Goodbye K-Shaped Recovery, Hello V-Shaped

Summary

• Both the headline and details of Friday’s NFP data suggest economic normalization has started.
• Normalization is driven by re-openings and the disbursement of fiscal support, that are set to pick up pace and bring about a strong, non inflationary recovery.

Market Implications

• Positive equities, negative bonds, positive dollar.

Friday’s NFP likely mark the onset of a noninflationary, V-shaped recovery. At 379,000 against less than 200,000 expected, Friday’s bumper non-farm payrolls (NFP) number probably signals the start of economic normalization. The sectors that the pandemic has hit hardest, leisure and hospitality, accounted for most of the increase. The weak employment recovery in these sectors is largely responsible for what has been a K-shaped economic recovery until now.

Also, February hourly earnings were flat despite the bumper increase in NFP – another sign of normalization. Wages in leisure and hospitality tend to be lower than in other sectors. Consequently, the March-April spike in unemployment was accompanied by a spike in wage growth that reflected a compositional effect, i.e., a decrease in low-wage employment, rather than labour market tightness. The reversal of this compositional effect in February is another sign that labour market conditions are returning to normal.

Furthermore, workers on temporary layoff fell by 500,000 in February, also indicating normalization (Chart 1). While temporarily laid-off workers did not increase during the GFC, this time around they rose to 16mn in April, out of 23mn total unemployed. The decline in temporary layoffs signals that firms are rehiring their pre-pandemic workers, a necessary step before expanding their workforce beyond pre-pandemic levels.

In addition, hours worked fell by the most since the beginning of the pandemic. This is also signals normalization due to the recession’s unusual nature. In a typical recession, employment and hours worked fall as firms try to minimize layoffs and reduce costs through lighter work schedules.

By contrast, this time, while temporarily laying off an unprecedented number of workers, firms also increased the hours that remaining employees worked. This unusual reaction could reflect the unprecedented intensity of the demand collapse and employers’ concerns that they might be unable to survive without exceptional measures. That said, employers may have expected the pandemic-induced mandatory closings meant demand weaknesses would be more temporary than during typical downturns. The combination of fewer workers on temporary layoffs and fewer hours worked could reflect that firms are exiting survival mode and starting to plan for the recovery.

This month’s high NFP number probably reflects a combination of the December stimulus percolating to the economy as well as states reopening. Both are likely to gather pace.

With the Senate passing President Joe Biden’s $1.9tn plan over the weekend, it is likely to become law by the end of the week. The plan will bring the budget deficit to about 15% of GDP for the second year in a row, against a CBO-estimated output gap of around 3% at end-2020.

In addition, the most powerful stimulus of all, re-openings, is only just getting underway. Texas and Mississippi have removed restrictions on businesses; other states will likely follow, if more gradually. This reflects several factors. Immunizations are rising fast: the US has administered 92mn vaccine doses so far. The administration has now secured enough vaccines to immunize the whole population by end-May. Lastly, lower death rates and hospitalizations show medical treatment has improved.

And most importantly, it has become difficult to ignore the evidence that heavy-handed responses such as lockdowns have failed to secure tangible benefits. Excess mortality (a measure of COVID incidence biased by neither testing nor death attribution methodologies) shows no difference between blue and red states, even though the latter have adopted lighter and better-targeted responses to the pandemic (Chart 2). By contrast, unemployment has increased by twice as much in blue than red states. With the mid-term elections only 20 months away, and with voters unhappy about government restrictions, the pressure is on to take advantage of medical progresses and reopen economies.

Reopening is the most important factor in moving from a K- to a V-shaped recovery, since the economy has seen no destruction of productive capacity nor major balance sheet damage. Reopenings will allow households and firms to spend the government stimulus and their accumulated savings. With the large pool of unemployed people, finding workers will be no constraint for firms. Therefore, employment increases, as well as the ongoing reopenings, imply increases in both the demand and supply sides of the economy, i.e. a noninflationary, V-shaped recovery.

Noninflationary growth is the most supportive macro environment for equities. Friday’s NFP therefore support more upside to equities, as well as to yields, though consolidation following the recent volatility could dampen a short-term yield move. Also, with the US one of the first countries to emerge from the crisis and one of the more generous with fiscal spending, Friday’s NFP also support a stronger dollar.