Recap: Recent U.S. economic data have been serially exceeding expectations. From the ISM manufacturing and service data that revealed not just resilience but the power to households that reflected a strong appetite to spend their government stimulus checks, to employment gains that signaled more of the same is to come in the months ahead. With fiscal stimulus in place and vaccine supply to soon outstrip demand, the U.S. economy has rapidly absorbed any remaining slack.
However, it has become increasingly evident the fastest growth in decades comes with some significant growing pains. Longer lead times, lack of available labor, and supply chain constraints have presented maddening speed bumps for economic growth. These challenges have been as disruptive to multinational manufacturing operations as they have been to independent tradespeople and even the most basic service providers with shortages ranging from microchips to two-by-fours to chicken wings.
Predictably, the scarcities have led to a big run-up in various prices particularly for raw materials with indications of increased labor costs. Even beyond commodities, where trading has been famously volatile, financial markets, in general, have taken note of the quickening growth and rising price environment.
A variety of factors will determine the way forward including, but not limited to, the deployment and effectiveness of COVID-19 vaccines; the impact of fiscal and monetary support; the status of labor markets and household consumption; and the pace at which mobility and travel restrictions are lifted. The 2021 U.S. GDP growth rate should come in at 7.0%, which would mark the second-fastest year for growth since 1955.
Consumer Spending: The robust economic rebound over the past year has been driven largely by consumer spending and the bulk of that spending has so far been on goods. A shift to the much larger services category is imminent. The service sector should see the equivalent of more than four years of typical spending packed into the remaining three quarters of this year. The sizable pickup in services spending will be the primary driver of consumer spending in the second half of the year, though that need not come at the expense of a complete collapse in goods spending.
Housing: Housing has been a bright light in the recovery. Low mortgage rates and increased household space needs have propelled home sales, builder confidence, and residential construction to shake off the early shutdowns, allowing it to rebound to new heights.
Like many other parts of the economy, however, robust housing market activity appeared to be bumping up against some supply constraints. Both housing starts and sales took a breather in April, after earlier brisk activity. Shortages of lumber, copper, and appliances have caused the prices of those building materials to skyrocket, and builders appeared to be delaying project starts as a result. Supply has also been an issue in the resale market as inventory levels remained tight. Consequently, housing prices have continued to rise at a brisk pace. Fast-rising prices and a scarce supply of homes for sale will likely continue to weigh on home buying activity.
Inflation: Inflationary pressures have intensified over the past month. In April, the consumer-price index jumped 4.2% from a year earlier. The index increased a seasonally adjusted 0.8% in April from March. Rising prices reflected strong consumer demand fueled by widespread Covid-19 vaccinations, easing business restrictions, massive fiscal stimulus, supply-chain bottlenecks, ample consumer savings, and a surge in demand as the economy has reopened. So-called calendar effects have also played a role as low inflation in April 2020, when much of the economy was shut down, dropped out of the 12-month price measure.
Whether an upswing in prices proves temporary is a key question for financial markets and the U.S. recovery, as the Biden administration, Congress, and the Fed continue to support the economy with fiscal- and monetary policy measures.
Solid monthly gains in headline and core inflation measures are likely as the supply-side struggle to meet demand has worsened. Commodity prices have continued to climb generally, but the ongoing rise in food prices suggested the solid clip of food inflation over the past year is not about to let up anytime soon. Beyond the scramble for food and commodities, the slow return of workers to the labor force has kept wage pressures firm. While the year-ago rates of inflation could peak during the current quarter thanks in part to low base comparisons after last spring's lockdowns, current pressures have been to keep the year-over-year pace elevated in 2021. Inflation could slow more discernibly over the latter half of 2022, but with inflation expectations continuing to firm, core PCE inflation is likely to remain above 2.0% over the next few quarters.
Inflation should not get out of hand. Inflation expectations, although higher than a few months ago, have generally remained contained, and a rise in the labor force participation rate, once the pandemic has subsided, should help keep a lid on outsized wage gains.
Labor Market: Hiring in the U.S. unexpectedly slowed in April, a sign the nation’s recovery from the pandemic still faces challenges as many businesses have struggled to find workers or have remained cautious about the economic outlook. U.S. employers added a modest 266,000 jobs in April, the weakest monthly gain since January. The unemployment rate ticked up to 6.1% in April from 6% a month earlier, partially reflecting an increase in people entering the workforce.
The U.S. economy has encountered restraints on job gains and broader economic activity as imbalances in supply and demand for goods, services, and labor have played out.
Some businesses have been cautious about ramping up hiring, given that the pandemic and related uncertainty has continued. Others have reported they cannot find enough workers due to expanded unemployment benefits, workers’ fear of contracting Covid-19, and child-care burdens due to school closures.
This has added to the likelihood that the Federal Reserve's easy-money policies will remain in place in the coming months as the Fed has made it clear it wants to see the labor market make “substantial further progress” before they would tighten monetary policy.
U.S. Dollar: Given the likelihood of a robust near-term U.S. economic outlook, the trade-weighted value of the U.S. dollar should remain steady over the next quarter or two. However, as the outlook for economies such as the United Kingdom and Canada improve, and even that of the Eurozone stay relatively steady, the U.S. dollar will likely soften with the eventual improvement in international growth and sentiment. The fact that some foreign central banks have appeared to be moving toward less policy accommodation ahead of the Fed is another factor that could weigh on the dollar, which could see moderate declines versus the developed and emerging currencies over the medium term.
Eurozone: The Eurozone economy had a tough start to 2021 as COVID cases and restrictions held the economy back. However, recent trends have turned more encouraging. Eurozone Q1 GDP fell 0.6% quarter-over-quarter, a second-straight quarterly decline. By late Q1, there were hints of stabilization as Eurozone March retail sales and industrial output edged up. That said, concerns have persisted that COVID could hold back the recovery, given restrictions were still in place in some countries to some extent in May, and given an initially slow rollout of COVID vaccinations across the region. However, the pace of vaccinations has since improved. These more favorable developments have boosted economic confidence and pointed to stronger growth ahead. Given these encouraging trends, GDP growth of 4.0% is expected for full-year 2021.
The European Central Bank's accelerated bond purchases and dovish tone have weighed on the euro at times. The medium-term outlook has remained for some firming in the euro over time. As evidence of a sturdy Eurozone rebound has been emerging, the ECB could slow bond purchases in the second half of this year and end purchases broadly as scheduled during the first half of next year. Eurozone economic and monetary policy trends should help the euro over time, especially if improving global economic and market sentiment is also providing overall support to foreign currencies.
China: Last month, forecasts for 2021 China GDP growth were lowered to about 9.0%. Since then, the Chinese economy has shown additional signs of slowing. The manufacturing and non-manufacturing PMIs both dipped in April, while retail sales and industrial production data came in below consensus expectations.
Risks to further slowing may continue to surface. In the coming month, activity and other indicators of additional softness will likely result in the further downgrading of growth prospects for this year below 9%.
Despite a slowdown in the local economy, the renminbi has continued to strengthen. The recent strength of the currency is likely to result in the People’s Bank of China (PBoC) looking to stem this appreciation, at least in the short term. A stable renminbi should hold through the end of Q2-2021 and for the currency to hover around current levels over the next few months. In the second half of this year, the PBoC could resume guiding interest rates higher and tightening monetary policy as a way to defend against asset bubbles. As interest rates and bond yields move higher in China over time, the renminbi will likely decline in relative purchasing power.
Outlook: The near-term view of U.S. economic growth is grounded in a forecast that fully absorbs economic slack created by the pandemic by the end of this year, with a recovery shaping up to be one of the quickest in modern history. This is occurring thanks to rising home prices, booming financial market assets, and strengthening the government safety net. By extension, maximum employment is expected to be reached by the middle of next year with core PCE inflation to move above 2% this quarter and stay there for the next few quarters. Given its dual mandate of full employment and average inflation of 2%, the Fed will have a hard time standing still with its current zero-bound interest rate policy by the end of 2022, assuming a one-year overshoot of inflation offers sufficiently convincing evidence.
And it is important to note that there are still many unknowns related to the outlook that is not uniquely positioned to the downside anymore. The Biden administration has put forward the American Jobs Plan and Families Plan at just under $4 trillion. These plans could lead to higher longer-term yields and an earlier exit from ultra-low rates by the Federal Reserve.
Diverging prospects for G10 and emerging market economies have become more apparent. G10 economies, in particular the United States and Canada, and to a lesser extent the United Kingdom, have experienced encouraging economic recoveries to this point. However, prospects across the emerging markets are dwindling amid a surge in COVID cases.
But the outlook for the global economy is still positive; however, these widening recovery divergences could eventually have a role in disrupting local financial markets and influencing the path of certain currencies, particularly within the emerging markets. Monitoring COVID-related developments and vaccine efforts across the emerging markets will help determine if the global economy is growing in unison or if economic laggards will continue to present themselves.
Given the strong economic recovery data in the U.S., yields in the United States could push higher. Yields outside of the United States should rise as well; however, with the U.S. economy outperforming on many fronts, it is likely the rise in U.S. Treasury yields will outpace the rise in yields abroad. In that sense, the U.S. dollar can see modest short-term strength on the back of yield differentials swinging in the favor of the dollar.
Over the longer term, yields in the U.S. and internationally should rise; however, Fed monetary policy will likely remain ultra-accommodative, which should weigh on the dollar over time. The Fed's willingness to let inflation and the economy run hot for longer should push real interest rates further into negative territory over time. Negative real interest rates could create conditions where the U.S. dollar gradually depreciates in relative purchasing power. In addition to negative real interest rates, a global economic recovery should create an environment where market participants become more confident in allocating capital toward more risk-sensitive currencies and markets. Emerging market (EM) currencies are tightly correlated to a global economic recovery, while hawkish emerging market central banks can also support those currencies over the longer term.
This Newsletter was produced for Atlantic Union Bank Wealth Management by Capital Market Consultants, Inc.
Sources: Department of Commerce, Department of Labor, Institute for Supply Management, Bloomberg, Morningstar, European Central Bank, Peoples Bank of China
Past performance quoted is past performance and is not a guarantee of future results. Portfolio diversification does not guarantee investment returns and does not eliminate the risk of loss. The opinions and estimates put forth constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
Securities are not insured by FDIC or any other government agency, are not bank guaranteed, are not deposits or a condition to any banking service or activity, are subject to risk and may lose value, including the possible loss of principal.
Atlantic Union Bank Wealth Management is a division of Atlantic Union Bank that offers asset management, private banking, and trust and estate services. Securities are not insured by the FDIC or any other government agency, are not deposits or obligations of Atlantic Union Bank, are not guaranteed by Atlantic Union Bank or any of its affiliates, and are subject to risks, including the possible loss of principal. Deposit products are provided by Atlantic Union Bank, Member FDIC.