U.S. economic data shifting into high gear

U.S. economic data shifting into high gear

*Beginning this week, releases of monthly economic data and surveys for March are showing significantly more strength, consistent with some key high-frequency data that are pointing sharply up. As spring unfolds, we expect robust economic growth and job recovery to be dominant themes.

*Following weather-related declines in an array of data releases for February, including retail sales, industrial production, durable goods orders, and housing, the stage is set for a decided acceleration of economic activity.

*Highlighting this week, the Conference Board Consumer Confidence Index and Expectations Index both soared far above consensus; the ISM for manufacturing (released tomorrow) is expected to be overwhelmingly positive, and the 517,000 employment increase in the ADP report points to robust job gains in this Friday’s Employment Report.

The consensus economic forecast has risen to expect strong growth, and our projection of 6.9% GDP growth for 2021 is among the strongest of all forecasts; but as the economy reopens, the flow of data in the economy and labor markets will nevertheless be striking.

A critical issue is what happens to growth following an initial surge as the economy reopens. Our assessment is that, while the vast majority of the deficit spending fiscal stimulus has been for income support of households and smaller businesses and will not raise sustainable potential growth, real GDP growth will remain strong through 2022. This assessment reflects the overwhelming magnitudes of monetary and fiscal stimulus, pent-up demand, excess personal saving that will fuel domestic demand, and parallel (but slower) global recovery that supports strong exports.

Any infrastructure legislation that adds to government purchases and investment would boost near-term GDP and jobs, even if the initiatives do not add to productive capacity. Tax increases and re-regulations will negatively affect economic growth, but lacking detail of any legislation, these potential policy changes are not reflected in this assessment.

Consumer spending will rise dramatically. The biggest pickup will be in services that include the sectors most constrained by the pandemic and government shutdowns—leisure and hospitality, recreation, and personal, business, and health services, along with education services. As spending on services rebounds sharply, consumption of goods, which have surged dramatically above pre-pandemic levels, will not fall back. They will continue to rise, albeit at a slower pace.

Spending will be fueled by strong increases in disposable income that have been supported by massive government income transfers and personal savings that exceed pre-pandemic levels by roughly $2.25 trillion (10% of GDP), even before the most recent distribution of $1,400 checks and the extension of enhanced unemployment compensation. Increased spending on services will generate substantial job gains in the sectors most damaged by the pandemic and government shutdowns. The job creation will support higher confidence and spending.

Consumer credit outstanding is moderate, debt service costs are near all-time lows as a percentage of disposable income, and banks are well capitalized and eager to lend. These favorable conditions differ starkly from those that constrained the recovery from the 2008-2009 financial crisis. Auto loans have been readily available to finance purchases, while credit card debt outstanding has fallen substantially during the pandemic—and will recover as economic activity gets back to normal.

Household net worth has soared to an all-time high, reflecting significant increases in home values and financial assets (stocks and bonds). On the margin, this will modestly increase the propensity to spend.

Virtually everything about housing activity is robust, and a confluence of cyclical and structural factors, along with very low inventories of homes for sale, point to sustained strength. Amid strong demand and low inventories, home prices are rising sharply: the S&P CoreLogic (Case-Shiller) home price index is up 11.2% yr/yr and the Freddie Mac home price index (prices of homes with loans purchased by either Freddie Mac or Fannie Mae) is up 11.5%. Both have accelerated in the last six months. No surprise here; besides highly favorable supply-demand trends, the Fed’s monetary policies and forward guidance that have kept bond yields low have pushed up home prices and other long-lived assets. Soaring lumber futures prices point to a robust building season.

We note that housing activity includes sizable spending on home improvements as well as new construction. Of the total residential investment measured in GDP in January, (real) spending on new construction was $376 billion annualized for single-family homes and $93 billion for multi-family units, while spending on home improvements was $244 billion, 17.9% higher than a year earlier.

Business investment, which was the largest source of weakness during the elongated expansion following the financial crisis, will continue to recover from its steep declines in 2020. However, whether investment spending slows following a recovery back to pre-pandemic levels will depend in part on tax and regulatory policies and how they affect expected rates of return on investment. It remains too early to assess such issues.

Exports are projected to grow, benefiting from the recovery in global economies and trade, but imports will grow more rapidly, reflecting the anticipated strength in domestic demand. High-frequency data of containership volumes and other indicators of global trade continue to point up. The widening trade deficit will involve domestic production growing slower than domestic demand.

Government purchases and investments, which are counted in GDP when the spending actually occurs (not when they are authorized by legislation), will continue to grow rapidly in absolute terms and as a percentage of economic activity (note that most government spending on entitlement programs are not counted in GDP because they are transfer payments and do not absorb national resources). We note that a sizable portion of the government’s deficit spending legislation over the last year, including the CARES Act of March 2020, has not yet been spent by states. The recent $1.9 trillion fiscal legislation will boost government purchases, and any infrastructure legislation would add significantly more. This is consistent with the intention of the Biden administration to greatly enlarge the role of government in the economy.

Inflation is projected to rise modestly in 2021, and then pressures will mount in 2022-2023 (Strong US growth, inflation and the Fed’s challenges, February 11, 2021). Business operating costs are rising, reflecting higher costs of materials and energy, and in some sectors, increases in wages amid (selectively) tight labor markets. To date, however, there is scant evidence of product prices rising. If aggregate demand remains strong following its surge as the economy reopens, as we expect, businesses will have flexibility to raise product prices and maintain margins. Inflationary expectations are rising in anticipation of mounting inflation pressures; market-based measures of inflationary expectations have risen to approximately 2.4%.

10-year Treasury bond yields have risen to 1.7%, close to their 1.9% pre-pandemic level, but they remain below inflation. Negative real rates are inconsistent with economic recovery and, historically, negative yields are infrequent and do not last long. As the economy strengthens, real rates and inflationary expectations are expected to rise, lifting bond yields significantly further (US bond yields to rise significantly further, February 26, 2021). In the coming months, inflation will jump, reflecting higher retail energy prices and the base adjustment from monthly declines in March-April 2020. We expect the Fed to emphasize that this rise in inflation is temporary. Amid a significantly strengthening economy, will financial markets agree with the Fed’s assessment, or will inflationary expectations rise? Among many issues, this one will be interesting as we enjoy the economy getting back to normal.

Mickey Levy, mickey.levy@berenberg-us.com

Member FINRA & SIPC
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