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With Ellen Zentner

SEP 8, 2021

Welcome to Thoughts on the Market, I’m Ellen Zentner, Chief U.S. Economist for Morgan Stanley Research. Along with my colleagues bringing you a variety of perspectives, I’ll be talking about third quarter GDP growth in the U.S. and the impact on Fed tapering. It’s Wednesday, September 8th, at noon in New York.

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So last week pulled no punches by delivering some surprisingly weak U.S. economic data. First, motor vehicle sales in August missed significantly to the downside, with a fourth consecutive monthly decline. And on Friday, August payrolls were reported at a disappointing 235k versus our expectation for 725k. And finally, our recent August Retail Sales Tracker forecasted another large decline. So, the bottom line is data in line with our expectation puts third quarter consumption in contraction at -0.6%. Our third quarter GDP tracking ended last week at just 3.4% – sharply lower compared with just one week ago.

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All of this data likely raises concerns that a growth scare is underway in the U.S. And at first blush, the sharp markdown to our third quarter growth estimates would seemingly support that view. For analysts, strategists and financial markets, it’s the second derivative that matters, and that is: is the pace of growth slowing or quickening? But for economists and monetary policymakers, it’s the first derivative: is growth positive or negative? Growth is still positive, even with our sharp markdowns. And so, the expansion continues to progress, just at a slower pace.

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Now, we also believe that August is the month when we think productivity slowed the most, which will be reflected in the data reported throughout the month of September. First, our motor vehicle analysts believe the slowdown in sales has run its course. And second, the slowdown in jobs also looks to be temporary. And almost all of the miss could be attributed to the education and leisure & hospitality sectors – indicating to us that job growth is still likely to bounce back in the months ahead.

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Delta left an ugly mark in August, weighing on household sentiment, spending, job searches and hiring plans. Friday’s employment report also revealed that in August the number of workers who were unable to work because of covid increased by 400k. Our BioTech analysts believe that the Delta wave in the U.S. has already peaked. As cases begin to decline, so too should the number of folks reporting covid as an impediment.

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So moving forward, we believe the Fed is unlikely to blink at the stark markdown to third quarter GDP growth that we just published last week. For the Fed, the jobs miss may certainly come as a disappointment going into the September FOMC meeting, but focus will remain on the September and October employment reports as the most important prints to watch, both to confirm an expected inflection in labor supply, but also now to judge the extent to which the apparently covid related slowdown in leisure & hospitality hiring is, indeed, temporary.

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For the outlook for tapering, we take the data and the Fed’s maximum employment focus as lining up for our call for a December taper announcement. November has become less likely, especially as there’s only one more employment data print before the November FOMC meeting. And we think we would need to see that report notably outperform – and ideally with upward back revisions – in order to have more evidence of reaching the ‘substantial further progress test’ on labor. In other words, for the Fed, keep calm and taper on.