Turning a battleship in the ocean
The juggernaut U.S. economy is pointed in the right direction with engines pumping.
Based upon the extraordinary amount of stimulus orchestrated by the Federal Reserve, Congress and the Trump administration last year, we knew 2021 would be a huge year for economic and corporate profit growth. Using fiscal and monetary policy to adjust an economy as large and complex as ours is not like flipping on a light switch. It’s much more akin to turning a huge ship in the ocean. It usually takes 12 to 18 months for the full effect of a change to impact the economy.
But President Biden’s $1.9 trillion American Rescue Plan (ARP) put cash directly into the pockets of 75% of Americans, and they spent some of it immediately. In conjunction with temperate weather and a broad re-opening of the economy, that spending contributed to strong retail sales in March, a positive trend we expect will continue into April. With Covid-19 infections falling and vaccine distribution accelerating to about 3 million doses per day, we now forecast adult herd immunity will arrive around Memorial Day, not Independence Day.
Economic activity is normalizing more quickly than we had previously thought it would. Businesses and schools are re-opening and social-distancing restrictions are being lifted in bars, restaurants, retailers and stadiums. At 13.6%, the personal savings rate in February is double the 6.6% average over the past 20 years. Many of us have money burning a hole in our pockets. As we get our vaccines and joyfully swap cabin fever for economic jailbreak, GDP and corporate profit growth should surge.
The labor market has recovered sharply over the past year, with initial weekly jobless claims down 91% and the unemployment rate decreasing from a peak of 14.8% in April 2020 to 6% last month. Workers in sectors such as leisure & hospitality, retail, education, health care and governments have made the biggest strides in recent months. The unemployment rate for individuals with less than a high school diploma, which peaked at 21.2% last April, plunged to 8.2% last month. In contrast, the unemployment rate for those with a bachelor’s degree or higher, which peaked at 8.4% last April, fell to 3.7% last month.
Business and consumer confidence strengthened in recent months, consumer spending rebounded strongly in January and March, housing reached a 15-year high, manufacturing hit a 38-year high, and inventory accumulation resumed in the fourth quarter after a year of liquidation. The earnings recession is over, and first-quarter corporate profits likely rose a stronger-than-expected 30% on a year-over-year basis, with a rate potentially double that on tap in the second quarter. We still believe that the recession likely ended in May or June 2020, but the official word from the National Bureau of Economic Research has not come yet.
The one potential fly in the ointment is that nominal commodity inflation has spiked over the past year, although core inflation has remained below trend. However, over the next several months, we will be lopping off low or negative inflation readings from the depths of the recession a year ago, resulting in a spike in core CPI and PCE by the summer. Is that rise transitory, as the Fed believes, or it is sustainable, as the market is beginning to think? Will it prompt a change in the Fed’s accommodative monetary policy stance at some point in the cycle? Up until now, Fed Chair Powell has remained steadfast that the fed funds rate will stay zero-bound through at least the end of 2023, and the Fed will continue indefinitely its monthly purchases of $120 billion in Treasuries and mortgage-backed bonds.
Benchmark 10-year Treasury yields have moved sharply higher, from 50 basis points last August to 90 basis points in December to 1.75% a fortnight ago, as the bond vigilantes have been pricing in a stronger economy. Forward-looking equity investors agree, and the S&P 500 has soared more than 90% from its historic trough last March 23 to last week’s new record high. We are sticking with our full-year target of 4,500, which implies 20% total return potential this year.
Tweaking our GDP estimates The equity, fixed-income and liquidity investment professionals who comprise the Federated Hermes macroeconomic policy committee met last Wednesday to discuss the powerful economic rebound that’s been underway since the middle of 2020 and the impact that President Biden’s fiscal stimulus plans may have on both the economy and financial markets:
- The Commerce Department revised fourth-quarter 2020 GDP up to a gain of 4.3%, but left full-year 2020 GDP at -3.5%.
- The Commerce Department will flash first quarter 2021 GDP on April 29. The U.S. economy has been in a powerful recovery mode since the middle of last year, and the ARP is the cherry on top. We raised our estimate from 5.4% to 5.9%. Blue Chip consensus raised its from 2.9% to 5.4% (within a range of 3.7% to 7.4%), and the Atlanta Fed’s GDPNow forecast is now at 6%.
- As the accelerated pace of vaccine distribution is unleashing a stronger-than-expected wave of economic activity, we increased our second-quarter 2021 growth forecast from 7.5% to 8.3%. Blue Chip consensus raised its from 6.3% to 8.7% (within a range of 6.1% to 11.6%).
- By pulling our forecast for adult herd immunity forward from Independence Day to Memorial Day, we trimmed our third-quarter 2021 estimate from 8.1% to 7.9%. Blue Chip increased its from 6.2% to 7.5% (within a range of 5% to 10.4%).
- We’re expecting a good Christmas, so we raised our fourth-quarter 2021 forecast from 5.5% to 5.9%. Blue Chip raised its from 4.7% to 4.9% (within a range of 3.2% to 7%).
- We raised our full-year 2021 GDP growth estimate from 6.1% to 6.4%. Blue Chip raised its from 4.9% to 6.3% (within a range of 5.3% to 7.3%). If achieved, that would be the strongest full-year growth since 1984, when the U.S. economy rose 7.2%.
- We are forecasting core CPI inflation of 2.6% for 2021, up from a trough of 1.2% last June; we are also projecting core PCE inflation of 2.2% in 2021, up from a trough of 0.9% last April.
- But we are concerned about the potential fiscal drag from higher tax rates embedded in Biden’s $4 trillion infrastructure proposal, which will be debated in Congress this summer. So we raised our full-year 2022 GDP growth estimate only modestly, from 4.5% to 4.6%. Blue Chip raised its forecast from 3.8% to 4.3% (within a range of 3.2% to 5.4%).
- We raised our 2022 forecast for core CPI to 2.8% and core PCE to 2.4%.
Happy birthday, Nina!