Economy

Dear Client, Next week, in lieu of our regular weekly report, I will be hosting two webcasts where I will discuss our view on China’s economy and financial markets. I will also address the topics that our clients are most concerned about, including China’s regulatory developments, inflation, and policy direction. The webcasts will be held on Wednesday, September 22 at 10:00 am EDT (English), and Thursday, September 23 at 9:00 am HKT (Mandarin). I look forward to discussing with you during the webcast. We will return to our regular publishing schedule on Wednesday, September 29. Best regards, Jing Sima, China Strategist Highlights China is facing cyclical inflationary pressures more than disinflationary ones. Prices of mining, raw materials and manufacturing goods have been rising at record rates. Chinese manufacturers are operating at close to full production, which suggests that there is little slack in demand. Despite soft headline readings in consumer prices, the costs of goods and services have rebounded to pre-pandemic levels. Prices for home durable goods, fuel and utilities have surged to multiyear highs. Measures to boost domestic demand will be limited as long as inflationary pressures continue and manufacturers produce at close to full capacity. Near-term policy support will likely focus on reducing costs for manufacturers and improving wage growth for lower-income households. We are initiating a trade: long industrial stocks/short A-shares.  Feature China’s Producer Price index (PPI) registered a 13-year high in August, at the time when the domestic economy continued to slow. On the other hand, consumer prices (CPI) - both headline and core CPI - have been lackluster. The acceleration in producer inflation and the demand dynamics raise the question whether China is in a stagflation, a situation in which prices climb but wages and demand do not follow. Consequentially, economy policy faces a dilemma between boosting demand and containing inflation. Inflationary pressures have been driven by pandemic-related factors and the supply-side constraints will likely continue into Q1 next year. These inflationary pressures, and more importantly, undercurrents in the inflation prints, will constrain Chinese policymakers’ efforts to reflate the economy. The recent rebound in Chinese infrastructure stocks is overdone. Material stocks are also vulnerable to price setbacks. Global commodity prices will soften, although from very elevated levels. Meanwhile, we are initiating a trade: long Chinese industrial stocks relative to the A-share market. Despite falling profit growth in recent months, China’s leadership is increasing its support, both cyclically and structurally, to the manufacturing sector. Inflation Or Deflation? The details in both the PPI and CPI readings indicate that China is facing more inflationary pressures than disinflationary ones. Producers are raising prices across the board. Although consumer prices will likely remain well below the PBoC's 3% inflation target for the year mainly due to low food prices, prices in some of the key consumer goods segments are rising at an alarming pace. The inflationary pressures will continue for producers, at least through the first quarter of 2022. The strength in August’s PPI was concentrated in mining and raw materials (Chart 1, top panel). Robust global demand and tight supply conditions supported high oil and base metals prices, while pushing up coal prices. Chart 1Chinese Mining And Manufacturing Goods Prices Accelerated To Record Highs Chart 2Commodity Prices Held Up Despite A Slowing China We do not expect China’s infrastructure investment growth to pick up and support industrial metal prices. However, this year’s unsynchronized recovery in global demand and severe supply shortages have delayed the global commodity market’s price reaction to slowing Chinese demand (Chart 2). Moreover, as China’s environmental policy remains stringent during the upcoming winter, supply-side constraints from production cuts will partially offset the slowdown in China’s demand for mining and raw materials (Chart 3A and 3B). Chart 3ASupply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Chart 3BSupply-Side Constraints And Chinese Production Cuts Likely To Continue Into Early 2022 Manufacturing goods inflation registered its topmost annual growth since data collection started in 1996 (Chart 1, bottom panel). Moreover, capacity utilization rates in the industrial and manufacturing sectors are at the highest levels since 2007, well above their means (Chart 4). Changes in manufacturing capacity are highly correlated with China’s export growth and tightly linked to PPI (Chart 5). Therefore, manufacturing goods prices will remain lofty as long as external demand stays robust and China’s manufacturers continue to produce near maximum output. Chart 4Chinese Manufacturers Are Producing Near Their Max Capacity Chart 5Robust Exports Have Been Supporting Strong Chinese Manufacturing Output The PPI’s weakest component has been consumer goods, which inched up by a mere 0.3% from a year ago (Chart 6). However, consumer goods only account for 25% of PPI, whereas industrial and manufacturing producer goods are 75%. In addition, the underlying data shows that among the four sub-components in the PPI’s consumer goods, only food prices have remained below their pre-pandemic levels (Chart 7, top panel). Prices in durable goods have rebounded strongly since March last year and clothing and daily sundry articles have recovered to their end-2019 rate of growth (Chart 7, mid and bottom panels).  Chart 6Producer Prices For Consumer Goods Remain Soft... Chart 7...But Food Prices Have Been The Main Drag The PPI’s price forces are consistent with the CPI, in which food has been the main drag. Core CPI, along with prices for consumer goods and services, have returned to pre-pandemic growth rates (Chart 8). Durable goods prices, such as home appliances, increased to a multiyear high in August. Fuel and utilities costs have also risen. This suggests that despite the soft CPI readings, inflation has flowed from producers to Chinese consumers through manufacturing goods. The passthrough will likely intensify into Q4 when domestic COVID-cases have been largely brought under control and the September – October holiday season will boost consumption for both goods and services. Chart 8Prices For Other Consumer Goods Categories Have Recovered Table 1A Look At China’s CPI Basket – Food Dominates We still expect that headline CPI will remain below the PBoC’s 3% inflation target for the year. Consumer durable goods prices are lightly weighted in China’s CPI, therefore, an acceleration in inflation passthroughs in this component is unlikely to significantly push up the CPI aggregates (Table 1). Chart 9Prices For Healthcare And Education Services On A Structural Downshift In addition, there are some structural headwinds that will affect prices in the education and healthcare and medical services components, which together account for about 15% of the CPI. Healthcare prices have been on a policy-driven structural downshift since late 2017 and recent regulatory changes in the education industry will depress pricing power in that sector (Chart 9). Despite sluggish aggregate consumer prices, climbing prices in consumer durable goods, services and particularly, fuel and utilities, will likely force China’s leadership to take action on policy. Bottom Line: Price pressures for Chinese producers remain intense and consumers will feel the heat of escalating prices in durable goods, fuel and utilities. Inflation is threatening domestic demand, which is already slowing from its peak earlier this year. Implications On Policy Response Inflation readings –even though they are lagging economic indicators –bear significant forward-looking market implications because changes in inflation dynamics herald various policy responses. Despite slower economic growth, higher inflation coupled with accommodative monetary and fiscal policies may indicate that the economy is in a “goldilocks” stage and corporate profits can still benefit (Chart 10). Chinese onshore stocks reached record high recently (Chart 11). Chart 10Are Chinese Corporates In A 'Sweet Spot'? Chart 11Accommodative Monetary Conditions Propelled Chinese Stock Prices To Highest Since 2015 However, underlying trends in China’s producer and consumer inflation prints raise the risks that policymakers may not deliver the ingredients needed for a “just right” scenario. Even though China has kept a loose monetary policy that we expect to extend into next year, inflationary pressures may force policymakers to either delay or reduce the magnitude of stimulus. Recent policy moves show that the authorities are focused on reducing input cost burdens and bumping up support for small- and medium-sized enterprises (SMEs), which are highly concentrated in mid- to downstream manufacturing and services sectors. In our view, the recent rhetoric from policymakers further reduces the odds of any broadly based stimulus to boost demand. Our view is based on the following observations: The elevated global input costs and limited price passthroughs to consumers are depressing Chinese manufacturers’ profit margins and incentives to expand production capacity. Despite strong exports and production, manufacturing investment has lagged that in infrastructure and real estate this year (Chart 12). Consumers, particularly lower-income households, are bearing most of the burdens; rising costs and slow wage growth are weakening their propensity to spend (Chart 13). Chart 12Slower Manufacturing Investment Recovery Than Infrastructure And Real Estate So Far This Year Chart 13Slow Wage Growth Limits The Pace Of Consumption Recovery The inflation prints came at the time when China’s top leadership shifted its structural policy goals to reduce income inequality and stabilize manufacturing share in the aggregate economy. The structural goals will likely be reflected in policy responses to the cyclical challenge.  Moreover, this year’s manufacturing production volume was growing twice as fast as producer prices, a reversal from 2017 when price increases outpaced production (Chart 14). Price changes are much more important to corporate profits than volume changes. A strong RMB and sharply escalating shipping costs have also reduced exporters’ pricing power and profits (Chart 15). In contrast, mounting prices across various commodities have allowed the upstream industrial sectors, which are dominated by SOEs, to deliver much stronger profits than the downstream and private sector (Chart 16). Chart 14Growth In Manufacturing Output And Prices Starting To Converge Chart 15Strong RMB And Rising Shipping Costs Have Reduced Chinese Exporters' Profitability   It is unsurprising that authorities are increasing support to the private sector in order to maintain manufacturing share in the economy and keep the export sector competitive (Chart 17). A boost in infrastructure investment, on the other hand, would exacerbate upward pressure on commodity prices and mostly benefit upstream SOEs. Chart 16Upstream Industries Disproportionally Benefited From Surging Commodity Prices Chart 17Private Sector: Lower Profit Margin, Higher Costs Furthermore, stimulating the traditional sectors would not revive household consumption. The subdued recovery in consumption and prices for consumer staple goods is due to slow growth in lower-income household wages and a disrupted recovery in the services sector. Ramping up infrastructure investment can support headline GDP growth, but will do little to provide jobs and wages since China’s private sector provides 80% of all jobs and 90% of annual job creations. Lower-income households have a higher marginal propensity to consume. We expect the government to accelerate fiscal support measures to fortify wages among lower-income households. Bottom Line: Ongoing inflationary pressures and the underlying forces will likely thwart policymakers from stepping up their efforts to stimulate the old economy sectors. Investment Conclusions Chart 18Rebound In Infrastructure Stocks Should Be Short-Lived Chinese onshore stocks in the infrastructure, materials, and industrial sectors recently advanced strongly in the expectation that policymakers will ramp up their fiscal support in the old economy sectors, particularly infrastructure. Although we agree that infrastructure investment will improve, we maintain our view that a sizable rebound is highly unlikely this year. Hence, we do not expect that the rally in infrastructure stocks will be long-lasting (Chart 18).  We are probably too late in the cycle to re-initiate our long material/broad market trade in the onshore and offshore equity markets (Chart 19). We closed the trade in December last year when Chinese policymakers started pulling back stimulus, and in expectations that raw material prices would tumble. However, we underestimated the intensity of China’s de-carbonization efforts and protracted global supply-side constraints. Although global commodity prices will remain elevated into 2022, the price rallies from this year are not sustainable on a cyclical (6- to 12-month) basis. Therefore, we do not recommend material stocks as a cyclical play.  Chart 19Price Rally In Materials Stocks Unlikely To Sustain Chart 20Industrial Stocks May Be On A Structural Upcycle Instead, we recommend a long industrial/broad A-share market trade (Chart 20). Even though China is in a late business cycle and the upcoming stimulus will be mediocre at best, we think that the industrial sector will benefit from policy support for investment in the manufacturing sector and a faster pace in the sector’s capacity expansion.   Jing Sima China Strategist jings@bcaresearch.com   Footnotes Market/Sector Recommendations Cyclical Investment Stance

Highlights Fed: The Fed will be forced to clarify its definition of “maximum employment” in 2022, and the path of inflation will ultimately dictate how far the Fed tries to push the labor market. We expect Fed rate hikes to start in December 2022 and that the pace of hikes will proceed more quickly than is currently priced in the yield curve. Duration: Investors should maintain below-benchmark portfolio duration in anticipation of a rate hike cycle starting in December 2022. Yield Curve: Investors should position in Treasury curve flatteners. Specifically, we recommend shorting the 5-year Treasury note versus a duration-matched barbell consisting of the 2-year and 10-year notes. Feature Chart 1Bonds De-Coupled From Inflation In 2021 One of our themes this year is that US bond investors should pay more attention to the employment data than the inflation data.1 This is because the Fed has successfully convinced markets that it will not lift rates until “maximum employment” is achieved, even if inflation is strong.2 This story has played out during the past few months as bond yields have remained low despite surging prices (Chart 1). Our view is that the muted reaction in bonds is due to the widespread belief that the labor market remains far from “maximum employment” and that rate hikes are therefore a long way off. In this environment, only surprisingly strong employment prints can upset the market’s narrative and send bond yields higher. This playbook for the bond market will continue to function for the next few months. Strong employment data will pull bond yields higher and disappointing employment data will push them down. Inflation prints will be largely irrelevant for the market. But this will change next year. In fact, we see the employment data taking a back seat to the inflation data in the minds of bond investors in 2022. A More Explicit Definition of “Maximum Employment” Must Emerge In 2022 Almost everyone agrees that the US labor market is far from “maximum employment” today, but that will no longer be the case in 2022. The Appendix to this report shows the average monthly nonfarm payroll growth that is required to reach different possible definitions of “maximum employment” by a few specific future dates. For example, we calculate that average monthly nonfarm payroll growth of 414 thousand would cause the unemployment rate to reach 3.8% and the labor force participation rate to reach 63% by the end of 2022. Our sense is that the US economy will be able to add more than 414 thousand jobs per month between now and December 2022. This means that if Fed officials believe that an unemployment rate of 3.8% and a participation rate of 63% meet the definition of “maximum employment”, then they will start to lift interest rates by then. This example sets the scene for what will become next year’s most important monetary policy debate. What constitutes “maximum employment”? Does our example of a 3.8% unemployment rate and a 63% participation rate meet the definition? Or does the Fed have different targets in mind? The Fed will be forced to clarify its position on the topic as the labor market gets closer to reasonable definitions of “maximum employment”. Our sense is that, as of now, there are a range of views on the committee with some FOMC participants taking a more hawkish view of how much slack is left in the labor market and some adopting a more dovish posture. We outline the differences between the hawkish and dovish positions below, but ultimately the path of inflation in 2022 will determine which camp wins out. If inflation remains high next year, then the Fed will be quicker to declare that the labor market is at “maximum employment”, and vice-versa. The Fed’s reliance on the inflation data to settle the argument of what constitutes “maximum employment” will make inflation the most important economic indicator for bond yields in 2022. Labor Market Slack: The Hawkish Case Chart 2The Unemployment Rate Is Falling Fast The hawkish case for the US labor market reaching “maximum employment” sooner rather than later was outlined nicely last month by our own Bank Credit Analyst.3 First, the Bank Credit Analyst points out that the US labor market was likely beyond “maximum employment” before COVID-19 struck. The implication being that the Fed may move to lift interest rates before the unemployment and participation rates fully recover their pre-pandemic levels. Notice that the unemployment rate (adjusted for the post-COVID surge in people employed but absent from work) was 3.5% in February 2020, well below the Congressional Budget Office’s 4.5% estimate of the natural rate of unemployment (Chart 2).4 Today, the adjusted unemployment rate is 5.5%, not that far above the 3.5%-4.5% range of FOMC participant estimates of the natural rate. If this year’s rate of decline continues, the unemployment rate will hit 4.5% by January 2022 and 3.5% by May 2022. Of course, we know that the Fed takes a broader view of labor market utilization than just the unemployment rate. In particular, we observed sharp declines in labor force participation rates across a wide range of demographic groups when the pandemic struck last year (Chart 3). While the Fed will want to see some improvement in labor force participation, it might be unrealistic to expect the overall labor force participation rate to return to its pre-pandemic level. This is because the aging of the US population imparts a structural downtrend to the participation rate. The dashed line in Chart 4 shows where the participation rate would be if the rate of labor force participation of every individual age cohort remained constant at its February 2020 level. Even in this case, the greater flow of people into the older age groups causes the part rate to fall over time. The message from Chart 4 is that even if the participation rates of every age cohort tracked by the Bureau of Labor Statistics rebound to their February 2020 levels, we would still only expect an overall participation rate of 62.8% by the end of 2022, significantly below the 63.3% seen in February 2020. Chart 3Labor Force Participation By Age Cohort Chart 4The Demographic Downtrend In Participation On top of the demographic argument, we also notice that the pandemic led to a surge in the number of retired people last year, a number that continues to rise quickly (Chart 5). While we should probably expect some increase in the flow of people coming out of retirement to re-join the labor force as the economy recovers, it’s also logical to assume that there will be at least some hysteresis among the retired population. That is, the longer someone is retired, the less likely they are to re-enter the labor force at all. To the extent that the increase in retired people is sticky, it may be ambitious to expect a full convergence of the 55-year+ part rate back to February 2020 levels (Chart 3, bottom panel). All else equal, this will cause the labor market to reach “maximum employment” more quickly than even our demographic trendline for participation suggests. Chart 5A Surge In Retirees The question of how many FOMC participants agree with the above arguments remains open, but our sense is that there are some who will be eager to declare that “maximum employment” has been achieved before we see a full rebound in the unemployment and participation rates back to pre-COVID levels. For example, Fed Vice-Chair Richard Clarida mentioned the “demographic trend” in labor force participation in his most recent speech.5 Also, Dallas Fed President Robert Kaplan said the following in a recent interview: We’ve had 3 million retirements since February 2020. […] Some of these workers will come back into the workforce, but some of these workers are 55 and older and they’re in reasonably good financial shape and COVID has caused them to re-think whether they really want to re-enter the workforce.6 Labor Market Slack: The Dovish Case There are also good arguments on the side of those who think that an appropriate definition of “maximum employment” involves an unemployment rate closer to 3.5% than 4.5% and a participation rate that does return to pre-COVID levels, and maybe even moves higher. First, a study from the Federal Reserve Bank of Kansas City noted that the bulk of the recent increase in the number of retired people is explained, not by an increase in the number of retirements, but by a reduction in the flow of people from retirement back into the workforce (Chart 6).7 This suggests that pandemic-related health risks are the likely culprit behind the increase in the number of retired people, casting doubt on the idea that the increase in retired people will be sticky. Chart 6Increased Retirees: A Closer Look Second, there is a strong case to be made that even the February 2020 labor force participation rate is not high enough to meet the definition of “maximum employment”. If we look at the participation rates for 25-54 year old men and women, we see that both were in strong uptrends prior to the pandemic (Chart 7), and there is every reason to believe that they would have continued to move higher if COVID hadn’t cut the recovery short. Chart 7Part Rates Were Rising Pre-Pandemic Consider what some FOMC participants were saying prior to the pandemic: The strong labor market is also encouraging more people in their prime working years – ages 25 to 54 – to rejoin or remain in the labor force, […] So far, we have made up more than half the loss in the Great Recession, which translates to almost 2 million more people in the labor force. But prime age participation could still be higher. - Jerome Powell, November 20198 Whether participation will continue to increase in a tight labor market remains to be seen. But I note that male prime-age participation still remains below levels seen in previous business cycle expansions. - Richard Clarida, November 20199 In a more recent interview, Minneapolis Fed President Neel Kashkari expressed skepticism about the idea that labor force participation is destined to remain in a long-run structural downtrend and said that he’s “not convinced we were actually at maximum employment before the COVID shock hit us.” He also said: Getting [labor force participation] and employment-to-population at least back to where they were before [the pandemic], but not necessarily even declaring victory when we do that. I think that’s a reasonable thing for us to try to achieve.10   Inflation: The Ultimate Argument Settler What the above arguments make clear is that there are good reasons to think that the US labor market will reach some policymakers’ definitions of “maximum employment” perhaps by as early as the middle of next year. However, there are also some policymakers who will adopt a more dovish view of what constitutes “maximum employment”. Ultimately, the path of inflation will determine which camp wins out. This is because the entire concept of “maximum employment” is only meaningful when viewed alongside inflation. If employment is pushed beyond its “maximum”, it definitionally means that labor market tightness is leading to unwanted inflationary pressures. With that in mind, the Fed will increasingly refer to the inflation data next year as it tries to make its definition of “maximum employment” more precise. Crucially, what will matter for the Fed (and for the bond market) is where inflation is next year, not where it is right now. Right now, core inflation is well above the Fed’s price stability target, but it is well known that the recent increase in inflation is concentrated in a few sectors – COVID-impacted services and autos – where prices will decelerate as post-pandemic bottlenecks ease (Chart 8). Just as the Fed ignored surging prices in those sectors this year, it will ignore plunging prices in those sectors next year. What will matter for monetary policy is whether core inflation excluding COVID-impacted services and autos remains contained or rises above levels consistent with the Fed’s target (Chart 8, bottom panel). The Fed will also be inclined to declare that “maximum employment” has been achieved if wage growth is accelerating. Currently, there is some evidence of rising wages but also some major supply bottlenecks in the labor market, as evidenced by the all-time high in job openings (Chart 9). Labor supply constraints should ease next year, but the Fed will be watching closely to see if wage growth moderates in kind or continues to increase. Chart 8Watch CPI (ex. COVID-Impacted Services And Autos) In 2022 Chart 9Watch Wages In 2022 Finally, the Fed will keep a close eye on inflation expectations next year. In particular, it will monitor the Common Inflation Expectations Index and the 5-year/5-year forward TIPS breakeven inflation rate (Chart 10). If either of these indicators break above levels consistent with the Fed’s 2% inflation target, then policymakers will be more inclined to think that “maximum employment” has been attained. Chart 10Watch Inflation Expectations In 2022 Bottom Line: The Fed will be forced to clarify its definition of “maximum employment” in 2022, and the path of inflation will ultimately dictate how far the Fed tries to push the labor market. The key indicators to monitor to decide when the Fed will declare that “maximum employment” has been attained are: core inflation excluding COVID-impacted services and autos, wage growth, inflation expectations and the prime-age (25-54) labor force participation rate (Chart 3, panel 2). Investment Implications For bond markets, the question of when the Fed decides that the labor market has reached “maximum employment” is crucial because it will determine the start of the next rate hike cycle. At present, the overnight index swap curve is priced for Fed liftoff in January 2023 and for a total of 78 bps of rate hikes by the end of 2023 (Chart 11). Chart 11Rate Hike Expectations Our expectation is that the Fed will start lifting rates in December 2022 and that rate hikes will proceed more quickly than what is currently priced in the market. The unemployment rate will be close to 3.5% by December 2022 and inflation will be sufficiently above the Fed’s target that policymakers will be inclined to view the labor market as at “maximum employment”. Investors should run below-benchmark duration in US bond portfolios to profit from this outcome. We also recommend that investors position for a flatter yield curve by the end of 2022. Specifically, we recommend shorting the 5-year Treasury note versus a duration-matched barbell consisting of the 2-year and 10-year notes. Table 1A shows fair value estimates for the 2-year, 5-year and 10-year yields as of the end of 2022 assuming the market moves to price-in the following path for the fed funds rate: The first 25 bps rate hike occurs in December 2022 Rate hikes proceed at a pace of 100 bps per year The fed funds rate levels-off at a terminal rate of 2.08%11 Table 1ATreasury Curve Fair Value Estimates: December 2022 Liftoff Scenario In that example, the 2-year and 5-year yields both rise by much more than the 10-year yield and both exceed the change that is priced into the forward curve by more than the 10-year yield. Table 1B shows the results from a similar scenario, the only difference is that the liftoff date is pushed back to March 2023. Both the 2-year and 5-year yields also rise by more than the 10-year yield in this scenario, though the delayed liftoff dampens the relative upside in the 2-year yield. Table 1BTreasury Curve Fair Value Estimates: March 2023 Liftoff Scenario Bottom Line: Investors should maintain below-benchmark portfolio duration and position in Treasury curve flatteners in anticipation of a rate hike cycle that will start in December 2022. Appendix: How Far From “Maximum Employment” And Fed Liftoff? Chart A1Defining “Maximum Employment” The Federal Reserve has promised that the funds rate will stay pinned at zero until the labor market returns to “maximum employment”. The Fed has not provided explicit guidance on the definition of “maximum employment”, but we deduce that “maximum employment” means that the Fed wants to see the U3 unemployment rate within a range consistent with its estimates of the natural rate of unemployment, currently 3.5% to 4.5%, and that it wants to see a more or less complete recovery of the labor force participation rate back to February 2020 levels (Chart A1). Alternatively, we can infer definitions of “maximum employment” from the New York Fed’s Surveys of Primary Dealers and Market Participants. These surveys ask respondents what they think the unemployment and labor force participation rates will be at the time of Fed liftoff. Currently, the median respondent from the Survey of Market Participants expects an unemployment rate of 3.5% and a participation rate of 63%. The median respondent from the Survey of Primary Dealers expects an unemployment rate of 3.8% and a participation rate of 62.8%. Tables A1-A4 present the average monthly nonfarm payroll growth required to reach different combinations of unemployment rate and participation rate by specific future dates. For example, if we use the definition of “maximum employment” from the Survey of Market Participants, then we need to see average monthly nonfarm payroll growth of +414k in order to hit “maximum employment” by the end of 2022. Table A1Average Monthly Nonfarm Payroll Growth Required For The Unemployment To Reach 4.5% By The Given Date Table A2Average Monthly Nonfarm Payroll Growth Required For The Unemployment To Reach 4% By The Given Date Table A3Average Monthly Nonfarm Payroll Growth Required For The Unemployment To Reach 3.5% By The Given Date Table A4Average Monthly Nonfarm Payroll Growth Required To Reach “Maximum Employment” As Defined By Survey Respondents Chart A2 presents recent monthly nonfarm payroll growth along with target levels based on the Survey of Market Participants’ definition of “maximum employment”. This chart is to help us track progress toward specific liftoff dates. For example, if monthly nonfarm payroll growth continues to print at the same level as last month, then we could anticipate a Fed rate hike by June 2022. Chart A2Tracking Toward Fed Liftoff We will continue to track these charts and tables in the coming months, and will publish updates after the release of each monthly employment report. Ryan Swift US Bond Strategist rswift@bcaresearch.com Footnotes 1 Please see US Bond Strategy Weekly Report, “Watch Employment, Not Inflation”, dated June 15, 2021. 2 Specifically, the Fed’s forward guidance states that it will not lift interest rates until (i) inflation is above 2%, (ii) inflation is expected to remain above 2% for some time and (iii) the labor market has reached “maximum employment”. 3 Please see Bank Credit Analyst Special Report, “The Return To Maximum Employment: It May Be Faster Than You Think”, dated August 26, 2021. 4 For details on the adjustment we make to the unemployment rate please see US Bond Strategy Weekly Report, “Overreaction”, dated July 13, 2021. 5 https://www.federalreserve.gov/newsevents/speech/clarida20210804a.htm 6  https://www.bloomberg.com/news/articles/2021-08-09/dallas-fed-president-rob-kaplan-on-the-economy-and-monetary-policy-right-now?sref=Ij5V3tFi 7 https://www.kansascityfed.org/research/economic-bulletin/what-has-driven-the-recent-increase-in-retirements/ 8 https://www.federalreserve.gov/newsevents/speech/powell20191125a.htm 9 https://www.federalreserve.gov/newsevents/speech/clarida20191114a.htm 10 https://www.bloomberg.com/news/articles/2021-08-16/neel-kashkari-on-the-fed-s-quest-to-get-to-full-employment?srnd=oddlots-podcast&sref=Ij5V3tFi 11 We assume a target range of 2% to 2.25% for the terminal fed funds rate. We also assume that the effective fed funds rate trades 8 bps above the lower-end of its target band, as is presently the case. Recommended Portfolio Specification Other Recommendations Treasury Index Returns Spread Product Returns