The latest Federal Reserve Beige Book noted that economic activity increased from early April to late May as vaccinated consumers returned to normal activities and businesses dropped pandemic restrictions. Economic activity is picking up as vaccinations are increasing and restrictions are being relaxed. Firms benefited from an $800 billion assistance for small businesses and owners are yearning for a return to a “normal” economy. Along the way, Major League Baseball is slated to return to full capacity and the largest state economy, California, will shed its final COVID-era restrictions on June 15 and give bars, restaurants, and other businesses a green light on the road back to “normal”. Despite a strong advance, the recovery is not without problems. Despite still having large numbers of unemployed people, labor shortages persist in the United States. Supply chain shortages are rampant across the manufacturing sector and inflation is emerging as a threat to future growth. This article will attempt to shed some light on future economic developments and to show that the economic transformation that we are seeing now will hopefully develop into a self-sustaining economic recovery.
Unprecedented economic numbers
First, the economy fell at an extremely sharp pace in the spring of 2020 but rebounded quickly. Real GDP fell 3.5% for the whole year in 2020, but this overall number somewhat clouded the extraordinary bounce back in the second half of the year. Stimulus will juice the economy in 2021, with a projected 6.4% increase. 2022-23 will present new challenges as the economy returns to a rate more closely associated with a “normal” trend of growth. Real GDP is projected to rise 3.0% in 2022 and 2.3% in 2023. July may be the month that marks the turning point return for the economy. The direct stimulus that boosted consumer spending earlier in the spring will fade and growth will be supported by the economy’s own strength, that is, pent-up demand for services and slow healing of the labor market back to a more conventional pattern of work.
COVID-19 was a shock event and such occurrences do result in changes in the economy. For example, the last great downturn was centered in housing. When that bubble burst, there were changes in housing loans and collateral that kept housing in the slow lane for years. In this recession, millions of people worked at home, a sea-change in how business is conducted. How consumers and businesses react in the coming months will leave a lasting mark on business strategy. Some analysts theorize that the large corporate offices, located in central metropolitan areas are doomed and the large proportions of the labor force will work at home, or in a mobile environment. Others say that human memory is short, and people will return to the office-centered environment in a few years. Likely, it will be some combination between the two, with some mobility and some fixed assets.
Supply chain bottlenecks
The main obstacles facing manufacturing are the supply chain bottlenecks that have slowed production and drove up prices of key input materials. The semiconductor shortage is a particularly intense issue slowing global production of autos and other transportation equipment. We expect a slow improvement in the supply problem. The supply chain is being held back by a lack of labor and the continuing bottlenecks in primary input commodities. There are some industries that are seeing a marked improvement in their supply chain problems for a particular industry. Others are only seeing slow improvement. Some analysts say the problem will be largely gone by the end of this year. Others say the problem will linger into 2022. For commodity and other inputs, we still expect a positive improvement in deliveries. The improvement is expected to display volatility. There will be months where deliveries speed up and others where there will be slowness, depending on when the critical input item is delivered. You will likely see a zig-zag course in manufacturing and industrial production over the next few months, as semi-finished goods receive the input part and are shipped.
Price increases are rampant, not only here but on a global scale. The rapid rise in prices has led to long-term inflation fears. A peek at past economic rebounds reveals that the law of supply and demand does still apply. Although recent inflation figures are indeed scary, there is some thought that we have reached peak inflation and are now heading for a period of at least, less intense inflationary numbers, or even lower prices for some key inputs. Prices of some commodities have started to retreat in recent weeks. Lumber futures are down about 24% from their peak in May and the prices of copper and aluminum are down about 5%. Bond markets soared earlier this year in fear the extra stimulus provided by the U.S. and other governments might start a period of runaway inflation that would force the hand of central banks. The Federal Reserve has repeatedly said that near-term price surges will not metastasize into lasting inflation, an assertion reflected in the University of Michigan’s consumer sentiment report, which showed inflationary expectations easing from last month’s spike. The yield curve has flattened, with the spread between the 10-year and the 2-year yield at its narrowest since late February.
In the U.S., consumer prices are continuing to increase at a rapid pace and the big question is whether inflationary pressures will settle down as some of the upward push is thought to be transitory. The CPI rose 0.6% in May, following a 0.8% advance in April. Over the last twelve months, the CPI has increased 5.0%, the largest increase since a 5.4% increase in August 2008. The index less food and energy rose 0.7% in May after posting a 0.9% advance in April. The core index was up 3.8%, the largest 12-month increase since June 1992. Inflation is projected to slow during the second half of the year. If that does not occur and inflation remains at a high level, the Fed will likely be forced to move quicker than planned. In the Fed’s latest meeting, more officials expected an interest rate move by the end of 2023, a assertation that suggests the Fed is waking up.
Central banks prepare
One of the reasons that economists expect inflation to settle down is that the world’s central banks are laying the groundwork to a transition to a life with less global stimulus. Many countries are already signaling moves towards the exit. While the Federal Reserve is committed to keeping interest rates near zero and no hikes are prices in until late near year at the earliest, official comments could lean towards some tapering in coming months. The Fed has said it would not start to taper back its huge stimulus until there has been “substantial further progress” in healing the U.S. job market. The Fed made no change at the last meeting, but some economists expect the Fed will start to communicate its taper policy at the meeting in August at Jackson Hole, with possible action later in the year.
In April, Canada’s central bank became the first among the Group of Seven to withdraw its pandemic era stimulus and signaled rates could rise in 2022. New Zealand and South Korea have already dropped broad hints that policy tightening is on the agenda as conditions improve. Economists believe that the inflation rates we see today are transitory and are to be expected in the early stages of a recovery. However, as the cycle matures, these inflation pressures will subside owing to the structural forces that have kept inflation at bay for the last ten years. There will be divergence in different economies as to withdrawing stimulus, but the road ahead remains clear, the stimulus is ending, and inflation should quiet down.
Employment is another problem facing businesses and relief may be slow in resolution. The NFIB reports that 48% of small businesses have at least one position that is hard to fill, a record high. Employment statistics are currently confusing, with the combination of people receiving enhanced benefits, those who are actually unemployed and those leaving the labor force clouding the picture. There is currently about one job position nationally for every unemployed person, something usually associated with a very healthy labor market. Wages are rising, yet there are about 3.6 million more people unemployed than before the pandemic and about 3.5 million people have left the job market altogether.
25 states are calling for an early end to the pandemic-related unemployment benefits, assuming an end of the enhanced benefits will drive people back to work and lower the record job vacancies. Some states have already moved to end the enhanced benefits and others will follow suit in early-July. The enhanced benefits are set to disappear in September. Those states that are planning to end benefits have recovered about 80% of the jobs lost in the pandemic, versus a 66% rate in the rest of the nation. The early end of benefits in half the country has set up an experiment on how much the weekly $300 is influencing behavior and how many people can be coaxed back into the workforce. So far, the numbers are hard to read. On a nonseasonal adjust basis, continuing claims for unemployment insurance fell by around 5% nationwide in the week ending May 29 and were little changed in the week ending June 3. The decline was about the same in states that stopped benefits early and those that did not. Unadjusted continuing claims in Alaska, Iowa, Mississippi and Missouri, the four states ending benefits as of June 12, rose 1.8%. The suggestion is that the forces driving the labor market are complex. There may be an improvement in finding labor, but the pace will be slow.
Moving back to trend growth
Last year was a roller-coaster, but the road ahead will be flatter. The economy is going to slow from over 6% growth in real GDP to a more trend like 2%. For long-term development, this is good, but returning to a world of pre-pandemic numbers might not be too exciting. This slowdown in economic activity could affect consumer and business confidence. The consumer will not be seeing any more stimulus checks, and businesses will have to survive without any PPP loans and other efforts that helped them get through a steep recession and get back on their feet. Of course, the steadiness of the trend growth of 2% does have many good points. The road back to this trend growth may also be rocky. Consumers and businesses have been spending on consumer durable goods at an extraordinary rate and not spending on services. The strength in the goods sector has resulted in strong orders for trucks and trailers. If spending reverts to its pre-pandemic ratios between goods and services, demand for goods will be lessened. Real GDP growth might not be affected, but less spending on goods means less freight and the need for transportation equipment to haul.