With recession over, it's time to pare fiscal and monetary stimulus.
The shortest and deepest recession in history ended in April 2020, just two months after it started, according to the National Bureau of Economic Research (NBER), whose Business Cycle Dating Committee made the pronouncement on Monday. The sharp downward spike that arrived that February with a once-in-a-century pandemic brought an abrupt end to the longest economic expansion in U.S. history—128 months from its start in June 2009.
Our longstanding forecast had been that the Covid recession ended in May or June of last year, so the end came a little earlier than we thought, aided by a powerful V-bottom economic rebound from the second to third quarter of 2020 amid unprecedented fiscal and monetary support. We also had thought the NBER would announce its conclusion this September, as it typically needs 12-15 months of data after a recession ends before it’s comfortable declaring it’s over.
The S&P 500 has doubled since its March 2020 pandemic trough, and the labor market continues to improve, consumer spending remains strong, inventory-constrained housing is at a 15-year high, manufacturing activity is working through supply-chain bottlenecks and companies are rebuilding their inventories.
Washington, however, has been conducting itself as if the recession is still raging, with uber-aggressive policy accommodation. So, the NBER’s announcement should represent an important inflection point, as the time to scale back our extraordinary fiscal and monetary stimulus is finally at hand.
Delta, Delta, Delta The success of Operation Warp Speed last year led to a surge in vaccine distribution from square zero in December 2020 to 3.5 million daily jabs in April 2021, allowing us to approach adult herd immunity. But the recent ascent of the highly contagious Delta variant, which now accounts for more than 80% of all new Covid infections in the U.S., comes as vaccination rates have fallen by 87% over the past three months to 450,000 jabs per day. This has fueled fears that a dreaded fourth wave is building, which may result in the re-imposition of mask mandates and another economic lockdown. However, the two-shot Pfizer and Moderna vaccinations have proven highly effective against the variant so far.
Inflation is soaring and sustainable The core PPI hit 5.5% year-over-year (y/y) in June, a record high, and core CPI was up 4.5% y/y, a 30-year high. Next week, we’ll see the core PCE (the Federal Reserve’s preferred measure of inflation), which we expect to rise 4% y/y for June, which would also be a 30-year high and at a level twice the Fed’s long-term 2% target. Due largely to energy prices and wages, which are rising sharply, we continue to expect that inflation will be much stickier and more sustainable than the Fed or the Biden administration believe.
However, in his prepared remarks at last week’s semi-annual Humphrey Hawkins testimony before Congress, Chair Powell admitted that “inflation has increased notably and will likely remain elevated in coming months before moderating.” This is an important acknowledgment as the so-called “procedural base effects” (negative inflation readings rolling off from a year ago) have already happened, and inflation is still rising sharply. Why is this? Because the supply-chain bottlenecks and strong business and consumer demand are still in motion, due to elevated savings rates and, arguably, overly generous government transfer payments. So, Powell’s Jackson Hole speech at the end of August will be critically important, potentially setting the table for a change in the Fed’s patient QE and ZIRP policies.
Are second-quarter profits the cycle’s peak? We’re nearly a quarter done with the Q2 reporting season and profits (compared with the pandemic-impaired year-ago quarter) will represent the strongest earnings growth since the fourth quarter of 2009. Revenues are up 18.5% y/y, with 79% of the companies beating consensus expectations by an average of 4.3%, the best growth and beat rates in recent history. Earnings-per-share are up 107% y/y, with 88% of the companies beating consensus estimates by an average of 18%.
The consensus had expected a 60-65% y/y increase in second-quarter profits; we were a little more aggressive with a 75% estimated gain. The market’s internals, however, tell an even stronger story. Domestic large-cap growth companies (like technology) are up by 30% y/y. But cyclical, domestic large-cap value companies (like financials, consumer discretionary, industrials, energy and materials) are posting y/y gains of 100% or more, as these companies were left for dead when the nation voluntarily shuttered the economy a year ago.
Tweaking our GDP estimates The equity, fixed-income and liquidity investment professionals who comprise Federated Hermes’s macroeconomic policy committee met in person this week for the first time since the pandemic to discuss the economic recovery:
- The economy started the second quarter with momentum but lost some steam in June as the pace of vaccinations slowed, some commodity prices began to recede and supply-chain bottlenecks impaired the growth of some key metrics. As a result, we trimmed our second-quarter 2021 GDP estimate from 9.2% to 9%, compared with final first-quarter GDP of 6.4%. The Blue Chip consensus also ticked its forecast down from 9.2% to 9.1% (within a range of 6.9% to 11%). The Bloomberg consensus is now at 8.3%, and the Atlanta Fed reduced its GDPNow forecast from 10.1% to 7.5%. Commerce will flash its initial read of Q2 GDP next Thursday, along with annual benchmark revisions.
- We’re still expecting a strong back-to-school season but are more concerned about rising inflation. So, we reduced our third-quarter 2021 GDP estimate from 8.1% to 7.8%. The Blue Chip raised its forecast from 7.2% to 7.3% (within a range of 5.2% to 9.2%).
- We’re still expecting a strong Christmas, so we increased our fourth-quarter 2021 GDP estimate from 6% to 6.2%. The Blue Chip raised its estimate from 5.1% to 5.5% (within a range of 3.5% to 7.8%).
- Those collective changes lowered our full-year 2021 GDP estimate from 6.8% to 6.7%. The Blue Chip forecast was unchanged at 6.6% (within a range of 6.0% to 7.1%). This would be the strongest full-year GDP growth since 7.2% in 1984.
- Due to sharply rising inflation, we raised our forecast for core CPI inflation from 4% to 5% for 2021, up from a trough of 1.2% in June 2020 (a 9-year low). We also raised our forecast for core PCE inflation from 3.8% to 4.5% in 2021, up from a trough of 0.9% in April 2020 (a 10-year low).
- We remain concerned about the potential for fiscal drag from sharply higher tax rates and federal debt, if President Biden’s proposed $3.5 trillion “human infrastructure” bill passes in a party-line reconciliation vote later this year. But we kept our full-year 2022 GDP estimate unchanged at 4.2%. The Blue Chip, however, raised its forecast from 4.4% to 4.5% (within a range of 3.5% to 5.5%).
- We increased our forecast for core CPI inflation from 2.9% to 3.3% for 2022 and raised our forecast for core PCE inflation from 2.6% to 2.9%.