The US economy is heading into spring with the strongest set of economic metrics we have seen in a long time. The passage of the $1.9 trillion fiscal stimulus brings the total amount of fiscal support to nearly $5 trillion (approximately 25% of GDP) since the onset of the pandemic.
Even as this influx of stimulus is making its way into the economy, the Fed reiterated their commitment to keeping interest rates anchored near 0% while maintaining their monthly purchases of $120 billion in assets until they see “maximum employment” in the labor market and inflation averaging 2%. Meanwhile, the consumer has built up a surfeit of savings that is over twice the level before the pandemic – and this was before the last batch of checks had been sent out – so there is considerable wherewithal for consumer spending to significantly increase.
The employment report for March most clearly showed the impact of the acceleration in the vaccination rate that is facilitating the re-opening of the economy. Broad-based gains across nearly all industries led to the strongest increase in payrolls since August (+916,000). The prior two months were also revised upwardly. The unemployment rate dropped from 6.2% to 6.0%, but the participation rate only increased from 61.4% to 61.5% (it was 63.3% in February 2020) suggesting that there is more slack in the labor market than the unemployment rate indicates.
The number of unemployed (those actively looking for employment) continues to trend lower, but at 9.7 million is still four million higher than February 2020. Over 18 million (9 times pre-Covid levels) are receiving some form of unemployment insurance. It is unlikely that the Fed will consider labor markets fully recovered until we see the participation rate and the unemployment rate back to near pre-Covid levels.
Manufacturing remains a bright spot in the recovery. The recent ISM manufacturing survey showed the strongest reading since 1983. Low inventories and inflated backlogs suggest that upward pricing pressures will become evident in the near term until production can catch up with pent-up demand that is expected to continue to accelerate as the economy re-opens.
Inflation risks are receiving a lot of attention as evidenced by the 1.1% increase in the 10-year Treasury yield over the past eight months. Inflationary expectations are the prime determinant of long-term interest rates. Inflation expectations for the next five years are now the highest since 2008 and are being driven higher by the historic amount of fiscal stimulus being provided to the economy and the imbalance between supply and demand during the re-opening of the economy. Additionally, the Fed has stated that they are prepared to allow inflation to run above their goal of 2% for some time before taking steps to rein it in.
Core inflation, which excludes the impact of food and energy prices, has been relatively stable but will likely show increases over the next several months as year/year data will make comparisons to the weak inflation numbers experienced at the outset of the pandemic last year. The anticipated jump in year/year inflation readings is expected to be transitory, however, as the overhang of excess labor supply will act as a deflationary force. Nevertheless, the re-acceleration of inflation remains one of the biggest risks on the economic horizon, outside of Covid.
Finally, given record fiscal stimulus, an accommodative Federal Reserve, and a consumer with elevated levels of savings, it is no wonder that expectations for GDP growth in 2021 have been steadily increasing and are now approaching 7% for the year -the strongest yearly reading since 1983 and 1984. The continued improvement in the pace of vaccinations is a basic assumption incorporated into the stronger GDP estimates. The path of the Covid virus and its variants remains a wildcard, however, in how smoothly and quickly the economy will be able to achieve this potential.