12/2020 Unemployment, Fed Funds, Bond Spreads

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12/2020 Unemployment, Fed Funds, Bond Spreads

One long-form analysis today and two brief updates:

#1: The US economy had 20.5 million fewer jobs in April 2020 due to COVID-19 shutdowns across public and private sector positions; how many will return between now and December 2020? We believe that is the question capital markets care most about just now.

Three points to frame an answer:

First, while the 20.5 million positions lost from the Establishment Survey (i.e. what businesses report) is important, the Household Survey has some useful data as well:

  • The number of employed Americans shrank by 22.4 million people last month.
  • But… 6.4 million of those individuals now count themselves as outside the workforce – neither working nor looking for work. Put another way, the US labor force participation rate is now 60.2%, the lowest level since women started entering the workforce in the early 1970s. How permanent that shift is a key question.
  • Looking at labor force participation by education attainment, we see that virtually the entire decline (92%) in the US labor force came from workers without a 4-year college degree. This cohort will face the most severe challenges in finding new employment if their prior employer does not rehire them.

Takeaway: December 2020’s US workforce could be 5-6 million people smaller than Q1’s 164 million count, and May/June/July’s data could see that number expand further. These may seem like small differences, but as we consider how many of the 20.5 million jobs “come back” and what that does to the unemployment rate calculation, they become very important.

Second, let’s look at the composition of April’s job losses by major categories and consider how many might return by December 2020. While April’s count is an imperfect proxy since the survey week was in the middle of the month, it’s the data we have for now and is broadly representative. Nonetheless, we make some adjustments here as needed:

  • The Leisure and Hospitality industries make up 10% of the US workforce, and the 7.7 million positions lost in April was 38% of total incremental unemployment last month. Most of these losses were in restaurants, bars and clubs (5.5 million fewer jobs).

    This is, in short, the most important industry when considering where December’s US unemployment rate may be since it will be informed by state/local physical distancing guidelines.

    Assuming this industry is running at 60% capacity in December 2020, there would still be 6.5 million unemployed Americans here assuming they do not find employment elsewhere or drop out of the labor force entirely.
  • Retail trade is another area to watch, with 2.1 million positions lost in April, over half (1.2 million) in clothing/furniture stores. May 2020 will likely see further losses, so we will assume 2.5 million jobs at least temporarily lost.

    December is peak retail employment but given the move to online shopping we estimate that this sector will still have 825,000 unemployed workers (a third of those currently out of work) at year end.
  • The last high-delta groups are a collection of cyclical industries. Manufacturing lost 1.3 million jobs last month as factories shut down. The number of construction jobs fell by 975,000.

    If 70% those jobs come back by December 2020, there would still be 683,000 unemployed workers.
  • On a brighter note, there are many industries with outsized job losses in April that could make a decent recovery by year end.

    Education and health services saw 2.5 million fewer jobs last month as dental and physicians’ offices closed, along with day care centers, private schools and other social services. Most/all of these should reopen with relatively minimal job losses.

    Professional and business services lost 2.1 million jobs in April, mostly from reduced temp work (842,000). As employers tiptoe back to “normal”, we suspect their use of temp workers will increase dramatically.

    Government employment fell by 980,000 in April, mostly from school closures. These should, in large part, return by December 2020.

The bottom line here: between just Leisure/Hospitality, Retail, Manufacturing and Construction there will be 8 million unemployed Americans in December 2020, or 5 points of unemployment on top of the 3-4% we had at the start of the COVID Crisis. Add in another 2-3 points from the sectors we assume will be quicker to return and you get a range of 10% – 12%.

The wild card, of course, has just as much to do with how many Americans exit the labor force entirely. The irony here: a higher unemployment rate in December 2020 could actually be a better sign than a lower one. The long-term risk to the US economy is not just joblessness. It is also the hopelessness workers will feel after +6 months of being without work.

Wrapping up quickly with two separate topics we’ve been tracking for you:

#1: Fed Funds Futures are still wobbling around their recent forecast of negative interest rates:

  • As of Friday’s closing prices they no longer expect the Fed to take rates negative this year. December’s contract price forecasts a +4 basis point rate.
  • Futures now place lower odds on negative rates in 2021, peaking out at a 6% probability in June/July.
  • Two-year Treasury yields are back to 0.16% from their 0.12% lows last Thursday.

Bottom line here: we’re not out of the woods here, if only because no one we’ve spoken to has a decent explanation for why FFF went negative in the first place. Even if those oddball prints last week were just hedging, who feels the need to hedge something that Chair Powell has essentially said will never happen on his watch?

#2: With the Federal Reserve soon set to start buying corporate bonds, here are the “Before” pictures for investment grade and high yield spreads over Treasuries (last 12 months of data):

Investment Grade Spreads:

High Yield Spreads:

Takeaways:

  • The only question that matters now is “where does the Fed think these spreads SHOULD be?”
  • The market’s best guess is basically halfway between trough (February 19th, the YTD high for stocks) and peak (March 23rd, the YTD lows). The exact levels: 251 bp for investment grade (221 on Friday) and 722 bp for high yield (760 on Friday).
  • These are the asset classes to watch over the next 2 weeks; any sign that the Fed is deliberately pushing spreads lower (or not) will be a boost (or not) for equities – especially US small caps.