Back in 2020, we outlined four key milestones that needed to be achieved before the economy could fully bounce back from the pandemic: provide swift fiscal and monetary support, bend the virus curve, adapt business to remain “open” amid COVID-19, and develop and distribute an effective vaccine.

From our perspective, all four milestones have largely been achieved. No doubt, the coronavirus is still flaring up in parts of the country, and it’s too early to claim total victory yet. However, we believe the environment has shifted to such a degree that it’s time to change the lens through which we view the path forward. For us, that means getting back to a more traditional economic framework to assess the health of markets and the economy.

In a nutshell, markets will be keying in on data that historically reveal our position in the business cycle. Inflation, unemployment, productivity, interest rates and the Federal Reserve will all be key players in this analysis. Markets, for example, will be laser-focused on the Federal Reserve’s tolerance for inflation and other indicators of an economy that’s running “hot.” Traditionally, business cycles mature and come to an end once the Fed tightens too aggressively and raises the cost of money, which dampens growth in the economy.

In our view, the Fed will be willing to let inflation run higher for some time while focusing on achieving full employment — its second primary mandate. And, even if there is a policy shift, that doesn’t mean the Fed would be moving too aggressively. We could see the Fed remove supports or address inflation sometime in the future, but that doesn’t necessarily mean growth would suffer. Regardless, the Fed and the business cycle will be the lens in this commentary through which we view data for the months ahead.

WALL STREET WRAP

Unemployment Report: Headlines highlighted that “only” 559,000 jobs were added, which is below the estimate of 675,000. The unemployment rate ticked down to 5.8 from 6.1 percent, but much of that was driven by people who dropped from the labor force. The labor market is likely being restrained by enhanced unemployment benefits, along with health concerns and childcare. In contrast, job openings are near record highs.

There is a silver lining here from a purely markets angle: a slight deceleration in job growth likely means the Fed won’t be eager to tighten economic conditions any time soon.

Evidence of a Continued Upswing: The ISM Manufacturing index rose to 61.2 in May versus 60.7 the month prior, marking a continued upswing. New orders increased to 67 (versus 64.3), which is just off the highest reading of 68 back in March. You’d have to go back to 1983 to get a higher reading, and this stands among the highest since the 1940s. Order backlogs were the highest ever — though this data point only goes back to 1993. Finally, customer inventories are their lowest ever (data going back to 1997). ISM Services were a similar story, rising to 64 from 62.7 — a record going back to 1997. New orders reached 63.9, up from 63.2, and backlogs were at 61.1 versus 55.7 —the highest level ever in this survey.

All together, these are great signals of future growth. Inventories are low, and demand is high enough to justify replenishing products and even expanding capabilities to meet demand. There’s a lot of production and labor needed to whittle away at these record backlogs, and that means hiring and growth is on the way.

Watching the Eurozone: We think it’ll be prudent to track progress in the eurozone over the intermediate term. For the first time, EU countries are working in a coordinated fashion to bolster their economies with a massive, U.S.-style stimulus package. And, while the eurozone lagged the U.S. in its vaccine rollout, it’s catching up, and cities throughout the region are again opening up for business.

We think a wave of economies reopening, along with stimulus, will provide a catalyst for the eurozone in the year ahead.

THE WEEK AHEAD

Small Business Labor Challenge: One of the ongoing storylines so far in 2021 is the divide between the number of people out of work and the number of job openings. Small employers are having a more difficult time attracting labor, and that’s something the NFIB Index will certainly measure. According to NFIB's monthly jobs report, a record 48 percent of small businesses had job openings. There’s a lot of work out there, but there’s a lot of trouble finding people to fill openings. We expect this is going to change, as states have moved to pull back enhanced unemployment benefits months before they expire across the country in September.

We’ll keep an eye on that this week to see how businesses are doing.

Inflation in the Crosshairs: The headline CPI number turned heads in April, rising 0.8 percent, which handily exceeded expectations for a 0.2 percent gain. While a notable uptick, it was driven by a few products categories and not broad based. We can reasonably expect some fits and starts in the numbers as the economy kicks back into gear.

Demand is kicking in faster than supply can keep up for now, and we’re seeing impacts of that imbalance ripple through the economy like train cars clanking and snapping into motion one after another down the line. Eventually, all the train cars get moving together, and that’s precisely the market’s hope for the rise in prices we’re seeing — they are temporary side effects of an economy jolting into action. We think supply catches up to demand in the coming months.

Euro GDP and the Fed: A quick note — we’ll also be keeping an eye on GDP reads in the eurozone, and the Federal Reserve meets this week. As always, comments about the economy will be parsed and studied, but we also might hear more about the Fed’s preliminary study of a digital dollar.

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