing was flat on the month. I think a larger issue is that the recovery has been consumer-driven and on goods not services. Spending on consumer goods tends to be disproportionally off-shored to foreign producers. Hence we would expect the trade balance to widen, which is has (in stark contrast to the last recession):

The data highlights of this week will be housing starts and permits for September on Tuesday ad existing home sales on Thursday. Housing has been a supernova-sized bright spot in the economy; how much of the upward momentum can be sustained is an open question as builders will avoid overbuilding to maintain profit margins. Substantial retrenchment however is unlikely given the strong underlying demographic factors supporting housing demand. Also this week we get the Markit PMI numbers (Friday). There are a slew of Fed speakers this week. Most notable will be Federal Reserve Chair Jerome Powell on Monday (Cross-Border Payments and Digital Currencies), Vice Chair Richard Clarida also on Monday (U.S. Economic Outlook and Monetary Policy, which looks like a repeat from last week), and Governor Lael Brainard (Economic and Monetary Policy Outlook). From a macroeconomic perspective the Brainard speech seems the most likely to bring new information to the table. There are some presidents speaking (Williams, Mester, Harker) but the presidents speak a lot and often add little value but lots of color. That’s a little honesty to start your week.

Good luck and stay safe!