Economy

Highlights The US Innovation and Competition Act shows that the US is rediscovering industrial policy amid domestic populism and foreign geopolitical risk.  Fiscal accommodation is a basis for the economy to improve, political polarization to moderate, and Congress’s approval rating to continue to normalize.  Biden’s infrastructure bill still has a subjective 80% chance of passage, despite bipartisan talks faltering and his own caucus growing restive. The price tag is still around $1-$1.5 trillion. Senate passage will mark peak US stimulus for this cycle. Close long consumer staples for a gain of 6%. Cut losses on long materials/tech. Close our fiscal advantage trade relative to the NASDAQ. Feature Bipartisanship is not dead in the 117th Congress, though a bipartisan deal on infrastructure may not come together. Investors should still expect Congress to pass the president’s signature legislative proposal, the American Jobs Plan. Our subjective odds remain 80% with high conviction. The bill’s price tag is still ranging from $1-to-$1.5 trillion in deficit spending this year, or 4.4%-6.7% of GDP – i.e. not a number that financial markets can ignore. A budget resolution is being drafted with a rough headline value of $1.5 trillion. Financial markets are experiencing an inevitable period of doubts over whether the bill will actually pass. In the short run investors should stay invested in infrastructure plays, cyclical equity sectors, and value stocks. However, market dynamics are shifting and there is a basis for upgrading the tech and health sectors. The Senate’s passage of Biden’s infrastructure bill, in whatever form, will mark the peak of US fiscal stimulus for this cycle. Meanwhile our theme of bipartisan structural reform is apparent in the Senate’s passage of the Innovation and Competition Act on June 8 (Chart 1). This bill marks a rare bipartisan achievement in Congress and a sea change in American policymaking. The sea change is the US’s need to revive industrial policy in order to compete with adversaries abroad – a mission that the political establishment supports after being snapped out of its slumber by President Trump’s populist rebellion. In this report we take a look at the domestic consequences of this bill. We leave the international consequences to our sister Geopolitical Strategy service. Chart 1Newsflash: Bipartisan Bill Passes Senate Via Regular Order! We also look at the surprising recovery in Congress’s popular approval rating. While the US remains at “peak polarization” from a historic point of view, there is a cyclical drop in polarization after the quadruple crisis of 2020 (pandemic, recession, social unrest, contested election) (Chart 2). This cyclical drop may well become a secular decline over the coming decade, as fiscal accommodation at home and geopolitical risk abroad will generate domestic policy consensus on the topics of trade, manufacturing, industry, and technology. This trend will support Congress’s approval rating. Chart 2Polarization Subsides From Crisis Peaks While Congress will never be loved, it will not be as hated in the coming decade as the past decade. The reason is that Congress is taking a more active role in the economy. This is positive for markets in the short run but adds policy uncertainty over the long run. The Return Of Industrial Policy The US Innovation and Competition Act (USICA) is the outcome of a crisis in the American political system two decades in the making. The hyper-globalization of the Bill Clinton presidency, combined with the profligate economic and foreign policies of the George W. Bush presidency, led to the Great Recession. While the US was distracted with foreign wars and financial crisis, China emerged as a challenger to the US’s strategic dominance (Russia also revived and undermined US stability). The Obama administration began taking tougher action on China in 2015 but by then it was too late to accomplish much. The sluggish recovery and loss of national status triggered a populist rebellion in the form of the Trump administration, which provoked an even greater backlash from the political establishment in 2020. The Republicans imposed fiscal austerity, took power, then abandoned austerity and declared a trade war on China. The Democrats took back power, abandoned austerity, and are continuing the trade war. Now the two parties agree on the need to increase government support for the economy (infrastructure, industrial policy, protectionism) and to redirect foreign policy to confront major powers like China and Russia (as opposed to wasteful forever wars in the Middle East and South Asia). Public opinion has been coalescing around these twin goals since 2008 and the Biden administration so far can be said to represent a kind of synthesis of the Obama and Trump administrations. Even more powerful is the formation of a new consensus in Congress, which is the “first branch” of the US government and represents popular attitudes. Congress has always been more nationalist and more protectionist in its leanings than the executive and judicial branches, which represent policy elites and technocrats.1 While Congress is fickle when it comes to passing fancies of the day, it can be incredibly stubborn when it comes to a nationwide, once-in-a-generation popular consensus. Moreover China does not present a fleeting challenge like Iraq or Al Qaeda. It is more like the Soviet Union and will motivate a congressional consensus and policy consensus for decades. Great power competition will work against US political polarization. A Productivity Mini-Boom The USICA consists of about $115 billion in federal research and development funding, $52 billion in funding for the US semiconductor industry, and $10 billion for regional tech hubs. Funding will flow to the National Science Foundation, NASA, the Department of Energy, and the Defense Advanced Research Projects Agency (DARPA), among others. There are also specific measures to counter China (including intellectual property protections) as well as a regulatory overhaul to codify “Buy America” provisions and require that materials used in federally funded projects are produced in the United States (Table 1). Table 1US Senate Passes Bipartisan ‘Innovation And Competition Act’ To Counter China In research and development, the USICA formalizes the key technologies that the federal government should focus on and fund. These include: AI, machine learning, and autonomy High performance computing Quantum science and technology Natural and anthropogenic disaster prevention and mitigation Advanced communication technology Biotech, medical tech, genomics, and synthetic biology Data storage and cybersecurity Advanced energy, industrial efficiency, batteries, nuclear energy Advanced material science The $81 billion allocated to the National Science Foundation, covering fiscal 2022-26, will be allocated as shown in Table 2. The Department of Energy will focus on energy-related supply chain issues within the key technological areas of focus. Table 2NSF Gets Additional Dole Private research and development amount to more than twice the R&D spending of the federal government (Chart 3). Higher spending will augment private R&D, rather than substitute for it. It will likely boost US productivity, which has been in the doldrums over the past few years. Chart 3A Boost To R&D Spending While it is speculative to say whether the revival of industrial policy will cause productivity to break out of its long-term structural decline, a mini-boom seems warranted, especially when considering that foreign competition will remain a constant impetus (Chart 4). There is ample pork-barrel spending and plenty of potential for boondoggles, as will always be the case with fiscal spending splurges. But a rise in productivity will have a greater macro impact. Chart 4US Productivity Boom, Or At Least Mini-Boom Another aspect of the bill consists of funding for regional technology hubs. The office of Economic Development Administration will oversee three tech hubs in each region covered by the EDA’s regional office. These must be areas that are not already tech centers. No less than one third of the funding will go to small and rural communities and at least one consortium must be headquartered in a low-population state. The info-tech revolution and de-industrialization have created a problem of regional inequality, which these measures attempt to address. The USICA also funds the incentives for the domestic semiconductor industry first outlined in the national defense appropriations last year. The CHIPS Act, for example, helps incentivize investment in facilities and equipment for computer chip fabrication, assembly, testing, advanced packaging, and R&D. This funding was subject to the availability of appropriations but is now authorized under the USICA to the tune of $52 billion. Substantial breakthroughs in the 1980s-90s, in software and other areas, followed on much smaller public investments in education and research.2 The semiconductor industry is capital-intensive. For every one dollar in sales, 15 cents of capital expenditures are needed, compared to just seven cents in the tech sector as a whole and six cents across companies in the S&P 500 index. The capex requirement for the energy sector grew from six cents in 2004 to 17 cents in 2015, almost tripling in a decade due to the capital intensity of the shale boom (Chart 5). Thus lowering the cost of investment for the semiconductor companies will have a major positive impact. Quarterly capex for the chip makers stands at around $25 billion. An infusion of $52 billion in government incentives over five years amounts to $2.6 billion per quarter or roughly 10% of current capex. Chart 5A Boon For US Semi Capex Finally, the USICA consists of notable “Buy America” or protectionist measures. The bill holds that public works must be produced by American workers and funding should not be used to reward companies that “offshore” their operations, especially to countries that do not share US regulatory standards on workers, workplace safety, and the environment. The USICA gives a big sop to US manufacturing: all manufactured goods purchased with the bill’s funding must be made in the USA or have at least 55% of their total components sourced in the country. All iron and steel manufacturing processes, from melting through coatings, must occur in the United States. Buy America provisions will stir up some quarrels with US allies and trading partners but ultimately the US will need to increase imports as a result of the USICA. Private non-residential investment in the US moves closely with import growth, whereas US government investment has less of a relationship with imports (Chart 6). Chart 6Supply Constraints Amid US Fiscal Stimulus The Buy American provision will put new pressures on a supply chain that is already strained by the pandemic and the Trump administration’s tariffs. Industrial production is at an all-time high and so are producer prices, which means that producers have high pricing power. This is beneficial for the industrial and materials sectors over the medium term, even if the short-term inflation scare proves overdone (Chart 7). Buy American provisions will even improve the pricing power of the machinery sub-sector, as contractors will be forced to buy American-made machinery. The bottom line is that the Biden administration has coopted the Trump administration’s agenda on China, trade, and manufacturing, which itself was an attempt to steal thunder from the Obama administration. However, Biden and the Democrats bring a defensive and domestic-oriented approach rather than an offensive and foreign-oriented approach. Tariffs and investment restrictions will stay on China but they are not being increased or tightened (at least not yet). Instead the emphasis falls on fiscal largesse for US industry and manufacturing as well as research and development, promotion of STEM education (science, technology, education, and mathematics), and semiconductor subsidies. Chart 7Sustained Proactive Fiscal Policy Is Inflationary The goal is to increase the pace of US innovation, notwithstanding the fact that countries will continue to borrow, spy, and steal from each other. The international context of competition – and the widespread resort to debt monetization – will have a positive impact on productivity over the long run. But the protectionist regulations will combine with US supply constraints to put upward pressure on material and industrial prices over the short and medium run. Will Americans Hate Congress Less? A bipartisan industrial agenda in Congress raises the question of whether a bipartisan infrastructure deal can also be achieved. We remain optimistic, though the talks are currently wobbling. Biden’s approval among Democrats is falling as the Democratic caucus abandons his attempt to forge a bipartisan infrastructure deal and presses for a Democrat-only reconciliation bill. However, his overall approval rating is not likely to settle at a lower level than that of Presidents Obama and Trump. His approval rating on handling the economy has probably already hit its floor (Chart 8). He still has the ability to pass a signature piece of legislation, according to our Political Capital Index (Appendix). Chart 8Biden Struggles With Democratic Party Chart 9US Public Approving Of Congress?!? The sharp increase in public approval for Congress is another signal of Biden’s political capital (Chart 9). About 36% of Americans now say they approve of the job Congress is doing while 61% disapprove. This is not very good in absolute terms but relative to Congress’s history it is notable. The sharp uptick is due in large part to the expanded unemployment benefits, stimulus checks, and other social subsidies doled out during the pandemic. A fleeting spike in approval also occurred around the GFC-era stimulus, only to give way to new lows. Yet there is a deeper source. Approval of Congress has risen continually since the bruising debt ceiling standoffs and government shutdowns of 2010-14, when the Obama administration squared off against a Republican Congress in the context of a sluggish economy (Chart 10). With Gallup polling data going back to the 1970s, the big picture is that Americans lost faith in Congress during the stagflationary 1970s, the first Gulf War and recession of the early 1990s, and especially the Iraq/Afghanistan wars and Great Recession. It is now slowly recovering to normally low (rather than abnormally low) levels. Chart 10A Longer View Of Public Attitudes Toward Congress Aside from fleeting rallies around the flag, such as after the September 11, 2001 terrorist attacks, public approval of Congress rarely rises above 50%. The reasons are obvious: Congress is an institution in which power-hungry politicians engage in endless and petty quarrels over the minutiae of public policy in full view of the world. Its job is inherently unpopular.3 But as partisanship and polarization have increased dramatically since the 1980s, Congress has lost effectiveness at its primary function of forging compromises and passing laws. The public differs on what laws should be passed but it generally disapproves of the lack of compromise (Chart 11). A clear uptrend in congressional approval has emerged since the near-recession of 2015. The one overriding change in national policy since that time has been the activation of the fiscal lever. Trump unleashed a bipartisan spending binge as well as tax cuts. COVID-19 encouraged a Trump-Biden spending binge. Now Biden’s measures are adding to this anti-austerity blowout. While voters rewarded Congress for balancing the budget in the 1990s, the Great Recession marked a secular change. Disapproval rose with the process of fiscal tightening from 2010-14 (budget sequestration) and fell as the fiscal deficit has widened since then (Chart 12). Chart 11Public Approves Of Lawmakers Who … Make Laws Chart 12Public Approves Of Spendthrift Congress? Voters do not approve of Congress based on wonky policy views. Their approval, like their approval of the president, tracks with the state of the nation. There is a fairly close correlation between the two approval ratings. A major deviation emerged in 2010-14 when President Obama partially restored public faith in the presidency (albeit with historically low approval ratings) while Congress sank to even lower lows than it witnessed during the Iraq war on the back of Republican obstructionism and Obama’s second-term legislative failures (Chart 13). The current trend is for presidential approval to remain flat at its post-2010 levels while Congress regains some support. Chart 13Approval Of Congress Tracks Approval Of President Congressional infighting will resume after Biden passes the American Jobs Plan. His American Families Plan is much less likely to pass. Opposition Republicans have a subjective 75% chance of retaking the House of Representatives in 2022, which would result in gridlock. However, congressional approval is normalizing from the depths of the disinflationary 2010s to around the 30%-40% range. It will probably continue tracking presidential approval. And history shows that presidential approval ultimately hinges on peace and prosperity as opposed to war, recession, and scandal (Chart 14). This will dictate the direction under the Biden administration and beyond. Chart 14Approval Of President Tracks ‘Peace And Prosperity’ A critical factor is whether polarization will continue to subside. High polarization makes it so that voters identify the passage or failure of government policy exclusively with the ruling party; this incentivizes the opposition to obstruct.4 Lower polarization enables bipartisan deals and thus forces the two parties to share the praise and the blame of new policies. Compromise and lawmaking increase congressional approval; higher congressional approval increases the odds of compromise. The current legislative agenda reveals several areas of emerging consensus, not only on industrial policy and manufacturing but also on anti-trust law and infrastructure (Table 3). Table 3Pending Legislation In Congress Under Biden The Biden administration may only get one or two more major bipartisan legislative accomplishments. Polarization is still at historically elevated levels. In the next two-to-five years polarization could easily re-escalate, given the ongoing power struggle between the two dominant parties and the grievances over the 2020 election. However, over the next five-to-ten years, polarization should settle at levels beneath the record highs witnessed in 2020 due to foreign competition and fiscal accommodation. The USICA shows how this trend could take shape. Investment Takeaways The macro implications of Biden’s political capital and Congress’s rising approval rating consist of trends and themes that we have emphasized before: the return of Big Government; populist monetary and fiscal policy; protectionist industrial policy; nation building at home; and geopolitical struggle abroad. There is no direct market impact of a less unpopular Congress – the implication can be positive or negative depending on the policies, assets, and time frames in question. For example, the congressional effect, in which markets rally while Congress is at recess, is debatable.5 Congress is least active in January, July, August, and December and yet this recess schedule manifestly has no consistent impact on well-known equity market calendar effects (Chart 15). Chart 15Calendar Effects But No Congressional Calendar Effect Markets under congressional gridlock often outperform markets under single-party sweeps but the difference is small and debatable (Chart 16). Markets dislike both effective congresses that pursue market-unfriendly policies and ineffective congresses that would be pursuing market-friendly policies. The pandemic and recession required an effective congress, bipartisan stimulus resulted, and approval has gone up. Sustaining this approval will require avoiding both deflationary and stagflationary environments in the coming years, as well as gratuitous wars and massive scandals. That will be difficult. Chart 16Sweeps Don’t Always Underperform Gridlock Still, a floor in congressional approval has probably been established over the past decade as the US political establishment has rediscovered proactive fiscal policy at home and nationalism abroad. These two key trends create cross-currents for the dollar. The macroeconomic backdrop for the dollar is bearish but the political and geopolitical backdrop is bullish. At present the dollar stands at a critical juncture. Any increase in global policy uncertainty and geopolitical risk abroad should push the dollar up (Chart 17). Given the dollar-bearish BCA House View, we are therefore neutral and will revisit the issue in our upcoming third quarter outlook report. We are adjusting our equity sector risk matrix. Our new US Equity Strategist, Irene Tunkel, argues convincingly that investors should continue favoring cyclicals but also take a more optimistic outlook on the tech and health sectors. We agree on health in particular since the Biden administration’s policy risks have largely been passed up. We are closing our long materials / short tech trade for a loss of 8.2% and our long fiscal advantage / NASDAQ trade for a loss of 1.3%. We will also close our long consumer staples trade for a gain of 6.5%. Chart 17Relative Policy Uncertainty Rising, Greenback On Edge   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com Jesse Anak Kuri Associate Editor jesse.Kuri@bcaresearch.com   Appendix Table A1USPS Trade Table Table A2Political Risk Matrix Table A3Political Capital Index Table A4APolitical Capital: White House And Congress Table A4BPolitical Capital: Household And Business Sentiment Table A4CPolitical Capital: The Economy And Markets Footnotes 1     See David R. Mayhew, “Is Congress ‘The Broken Branch?,’” Boston University Law Review 89 (2009), 357-69, bu.edu. 2     See Danny Crichton, Chris Miller, and Jordan Schneider, “Labs Over Fabs: How The U.S. Should Invest In The Future Of Semiconductors,” Foreign Policy Research Institute, March 2021, www.fpri.org. 3    See John R. Hibbing and Christopher W. Larimer, “The American Public’s View Of Congress,” Faculty Publications: Political Science 27 (2008), digitalcommons.unl.edu/poliscifacpub/27.  4    See David R. Jones, “Partisan Polarization and the Effect of Congressional Performance Evaluations on Party Brands and American Elections,” Political Research Quarterly 68:4 (2015), 785-801, jstor.org. See also Jones, “Declining Trust In Congress: Effects of Polarization and Consequences for Democracy,” The Forum 13:3 (2015), degruyter.com. 5    Some market participants and researchers have uncovered a “Congressional effect” in which stock market returns are higher on average on days when Congress is on recess than on days when it is in session.   

Dear Client, Next week, in lieu of our regular weekly report, I will be hosting two webcasts where I will discuss the outlook for China’s economy and financial markets, a year into policy normalization. The webcasts will be held on Tuesday, June 22 at 10:00 am EDT (English), and Thursday, June 24 at 9:00 am HKT (Mandarin). We will return to our regular publishing schedule on Wednesday, June 30. Best regards, Jing Sima, China Strategist   Feature China’s onshore stocks rebounded in the past two months on the back of a rapidly appreciating RMB versus the US dollar and accelerating foreign capital inflows (Chart 1). However, in our view, China’s domestic policy backdrop and economic fundamentals do not support a sustained rally in Chinese stocks in the next six months. The RMB’s rise vis-à-vis the US dollar will likely falter in the second half of the year as China’s growth weakens. A narrowing in real yields later this year between China’s government bonds and US Treasuries will also discourage foreign flows into Chinese assets. Performance of Chinese cyclical stocks versus defensives failed to decisively breakout in both the onshore and offshore equity markets. An underperformance in cyclical stocks relative to defensives has historically pointed to waning market sentiment towards the Chinese economy (Chart 2). Chart 1Rapid Appreciation In The RMB Buoyed A Recent Rebound In A-Shares Chart 2Cyclical Stocks Continued To Underperform Defensives The number of onshore stocks with prices rising versus falling remains low, even though there has been a slight improvement this year from Q4 2020. The narrow breath in the equity market implies that recent rebound in A-share stocks has been largely driven by a handful of companies (Chart 3). Such narrow breadth suggests that the rebound in Chinese stock prices will not sustain (Chart 4). Chart 3A Narrow-Based Market Rally in A-Shares Chart 4Narrowing Market Breadth Has Historically Led To Price Pullbacks A tightened monetary and credit environment has created obstacles for Chinese equities since early this year. Credit numbers released last week show that credit growth deceleration has gathered speed in May, raising the risk of policy overtightening, i.e. credit growth undershooting the government’s 2021 targets. We could see some moderation in the credit growth deceleration into 2H21. A delay in the rollout of local government (LG) bonds and LG special purpose bonds (SPBs) in the first five months of the year means the pace of LG bond issuance between June and October will escalate, which will help to stabilize credit growth. However, weak corporate bond net financing and contracting shadow banking will cap the upside in credit expansion. Chart 5The Economy Could Surprise The Market To The Downside In Q3 Additionally, if more LG bonds come onto the market in Q3, then we could see tighter interbank liquidity conditions and higher bond yields. This, in turn, would partially offset the positive effects on the economy and equity market from a slower pace in credit growth deceleration. For the next six months, we continue to hold an underweight position in Chinese onshore and investable stocks, in both absolute terms and within a global equity portfolio. Policy tightening has not reversed course and there is an escalating risk that economic data will surprise the market to the downside in Q3 (Chart 5). Qingyun Xu, CFA Associate Editor qingyunx@bcaresearch.com     Macro Policy Conditions Are Still Unfavorable For Risk Assets A further deterioration in the credit impulse in May reflects Chinese authorities’ efforts to reduce local government leverage and shadow banking activities. Net corporate bond financing contracted for the first time since early 2018, driven by shrinking local government financing vehicle (LGFV) bonds (Chart 6). Meanwhile, the pace of contraction in shadow-bank loans climbed. At this rate of deceleration, credit growth will undershoot the government’s 2021 target, which is expected to be in line with this year’s nominal GDP growth. The pace in credit expansion on a year-over-year basis has dropped to its previous cycle’s trough (Chart 7). Moreover, the speed of the deceleration in credit growth has outpaced the 2017/18 tightening cycle. It has been seven months since Chinese credit growth peaked (October 2020), which is significantly less than the 13 months it took for credit to decline from top to bottom in 2017/18. Chart 6Contraction In Net Corporate Bond Financing And Shadow Banking Dragged Down Credit Growth In May Chart 7Credit Growth Has Decelerated To Its Trough Reached In 2017/18 Tightening Cycle Chart 8Most Of LG Bonds Issued In The First Five Months Are Refinancing Bonds So far this year, LG bond issuance is also behind schedule. About 63% of LG bonds issued in the first five months are refinancing bonds (Chart 8). The new LG bonds and LG SPBs issued to date account for only 21% and 16.5%, respectively, of their 2021 quotas. A delay in LG bond issuance in the first five months means that much more bonds will be on the market between June and October, which may help to stabilize credit growth in Q3. However, weak corporate bond financing and an acceleration in contracting shadow banking activities will cap the upside on broad credit. We do not expect a reversal in policy tightening. Instead, credit growth will likely hover near current levels for the rest of the year. In the past, Chinese policymakers eased when the global manufacturing backdrop faltered. Given that global growth is robust, Chinese policymakers will not feel any urgency to reverse policy setting and will likely use the strong external environment as an opportunity for domestic deleveraging. Chinese Exports Will Face Challenges In The Second Half Of The Year Chart 9A Broad-Based Moderation In China's Exports to DMs Export growth slowed in May with a broad-based moderation in the country’s exports to developed markets (DMs), albeit from a very elevated level (Chart 9). The easing in exports reflects an ongoing demand shift in the DMs away from goods to services as economic activity normalizes (Chart 10). China’s robust exports, which have been driven by strong and partly pandemic-induced global demand for goods, will likely gradually lose strength in the second half of the year. China’s weakening new export orders component in the May manufacturing PMI reflects this trend (Chart 11). Chart 10Global Consumption Recovery In Services Will Likely Outpace Goods Chart 11China's Softening New Export Orders Signal Further Export-Sector Weakness An appreciating RMB versus the US dollar is also a headwind for Chinese exports. The USD/CNY historically has led Chinese new export orders by around six months, with the exception of the pandemic-hit outlier in 2020 (Chart 12).  The recent sharp RMB appreciation is starting to weight on Chinese exports. Moreover, BCA’s Geopolitical strategists do not expect that China will principally benefit from US President Biden’s $2.4 trillion infrastructure and green energy plan . US explicitly aims to diminish China’s role as a supplier of US goods and materials. The widening divergence between US’s trade deficit with China and the rest of world already shows evidence (Chart 13). Chart 12The RMB's Rapid Rise Creates Headwinds For Chinese Exports Chart 13China's Exports May Not Benefit From Biden's Infrastructure Plan Still No Inflation Pass-Through Chart 14Chinese Producers Are Unable To Pass Rising Input Costs On To Consumers Chinese surging producer prices overstate domestic inflationary pressures. Inflation in the Producer Price Index (PPI) surged by 9.0% year-over-year in May, jumping to its highest level since 2009. High PPI inflation reflects rising commodity prices and a low base effect. Meanwhile, inflationary pressures are much more muted for consumer goods and services. The gap between producer and consumer prices widened to the highest level since 1990, highlighting the absence of price inflation pass-through from producers to consumers (Chart 14). We expect soaring PPI inflation to be transitory; it will ease when low-base factors from last year and global supply constraints are removed later this year. CPI inflation will remain tame through the year. As such, Chinese authorities are unlikely to tighten monetary policy in response to high PPI readings. Instead, Beijing will continue to use regulatory measures to curb speculation in the commodity market and window-guide industries to readjust material inventories to help ease the pace of rising commodity prices. Historically, PPI inflation’s impact on consumer prices has been weak when prices on producer goods were pushed up by supply shocks rather than mounting domestic demand. The sharp uptick in the PPI during the 2017/18 cycle was mostly due to China’s supply-side reforms and a rapid consolidation in the upstream industries. Global supply constraints linked to the pandemic have also resulted in a sharp upturn in the Chinese PPI since mid-2020. Moreover, Chart 15 shows that the pass-through from PPI inflation to consumers is closely correlated to household income growth. The pass-through has weakened significantly since 2011 when household income growth subdued along with a declining Chinese working population (Chart 16). Chart 15Subdued Household Income Growth Since 2011 Has Suppressed CPI Inflation Chart 16Income Growth Decelerated After China's Working Population Peaked Chart 17Profits Diverged Between Upstream And Mid & Downstream Industries Lacking inflation pass-through from producers to consumers has led to a bifurcated profit recovery between upstream and mid & downstream industries. Since late last year, the share of upstream industries in total profits increased sharply at the expense of mid and downstream businesses (Chart 17). A deterioration in the profits of mid and downstream industries will weigh on the outlook for their capex, which in turn, will reduce the demand for upstream goods.     Domestic Demand Remains China’s Weakest Link Investments and household demand remain the weakest links in China’s economy. Sluggish household consumption reflects a fragile post-pandemic recovery in manufacturing and services employment, and a rising propensity for precautionary savings (Chart 18). A PBoC survey shows that households’ preference for more saving deposits soared in 2020 (Chart 19). Although it has slightly diminished since late 2020, the reading is still much higher than its pre-pandemic level and will likely persist to year-end on the back of a subdued outlook for employment and income. Chart 18Weak Employment In Both Manufacturing And Service Industries Chart 19Propensity For Precautionary Savings Is Still Elevated Manufacturing investment continued its rebound in April, but the growth has not rallied to its pre-pandemic state and the recovery was more than offset by falling old-economy infrastructure and real estate investment growth (Chart 20). Although a pickup in LG SPB issuance in Q3 will provide some support to infrastructure expenditures, the effect on aggregate infrastructure investment probably will be muted. China’s Ministry of Finance has raised the requirements for approvals of new investment projects, which have decreased notably since early this year (Chart 21). Hence, growth in infrastructure investment may not significantly improve in 2H21 without a harmonized policy impetus for more bank loans and loosened regulations on local government spending. Chart 20Recovery In Manufacturing Investment Was More Than Offset By Falling Infrastructure And Real Estate Investment Growth Chart 21Falling New Projects Approval Real Estate Sector: Mounting Deleverage Pressure Property developers face challenges from heightened government scrutiny on bank loans and limits on the sector’s leverage ratio, along with curtailed off-balance sheet funding due to Asset Management Regulation (AMR) . Bank loans to real estate developers and household mortgages have tumbled to historical lows and will likely slow further in the next few months (Chart 22, top panel). The tightened financing policies have started to cool demand in the real estate market (Chart 22, bottom panel). Softer housing demand will start to drag down property developers’ capital spending and real estate construction activities (Chart 23). Chart 22Deteriorating Financing Starting To Cool The Property Market Chart 23Real Estate Investments And Construction Activities May Slow Further   Table 1China Macro Data Summary Table 2China Financial Market Performance Summary   Footnotes Cyclical Investment Stance Equity Sector Recommendations

Highlights Economy – We think the current hiring logjam will prove to be temporary: Once schools fully re-open for in-person learning in August and September and enhanced unemployment benefits expire, restraints on labor supply should ease. Markets – We expect that employment will rebound quickly enough to support an initial rate hike in 2022, ahead of the bond market’s current expectations: Liftoff expectations will have to be pulled forward if nonfarm payrolls return to their pre-pandemic peak before the end of 2022. Strategy – Remain underweight duration to stay ahead of a repricing of Fed tightening: Rates may continue to consolidate or edge lower in the near term, but we still see them rising over the next twelve months. Feature The state of the labor market is the key uncertainty for US macro observers. Although the headline unemployment rate has come down nine percentage points from its 14.8% peak, retracing nearly 80% of its sudden increase, it overstates the healing that has occurred. 22 million people, or nearly 15% of employees, lost work in March and April 2020. Two-thirds of those jobs have been recovered, but 5% fewer Americans are employed now than at last February’s employment peak. Even if today’s much-reduced shortfall had marked the trough, it would represent a postwar drawdown surpassed only by the Great Recession (Chart 1). Chart 1An Especially Severe Bloodletting The economic implications of a plunge in employment follow from what we like to call the fundamental theorem of macroeconomics: my spending is your income and your spending is my income. The US economy has dodged those implications, thanks to a massive infusion of fiscal stimulus that featured three waves of direct assistance to households, but it will not be able to stand on its own until nonfarm payrolls close in on their previous peak. Financial markets will take some notice of payrolls’ impact on economic fundamentals, but they are mostly concerned about their effect on monetary policy settings. With the Fed’s inflation-related criteria for hiking rates largely met, its full-employment goal is set to take center stage. It is easy to envision a scenario in which bond yields and equity multiples begin taking their cue from payrolls’ ongoing progress. We center our examination of that progress on labor force participation, which is likely to inform the pace of payroll expansion and wage gains. The Incredible Shrinking Work Force Only 61.6% of civilians 16 and over are participating in the labor force, recovering less than half of the pandemic decline from 63.4% to 60.2%. The participation rate has been subject to a structural headwind since 2001 when the baby boomers, born between 1946 and 1964, began exiting their prime working years1 (Chart 2, top panel). Except for a modest decline in the wake of the global financial crisis, however, the labor force kept expanding, even during recessions (Chart 2, bottom panel), thanks to an expanding working-age population. The pandemic decline was large enough to overcome population growth, with the participation rate now at a (pre-pandemic) level it last hit in January 1977, when female prime-age participation was 17-1/2 percentage points lower than it is today. Chart 2Participation Took A Big Hit From The Pandemic Table 1Labor Force Growth Has Been Slowing For A While Labor force growth has been decelerating since the ‘70s (Table 1), when it was souped up by the first half of the baby boomers’ entry into their prime working years and the explosion in female participation. It tapered in the ‘80s as the growth in female participation moderated even as the rest of the boomers turned 25. After a middling decade of labor force expansion in the ‘90s, growth slowed sharply over the last two decades as one cohort of baby boomers exited their prime working years every year from 2001 through 2019. The demographic headwind from aging boomers never produced outright contraction like today’s, though, with the labor force plunging by 5% at last April’s trough, and still languishing 2.2% below its pre-pandemic peak today. Where Did All Those Workers Go? There is no smoking gun among demographic breakouts of those who have left the labor force, but the loss of external caregiving resources appears to have been a formidable obstacle to participation. Child care burdens tend to fall more heavily on women, married or unmarried, and the recovery in the participation rate of women with young children has consistently lagged the recovery for women without young children and men with or without young children (Chart 3). It currently sits nearly a percentage point below the other three gender/children categories. Participation rate data by age group suggests that increased adult caregiving burdens may also be playing a role in suppressing participation, based on the mean and median ages of 49.4 and 51, respectively, of adult caregivers.2 Among all workers, the 45-to-54 and 55-and-above cohorts accounted for an outsized share of labor force departures while the 35-to-44 cohort, which is less likely to have adult-care burdens, has experienced labor-force losses at one-fifth of its proportion of the labor force (Table 2). Though adult caregivers skew female (61%), there is not an observable difference in the change in male and female participation at the ages of 45 and above. Chart 3Remote Learning Is Weighing On Participation Table 2Pandemic Labor Force Changes By Age And Gender Cohorts As part of the Household Pulse Survey it began conducting in late April 2020 to track the effects of the pandemic on American households, the Census Bureau has asked the jobless why they are not working. Childcare has steadily gained share and together with eldercare accounted for 9% of responses in May (Chart 4). The largest factor last April and May – the coronavirus’ impact on businesses, covering business drop-offs, temporary and permanent closures and furloughs and layoffs – rapidly fell away and is down to just 11%. Retirements have taken up 11 percentage points of the slack, with 42% of May survey respondents saying they are retired (Chart 5). Chart 4Childcare, Eldercare And ... Chart 5"Retirement" Have Shrunk The Work Force The huge pickup in retirees matches the plunge in 55-and-over participation, but it flies in the face of longer-term trends. 55-plus participation surged during the nineties’ expansion and during all of the aughts, including the dot-com and the GFC recessions, both of which dealt a blow to retirement nest eggs (Chart 6). The 55-and-over participation rate had held remarkably steady around 40% over the last ten years and we are skeptical that so many older workers are exiting at a time when their share of the population is increasing along with life spans. We expect that many of these respondents’ stated retirements may prove to be as "final" as their favorite bands’ retirement tours. Chart 6Previous Equity Selloffs Forced Older Workers To Stay On The Job The Demand Picture Is Different This Time “Jobless recoveries” have become a fixture of the post-recession landscape of the last three decades, which have seen the time it takes to recover the previous cycle’s employment peak become increasingly protracted (Chart 7). We do not believe that we are in the throes of a jobless recovery now, however. The sluggish pace of hiring that followed the last three recessions has mainly been a function of weak demand. This time around,3 the issue appears to be a dearth of labor supply, as increasingly desperate employers report that they are unable to find capable workers to fill open positions. Chart 7It Takes A Long Time To Regain Peak Employment In A Jobless Recovery, ... Chart 8... But It Doesn't Look Like We're In One Now Chart 9Help Wanted Per the job openings component of the Job Openings and Labor Turnover Survey (JOLTS), there is very nearly one job for every unemployed worker. Although the JOLTS has only existed since 2000, the current level of demand is remarkably robust compared to each of the last two cycles (Chart 8). May’s NFIB survey of small businesses shows the percentage of firms with at least one job opening extended its all-time high (Chart 9, top panel) and hiring intentions over the next three months matched the high set late last cycle (Chart 9, bottom panel). Surging demand for workers is also evident in the record-high rate at which they’re quitting their jobs, presumably to hop to better ones (Chart 8, bottom panel). The Bond Market’s Take The Fed is at pains to avoid market disruptions from its inevitable future moves to tighten monetary policy from the pandemic’s emergency levels. It has explicitly laid out three criteria for hiking rates: year-over-year PCE inflation above 2%, PCE inflation on track to moderately exceed 2% for some time and labor market conditions consistent with its assessment of maximum employment. With both inflation criteria seemingly accomplished, attaining maximum employment shapes up as the swing factor. Maximum employment is a squishy concept that affords the Fed ample discretion in setting its liftoff date. Fed officials keep referring to the previous employment peak in their public comments, and we view it as a simple proxy for meeting its labor market condition. At the end of May, 7.6 million fewer people were working than at the cyclical employment peak in February 2020. At a monthly rate of 500,000 net payrolls gains, it would take fifteen months to get back to the pre-pandemic peak; at a 400,000 clip, it would take nineteen months. Sustaining monthly payrolls additions at the required 4.2% and 3.3% annualized rates for fifteen and nineteen months, respectively, may seem improbable, but it has been done before (Chart 10). The economy’s trend rate of growth was much faster in those past instances, but the employment decline was much larger now, like the fiscal aid meant to counter it. We expect that nonfarm payroll employment will recover its pre-pandemic peak level before the end of 2022. Chart 10It's Not Easy, But It Has Been Done Before Investment Strategy The 10-year Treasury bond yield spent much of April and May consolidating its August-to-March surge from 0.5% to 1.75% and has retraced about a quarter-point of it after its recent slide. It may well stay put or even ease a little more over the next month or so if the Fed sticks to its transitory inflation messaging and the hiring logjam stretches into the summer. We expect that it will eventually be broken, however, as school re-openings and the return of adult-care providers allow sidelined workers to come back to work and the end of enhanced employment benefits forces some lower-wage earners to clock in again. As the pace of hiring picks up in line with our expectations and increasingly points to a return to pre-pandemic employment sometime in the latter half of 2022, we expect that the fixed income markets will pull their liftoff date estimates forward. As market expectations get closer to our first-hike-in-2022 view, bond yields will rise and longer-maturity Treasuries will bear the brunt of the ensuing selloff. Over our cyclical 3-to-12-month timeframe, we therefore continue to recommend that investors underweight fixed income in multi-asset portfolios while maintaining large Treasury underweights and below-benchmark duration. There may well be a tactical opportunity to overweight duration in fixed income or equity portfolios, and our sister US Equity Strategy publication recommends overweighting growth sectors over value sectors to position for it. We do not disagree with our equity colleagues’ call but are keeping our asset allocation eyes fixed on the 12-month horizon.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 An individual is deemed to be in his/her prime-age employment years between the ages of 25 and 54. The baby boomers entered their prime working years from 1971 to 1989, and exited them from 2001 to 2019. 2Caregiving in the US 2020, AARP and The National Alliance for Caregiving. 3 The NBER’s business cycle dating committee declared that the last expansion ended in February 2020, but it has not yet made a judgment as to when the new one began. We assume it likely began in last year’s fourth quarter or this year’s first quarter.

Highlights Duration: The Fed will ignore inflation for the time being and focus on its “maximum employment” target to decide when to lift rates off the zero bound. As a result, bond investors should also ignore inflation and focus on the employment data. We anticipate that significant positive nonfarm payroll surprises will start in late-summer/early-fall and that they will catalyze a move higher in bond yields. Keep portfolio duration below benchmark. Fed Operations: We see no implications for the Fed’s balance sheet or interest rate policies stemming from the recent uptick in ON RRP usage. It is possible that the Fed will decide to slightly increase the IOER or ON RRP rates at this month’s FOMC meeting in an effort to move the funds rate closer to the middle of its target range, but we don’t view this as a pressing need. Inflation: Inflation will moderate in the coming months, but 12-month core inflation will remain close to or above the Fed’s target at least through the end of 2022. Baffling Bond Market Strength We’ve received more questions than usual in recent days, mostly from readers seeking to understand why long-dated bond yields fell during a week that saw one of the strongest CPI prints of the past 40 years and the Treasury dump $38 billion of new 10-year supply on the market. We believe we can explain the conundrum. First, consensus expectations are finally starting to catch up with the pace of economic recovery. Economic surprise indexes measure the strength of economic data relative to consensus expectations and they have fallen a lot compared to the elevated levels seen last year (Chart 1). In fact, if it weren’t for incredibly strong inflation data these indexes would be much closer to “negative surprise” territory. The Industrial Sector and Labor Market components of the Bloomberg Economic Surprise Index have already dipped well below the zero line (Chart 1, bottom panel). Encouragingly, the fall in surprise indexes has more to do with investor expectations ratcheting higher than it does with a slowdown in the pace of economic growth, or at least that is the message you get from the CRB/Gold ratio, an excellent coincident indicator for bond yields (Chart 2). The CRB Raw Industrials commodity price index serves as a proxy for global economic growth and it remains in a solid uptrend. What has changed in the past few weeks is that gold is also staging a rally (Chart 2, bottom panel). This tells us that bond yields are not falling because of a slowdown in economic growth. Rather, they are falling because investors see the Federal Reserve turning increasingly dovish. Chart 1Surprise Indexes Chart 2CRB/Gold Ratio Why might investors have this impression of Fed Policy? During the past few months the Fed has successfully convinced markets that it will not lift rates until its “maximum employment” target is achieved, irrespective of what happens with inflation or inflation expectations (more on this in the section titled “A Checklist For Liftoff” below). This explains why bond investors are ignoring positive inflation surprises and focusing instead on the employment data, which have been disappointing. Nonfarm payroll growth came in significantly below consensus expectations in both May and April (Table 1). In light of those disappointing numbers, investors have pushed out expectations for the timing of Fed liftoff and bond yields have fallen as a result. Table 1Monthly Nonfarm Payroll Results Versus Consensus In For A Jolt Chart 3Labor Demand Is Not The Problem We view the recent drop in yields as a bond market over-reaction to weak employment data. Investors are focusing on the weaker-than-expected nonfarm payroll numbers but ignoring skyrocketing indicators of labor demand such as the JOLTS Job Openings Rate, the NFIB Jobs Hard To Fill survey and the Consumer Confidence Jobs Plentiful less Hard To Get survey (Chart 3). As we have noted in past reports, the demand for labor has already fully recovered from the pandemic and it is the lack of labor supply that is holding back the employment recovery.1 That is, people are not making themselves available to work. When we think about possible reasons why people are not making themselves available for job opportunities, the most obvious candidates relate to the pandemic and the fiscal response to the pandemic. Table 2 shows the net number of jobs lost since February 2020 broken down by major industry group. It shows that the Leisure & Hospitality sector (mostly restaurants and bars) accounts for about one third of the net job loss. Together, the Education & Health Services and Government sectors account for another third. A lot of these missing jobs are close-proximity service industry jobs that pay a relatively low average hourly wage. It therefore shouldn’t be too surprising that people are reluctant to take these jobs due to fears of contracting COVID and the fact that they have received large income supplements from the federal government in the form of stimulus checks and expanded unemployment benefits. Table 2Employment By Industry It seems unlikely that these constraints to labor supply will persist beyond the next few months. Virus fears will ebb over time, as long as the case count remains low, and government income support will also go away. There will be no more stimulus checks and expanded unemployment benefits are scheduled to expire in September. Chart 4S&L Government Hiring Will Increase With this in mind, we expect that labor supply constraints will ease by end-summer/early-fall and the result will be significant upside surprises to nonfarm payroll growth. Bond yields will likely stay rangebound in the near-term, but the next significant move will be an increase in yields driven by strong employment data. As a final point on the labor market, we noted above that the Government sector accounts for about 15% of the net job loss since February 2020. In fact, all those missing government jobs are from state & local governments.2 State & local governments cut expenditures drastically last year, but thanks to a faster-than-expected recovery in tax revenues and generous transfers from the federal government, they actually saw overall revenues exceed expenditures in 2020 and again in the first quarter of 2021 (Chart 4). The upshot is that state & local governments are now in a position to ramp up spending, and their pace of hiring should accelerate in the coming months. Bottom Line: The Fed will ignore inflation for the time being and focus on its “maximum employment” target to decide when to lift rates off the zero bound. As a result, bond investors should also ignore inflation and focus on the employment data. We anticipate that significant positive nonfarm payroll surprises will start in late-summer/early-fall and that they will catalyze a move higher in bond yields. Keep portfolio duration below benchmark. A Note On Reverse Repos And Fed Operations Chart 5An Over-Supply Of Reserves Many investors have noticed that usage of the Fed’s Overnight Reverse Repo Facility (ON RRP) has surged during the past few weeks, and many are also wondering if this will force the Fed to alter its interest rate or balance sheet policies. The short answer is no. In fact, the increased take-up of the ON RRP is a sign that the Fed’s operational strategy is working as intended. Let’s explain. The Fed’s main task is to set a target range for the federal funds rate and then ensure that the funds rate stays within that range. Today, that target range is between 0% and 0.25%. The fed funds market is where banks trade reserves amongst each other. If the Fed has over-supplied the market with reserves, then they will be very cheap to acquire and the fed funds rate will fall. Conversely, if the Fed has under-supplied the market with reserves, they will be more expensive to acquire and the fed funds rate will rise. At present, the market is awash with reserves. This is the result of the Fed’s asset purchases and the Treasury department’s ongoing policy of reducing its cash holdings.3 This over-supply of reserves is forcing the fed funds rate down, toward the lower-end of the Fed’s target band (Chart 5). This is where the ON RRP comes to the rescue. Through the ON RRP, the Fed pledges to borrow reserves from any eligible counterparty at a rate of 0% using a security off its balance sheet as collateral. This effectively gives any eligible counterparty the option of depositing excess reserves at the Fed in return for a rate of 0%. The result is that the ON RRP establishes a firm floor of 0% under the fed funds rate. Chart 6An Under-Supply Of Reserves This is why we say that the ON RRP is working as intended. The market is currently over-supplied with bank reserves and the ON RRP is absorbing that excess while keeping the funds rate anchored within the Fed’s target range. We should note that, in addition to the ON RRP rate, the Fed also pays a rate of interest on excess reserves (IOER). This IOER rate is currently 0.10%. Much like the ON RRP, the IOER should function as a floor on interest rates since it promises banks a rate of 0.10% for excess reserves deposited at the Fed. The problem is that the IOER is only available to primary dealer banks that have accounts at the Federal Reserve. There are other major players in overnight money markets, such as the GSEs and large money market funds, and these institutions do not have access to the IOER, only to the ON RRP. It is this broader counterparty access that makes the ON RRP the true floor on interest rates. It’s also interesting to look back at a time when the Fed was grappling with the opposite issue. In September 2019 the Fed was supplying the market with too few reserves and the fed funds rate was rising as a result (Chart 6). During this period, the fed funds rate actually did briefly break above the top-end of the Fed’s target range. This is because the Fed does not have a standing facility to put a ceiling above rates the way that the ON RRP provides a floor. In September 2019, the Fed had to conduct ad-hoc repo operations – lending reserves in exchange for securities – in order to bring the funds rate back down. Fortunately, the Fed has plans to rectify this problem. The minutes from the last FOMC meeting reveal that a “substantial majority of participants” supported the establishment of a standing repo facility to serve as a ceiling on interest rates in the same way that the ON RRP serves as a floor. The establishment of such a facility will make it easier for the Fed to shrink the size of its balance sheet when the time comes. All in all, we see no implications for the Fed’s balance sheet or interest rate policies stemming from the recent uptick in ON RRP usage. It is possible that the Fed will decide to slightly increase the IOER or ON RRP rates at this month’s FOMC meeting in an effort to move the funds rate closer to the middle of its target band (the fed funds rate is currently 0.06%), but we don’t view this as a pressing need. It is more likely that the Fed will stay the course, knowing that the over-supply of reserves will abate once the Treasury’s cash balance re-normalizes and that the ON RRP will keep the funds rate well-anchored in the meantime. A Checklist For Liftoff Table 3The Fed’s Liftoff Checklist At the beginning of this report we claimed that, in determining when to lift rates off the zero bound, the Fed will ignore inflation and inflation expectations and will be guided only by the labor market. This claim stems from the three criteria that the Fed has said will determine the timing of liftoff (Table 3). Yes, above-target inflation is one of the items on the checklist. However, the checklist places no upper limit on inflation that would cause the Fed to ignore the checklist’s “maximum employment” criteria. Further, it’s highly likely that inflation will remain close to or above the Fed’s target at least through the end of 2022. In essence, this means that the inflation portion of the Fed’s liftoff checklist has been achieved and it is only employment that will determine the timing of liftoff. Inflation To see why inflation is likely to remain close to or above target levels we look at 12-month core CPI (Chart 7A) and 12-month core PCE (Chart 7B) and run some scenarios based on future monthly growth rates of 0.1%, 0.2%, 0.3% and 0.4%. For context, core CPI grew 0.9% in April and 0.7% in May. Core PCE grew 0.7% in April and May data have not yet been released. Chart 7A12-Month Core CPI Scenarios Chart 7B12-Month Core PCE Scenarios Charts 7A and 7B show that an average monthly growth rate of 0.2%, a significant drop from current rates, will cause 12-month core CPI and core PCE to level-off either at or above target levels and this leveling-off won’t even occur until the middle of next year. Given that we are likely to see at least a few more elevated monthly inflation prints, it is highly likely that inflation will be at or above the Fed’s target by the end of 2022. Employment As for the Fed’s “maximum employment” criteria, we have updated our scenarios for the average monthly pace of nonfarm payroll growth required to reach “maximum employment” by specific dates in the future. As a reminder, we define “maximum employment” as an unemployment rate between 3.5% and 4.5% and a labor force participation rate of 63.3%, equal to its February 2020 level. Our results are presented in Tables 4A-4C. We calculate that average monthly nonfarm payroll growth of between +378k and +462k is required to reach “maximum employment” by the end of 2022. As noted above, we expect that nonfarm payroll growth will come in far above this range starting in late-summer/early-fall. Table 4AAverage Monthly Nonfarm Payroll Growth Required For The Unemployment To Reach 4.5% By The Given Date Table 4BAverage Monthly Nonfarm Payroll Growth Required For The Unemployment To Reach 4% By The Given Date Table 4CAverage Monthly Nonfarm Payroll Growth Required For The Unemployment To Reach 3.5% By The Given Date All in all, we think that the Fed’s maximum employment and inflation criteria will both be met in time for a rate hike in 2022.   Ryan Swift US Bond Strategist rswift@bcaresearch.com Footnotes 1 For more details on the lack of labor supply please see US Bond Strategy Weekly Report, “Making Money In Municipal Bonds”, dated April 27, 2021. 2 The federal government has added a net 24 thousand jobs since Feb. 2020. State & local governments have lost a net 1.2 million. 3  For more details on how the Treasury department’s cash management policy is influencing the supply of bank reserves please see US Bond Strategy Weekly Report, “No Panic From Powell”, dated March 9, 2021. Fixed Income Sector Performance Recommended Portfolio Specification