What a difference a month can make in economic data and related perceptions for longer-term economic growth. As mentioned last month, the ebullient readings for personal income and retail sales in March were a one-time event as a result of the fiscal stimulus package passed on March 11. Data released during May for the April period have come back to earth and indicate that challenges remain in the economy. Meanwhile, inflation and the Fed’s position on inflation continue to be the areas generating the most interest among economists and investors.
Starting with inflation, the April Consumer Price Index (CPI) advanced at a year-over-year rate of 4.2%, the strongest such reading since 2008. The April Producer Price Index (PPI) grew 6.2% year-over-year. The elevated readings are comparisons to April 2020 when the economy was feeling the initial impact of the pandemic. They also reflect the re-opening of the economy in which demand is currently outstripping supply. The Fed’s position is that these inflationary readings are transitory (9-12 months), and consequently do not require any change in their monetary policy. The bond market is giving the Fed the benefit of the doubt, so far, as shown by 10-year Treasury rates remaining around 1.60%.
Supporting the Fed’s position is the recent report showing that productivity in the non-farm business sector increased at 5.4% in 1Q-21 while unit labor costs only rose 1.7%. Sustained inflation pressures are not likely to develop while productivity is growing faster than unit labor costs. Along this same line, capacity utilization of corporate resources remains significantly below historic levels where inflationary pressures become problematic.
Next, the report on retail sales during April was flat, coming off the 9.8% reading for March that was clearly supported by fiscal stimulus. Also reflecting no additional stimulus, personal income was down 13.1% in April. The personal savings rate remains nearly twice what it was pre-COVID and may be indicating some caution by consumers as they look toward the expiration of extended unemployment benefits. The little publicized fact is that real incomes excluding government transfers are slightly negative year over year, thus demonstrating that the economy remains heavily dependent on fiscal stimulus to grow until employment levels recover more completely.
The May employment report, released on June 4, showed a gain of 559,000 in non-farm payrolls. This was an improvement from the anemic April report showing a gain of 278,000 but below expectations of 675,000. The level of employment is still 7.6 million below the pre-COVID peak, and it will take more than 12 months at the current pace to return to the previous peak. The unemployment rate fell to 5.8% from 6.1% due to a 53,000 reduction in the labor force. People are reluctant to return to work for various reasons. With the expiration of extended unemployment benefits in half of the states, it will be interesting to see if the labor force starts to increase during the coming months.
The labor market is not displaying the “substantial progress” that the Fed wants to see that would warrant a change in monetary policy. The Fed rarely, if ever, starts tightening its policy before the job losses from the previous recession are recovered.
The second release of the 1Q-21 real GDP report showed no change from the previously reported 6.4% annualized advance. Expectations for growth in the second half of 2021 are beginning to be tempered, however, as the reliance on stimulus becomes more evident. A potential risk is that growth in the last part of the year could be weaker than forecast as fiscal stimulus runs out. Remember what happened in fourth-quarter 2020 when fiscal stimulus ran out.
Longer term, the prospect of slower growth is not only reflected in private forecasts but acknowledged in the current budget proposal by the administration that was released in May. While expecting fiscally supported above-trend-growth in 2021 and 2022, the administration expects real GDP growth to return to 2.0% or lower from 2023 through the end of the decade. Although not specifically mentioned, the impact of the ever-increasing government debt is clearly the long-term headwind for economic growth.