Punchbowl Dynamics in a “K”omplex Economy
In our December U.S. outlook we mentioned the complex set of economic risk factors that we are weighing. That set of risk factors has become even more complex over the last month for at least two key reasons. First, the discovery of multiple hybrids of the coronavirus, combined with the less-than-fluid rollout of vaccines in the U.S. and in many other countries, is a concern. The progress in the development of vaccines last fall reduced tail risk from the coronavirus pandemic, but it did not eliminate it. The slower-than-expected rollout of the vaccines, combined with only partial uptake by populations, in the presence of a mutating virus, suggests that there will be an opportunity for the virus to continue mutating, elevating the risk of long-term economic drag from the pandemic.
Second, the outcome of the Senate runoff election in Georgia has shifted the balance of power in Washington. The control of both legislative chambers by the Democrats increases the likelihood of additional significant fiscal stimulus early this year. Incoming Senate majority leader Schumer has stated that he wants to issue checks as soon as possible. Additional fiscal stimulus increases upside risk for the U.S. economy in the near term. It also increases the hangover risk associated with ballooning federal debt, and it may increase the risk of inflation later.
Recent labor data is also complex. Payroll employment declined by 140,000 jobs on net in December, worse than consensus expectations. The decline in December payrolls continues a months-long trend of cooling job growth following the spring/summer bounce-back in employment as businesses reopened. However, the industry data in the December jobs report shows some very positive developments. Construction companies gained 51,000 workers as the single-family component of the market remained strong. Manufacturers hired an additional 38,000 workers, consistent with the strong ISM Manufacturing Index for December. Wholesale trade added 25,100 workers. Retail trade was very strong, up 120,500 workers, including seasonal adjustment. Transportation and warehousing added 46,600 jobs. Professional and business services employment was up by 161,000.
The inflation story is complex too. In the Great Recession of 2008-2009 commodity markets were buoyant ahead of the recession and deflated with the recessionary crash in demand. Now we see the opposite pattern. Commodity markets were softening before the recession and are tightening up through it. In the December ISM Manufacturing and Service reports, every commodity input listed in both reports was up in price in December. Often we think about inflation resulting from one of two key dynamics, demand-pull and cost-push. Now, even with soft demand at the end of 2020, it looks like the embers of inflation in industrial commodities may be warming up, and may eventually push on consumer inflation. Add in the falling value of the dollar putting upward pressure on import prices for good measure.
After a weak winter, we expect the U.S. economy to show above-trend growth in the second half of 2021, likely extending into 2022. Low interest rates, the unleashing of pent-up demand, improving confidence, the vaccines and fiscal stimulus are a potent combination. Many countries globally share these attributes. Still, we are mindful of the K-shaped economy, characterized by winners and losers. K-shaped and complex = “K”omplex.
The potential for warming inflation brings us to the Fed. Former Fed chair William McChesney Martin famously said that the Fed’s job is, “to take away the punch bowl just as the party gets going.” That is, the Fed’s job is to raise interest rates and dampen growth before inflation takes hold. However, Jerome Powell’s Federal Reserve has plainly stated that the current Fed has a new reaction function. The Powell Fed has instructed us that they will tolerate above-2-percent inflation for brief periods of time as long as they think inflation is still centered near 2 percent. They have also said that they will not pre-emptively raise interest rates before companies re-absorb excess labor. We will see if lower for longer leads to a happier party, and if a happier party leads to a bigger hangover.
For a PDF version of this publication, click here: January 2020 U.S. Economic Outlook
