While a full recovery remains likely, the full-employment economy of 2022 will be very different from the full-employment economy of 2019 — and the differences may have important implications for investors.
Dr. David Kelly
Chief Global Strategist
The broad story on the U.S. economy remains one of very strong recovery. Real GDP numbers for the first quarter showed strong 6.4% annualized growth. However, April data for consumer spending, inventories and durable goods orders reinforced our view that this growth is accelerating and that second quarter growth could be over 10%. Even with a moderation in the growth rate in the second half of the year, real output by the fourth quarter of this year could be up by roughly 7.5% year-over-year and by 5% relative to the fourth quarter of 2019, essentially marking a full recovery from the pandemic recession, even accounting for normal trend-like GDP growth.
Exhibit 1: GDP looks set to surge as the pandemic recedes
Billions of chained (2012) dollars, seasonally adjusted at annual rates
The labor market tells a similar story with the economy producing a net gain of 559,000 jobs in May, with the unemployment rate falling from 6.1% to 5.8%. While this was a marked improvement from April’s disappointing report, it still understates the potential for major job gains in the months ahead. Survey data confirm that many businesses are hungry to hire workers and that workers recognize the strength of labor demand. However, employment growth continues to be restrained by lingering pandemic worries and by generous federal unemployment benefits.
Thankfully, as more Americans have gotten vaccinated, the pandemic has receded and should be a much less significant drag on the labor market in the months ahead. In addition, 25 states, accounting for more than 40% of U.S. workers, are ending supplemental unemployment benefits by early July, while these benefits will expire for everyone else by September 6. In combination, these trends should eliminate most of the current distortions in the labor market, potentially allowing the unemployment rate to fall below 5% by the fourth quarter of this year.
The Evolving Expansion
However, while a super-fast economic recovery remains on track, a detailed look at April consumer spending reveals the distortions wrought by the pandemic and massive fiscal aid.
Some areas clearly remain depressed. Compared to April 2019, real consumer spending in April 2021 was down 16% for dentists, 17% for flights, 30% for taxis, 38% for hotels, 46% for hairdressers, 65% for spectator sports and 89% for movie theatres. Presumably, most of this spending will fully recover by the end of the summer, as pandemic restrictions fade.
Exhibit 2: Consumer spending has changed materially in the pandemic
Percent change in real consumer spending from April 2019
Other areas have thrived through the pandemic. Again compared to April 2019, real consumer spending in April 2021 was up 9% for food consumed at home, 18% for lottery tickets, 19% for alcohol consumed at home, 28% for jewelry, 36% for televisions, 53% for games and toys, 58% for computer equipment and 66% for new light trucks. Some of this will likely fade in the months ahead, as consumers devote more of their money to services and return to their physical workplaces in greater numbers. However, some of it reflects a surge in household wealth from a booming stock market and in income from generous federal aid, and these areas should continue todrive consumer spending even as the pandemic winds down.
More importantly, both the pandemic and massive fiscal stimulus have changed the economic landscape.
- How and where we work will likely be permanently altered:
Multiple recent surveys1 have shown that most employees who were forced to switch to remote work by the pandemic feel the change has largely been productive and would prefer a remote or hybrid model going forward. While maintaining motivation and a corporate culture requires some in-person interaction, particularly for younger employees, the forced adoption of work-from-home technology will likely permanently reduce the demand for office space. This could also alleviate peak-hour traffic congestion and the need for new physical infrastructure. A similar argument can be made for business travel, which will likely be permanently reduced by the adoption of virtual technology.
- Cheap labor will become increasingly scarce: While Federal Reserve (Fed) officials might argue otherwise, there is clear evidence that a tightening U.S. labor market was adding to wage growth prior to the onset of the pandemic. A very quick recovery from the pandemic will mean much less time for labor market slack to erode wage growth as, of course, will generous unemployment benefits. In addition, a sharp decline in immigration, even before the pandemic, is limiting U.S. labor supply, and the highly political nature of the immigration debate suggests that this trend may continue for some time. All of this points to stronger wage growth in the wake of the pandemic. Conversely, very easy monetary policy could continue to fuel investment in labor-saving technology, such as robotics and artificial intelligence. This could herald the arrival of stronger productivity growth across the economy.
- The risks of higher inflation and interest rates have increased: The failure of monetary stimulus to generate either stronger economic growth or higher inflation in the last expansion has resulted in even more dovish Fed policies. Meanwhile, political populism on both the right and left has reduced concerns about rising government debt. Both of these trends suggest that debt will increase and monetary policy will remain very easy until inflation is steadily above the Federal Reserve’s 2% long-run target for the personal consumption deflator. Indeed it is worth noting that the personal consumption deflator posted a 3.6% year-over-year increase in April. If prices, by this measure, rise by just 0.2% per month for the rest of the year, inflation will still be 3.2% year-over-year by the fourth quarter of 2021.
There is now a very good chance that real economic growth will be stronger and inflation will be higher in the fourth quarter of 2021 than in current Federal Reserve projections. As we note in our comments on fixed income, this could well force the Fed to taper bond purchases in late 2021 or early 2022 and raise the federal funds rate in late 2022 or early 2023.