Groundhog Day: Variants and the Outlook for 2022

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Living through the pandemic has been a bit like being Bill Murray’s character in the 1993 film Groundhog Day. We emerged from the first wave of infections and lockdowns hoping to return to the world we left behind only to realize we were entering a loop of recurring infections and disruptions that proved hard to escape.

Once the reality of his predicament set in, Murray started to slide down a rabbit hole of riskier behaviors, living life as “if there were no tomorrow.” He even drove off a cliff in one scene only to reawaken to the sound of Sonny and Cher singing “I Got You Babe” again on his alarm clock. He was stuck reliving February 2.

The only constant in our world is the virus, the havoc it wreaks and our unwillingness to leverage the tools we have to wrestle the virus to its knees. Fatalities worldwide are now approaching those of other pandemics, after adjusting for the undercount in developing economies and the surge in excess deaths they have endured. This is despite the breakneck speed at which vaccines were developed and can be altered to target variants.

The resulting loss of life and fear of infection have resulted in labor shortages and wage hikes, much as we have seen in other pandemics. What is unique is the synchronous surge in inflation. Pandemics typically trigger a slowdown in inflation or all-out price declines because of the destruction of demand.

This time is different. Technology accelerated the shift of economic activity online and kept large swaths of the population working and spending, even as fear of contagion and mitigation efforts kicked in.

The inability to vaccinate the world and suppress the spread of the virus exacerbated global supply chain disruptions. The Delta variant was particularly costly.

Unprecedented fiscal stimulus and interventions by central banks provided a much-needed bridge for those who could not work to traverse COVID-tainted waters. Chart 1 shows the boost to the level of real GDP that everything from enhancements to unemployment insurance and stimulus checks to forgivable loans and transfers to the states provided and are expected to continue to provide to real GDP through early 2023. In response, inflation also accelerated along with wages.

The question for the Federal Reserve is whether what we are enduring will morph into a more entrenched, wage-price spiral, in which wage hikes start to feed into inflation. That would require an aggressive jump in rates.

The most recent Delta and Omicron waves are hitting when the private sector appears to be picking up the baton from the public sector to carry growth. The fourth quarter of 2021 will easily be the strongest of the year for the U.S.; annual growth is poised to reach 5.7%, the fastest since 1984. This is despite the expiration of much of the direct aid to individuals and businesses.

This edition of Economic Currents takes a closer look at the outlook for 2022, with the hope we make the transition from a pandemic to an endemic - an illness that is seasonal and more manageable. We have the tools - vaccines, rapid testing, masking and better therapeutics. The challenge is to use them to their fullest, which we have thus far failed to do.

Special attention will be paid to the outlook for inflation, the risks of a wage-price spiral even in the absence of additional fiscal stimulus and how the Fed is likely to react. It is now convinced that the disruptions created by outbreaks will compound underlying inflationary pressures, and that will need to be combated with rate hikes. The only question is how aggressive those rate hikes will have to be.

The 2022 Outlook: Chart 2 shows the forecast for growth in 2022. The economy is expected to slow but remain robust with overall growth still averaging more than 4% for the year. That is nearly double the annual average from 2010-2019.

The private sector is expected to pick up the baton from the federal government in 2022. Payroll employment slowed in November, but those figures likely understated the actual strength in the labor market. The response rate on the establishment survey dropped to a decade low this year, which has meant subsequent upward revisions.

The household survey, which is not subject to revision, revealed a much more robust labor market and more healing in November. It showed more than 1.1 million jobs were generated, with more than half a million workers rejoining the labor force.

Chart 1

Effects of Fiscal Policy on the level of GDP

The ranks of the unemployed fell to a pandemic low of 4.2% even as participation in the labor market moved significantly higher. The ranks of long-term unemployed continued to shrink, while those working only one instead of multiple jobs held at a million fewer than we saw in February 2020.

That was at the same time that everything we know about in the labor market in November was improving. Initial claims for unemployment insurance continued to fall; the Institute for Supply Management (ISM) for services hit a record high; plans to hire picked up; and, the ADP report on payrolls showed hiring held above a half a million jobs for the fourth consecutive month. Many of those trends carried into early December. Google searches for how to apply for unemployment insurance benefits fell through early December.

Separately, hiring by state and local governments is expected to pick up. Their coffers are brimming with cash as understaffing is rampant. The largest hurdle is public sector compensation, which grew at about half the pace of that in the private sector over the summer.

Any setback in hiring as a result of Delta and Omicron is likely to show up in early 2022 as hospitals are overwhelmed. Lockdowns have already been implemented abroad. That could further disrupt supply chains that were beginning to uncoil.

There is little tolerance for lockdowns in the U.S. but fear is its own tax on the economy. Look for governments and firms to push harder to get the unvaccinated to be vaccinated. It is the only way out of a vicious cycle.

Consumer Spending Pivots After an initial setback at the start of the year, consumers are expected to pivot back into spending on services over goods. That shift will generate less spending than the surge we saw on goods. The pent-up demand for services is inherently different from that for goods. Haircuts lost to the pandemic cannot be replaced.

The wild card is the $2.5 trillion in excess savings amassed during the pandemic. Low-income households are expected to deplete their savings by year-end when they reach the cliff in monthly child tax credits provided by the last round of fiscal stimulus. High-income households tend to spend their incomes but not their savings.

Spending on travel, tourism and medical services delayed by outbreaks is expected to see the strongest gains. Leisure travel has already rebounded close to precrisis levels. The backlog for elective surgeries and routine medical exams is substantial and likely to suffer another setback with a winter wave of infections.

Housing Bubbles Intensify Home buyers scrambled to lock in what they feared may be the last, low rates in late 2021. Higher mortgage rates and already high prices are expected to dampen demand in 2022. Home building is also expected to slow, but only after some catch-up on backlogs due to materials and labor shortages early in the year.

Investors will provide the most support for sales. They are paying cash and snapping up properties unseen to flip to rent instead of sell. This has already crowded out many first-time buyers and could keep home values, which are already pushing up shelter costs up along with rents, rising at a scorching pace. Some properties are in rural areas, which lack the broad-band necessary to support remote work.

Chart 2

Real GDP above trend, despite soft start

Investment Remains Robust Large corporations are awash in cash and eager to offset the crimp in profit margins associated with rising wages with productivity-enhancing technologies. This gives them the means and motivation to invest and automate, which will further shift the demand for workers away from the less to more educated.

Large tech-savvy retail behemoths, who are driving the gains in wages for the lowest paid workers, have greatest incentives and scale to do so. That is good news for low-wage workers, who are finally getting a moment in the sun after years in the shadows. There could be a problem, medium-term. Large firms are better able to erect barriers to workers unionizing than midsize firms.

The shifts we are seeing are challenging the business models of many small and midsize firms. That could undermine dynamism in the broader economy, which could curb innovations and keep productivity gains triggered by new technologies concentrated in larger firms instead of being shared across firms and with the broader economy.

Chart 3

Inflation doesn't cool enough

Inventories Rebuild Inventories fell to rock-bottom lows as supply chain disruptions worked their way around the globe. We have seen uncoiling of backlogs as we entered the fall, but could suffer additional setbacks as the current Delta wave and Omicron circle the globe.

That said, inventories have begun to rebuild and are expected to be more fully replenished by year-end. Double ordering to hedge against future shortfalls and a pivot from just-in-time to just-in-case inventories systems virtually assures rebuilding. We could even see a bullwhip effect, or unwanted surge in inventories, in 2023.

Transfers to State and Local Governments are Spent Congress kicked the can down the road on debate over the administration’s Build Back Better plan with a continuing resolution that will keep the government funded into February of 2022. That means that what is left of support for individuals - monthly child tax credit checks - will lapse December 31, 2021.

Congress did approve the bipartisan infrastructure bill. The bulk of those funds will not show up until the mid-2020s, as infrastructure projects take time to ramp up.

A pickup in spending by state and local governments is expected to more than offset the slowdown in federal spending. A surge in retail sales and real estate tax revenues, and transfers from the federal government, has filled the coffers of many state and local governments.

The cost saving triggered by the move to online learning left many public school districts awash in cash. The problem is getting those funds out the door. Public sector wages are rising much slower than private sector wages. Some teachers are quitting to become substitutes because the pay is better. The blows to morale and staffing are so widespread that school districts extended the Thanksgiving holiday with little to no notice; that left parents scrambling to find child care.

Trade Deteriorates The U.S. is expected to continue to grow faster than most other major economies, which means imports should outpace exports over the course of the year. The pivot in spending to services over goods means fewer imports per dollar consumers spend; much of trade is trade in goods, not services, which tend to be domestically produced.

Risks: Risks to the near-term outlook are to the downside, given the current Delta wave and the threat posed by Omicron. The bet is that Congress holds back on additional stimulus given the surge in inflation. That said, 2022 is an election year; stranger things have happened.

Inflation Simmers Chart 3 shows the forecast for the core personal consumption expenditures (PCE) index, which the Fed watches the closest. Inflation is expected to moderate in 2022 from the red-hot pace we saw in the fall of 2021 but remain elevated through year-end:

  • Commodity prices have begun to cool in response to the threat posed by Omicron;
  • Supply chain disruptions have begun to uncoil, allowing production to ramp up; and
  • A surge in inflation in the spring of 2021 should temper year-on-year comparisons by the spring of 2022.


  • Shelter and medical costs, both key drivers of inflation, have just begun to accelerate;

Chart 4

Fed gets to liftoff sooner

  • Surge pricing on services is expected to offset some of the slowdown in inflation in goods; and
  • Services, which are more dependent on labor costs than goods prices, could start to see a wage-price spiral begin to take root.

Medical care is particularly sensitive to staffing shortages; assisted living facilities have lost the most staff and face the worst labor shortages. The latter is one of the places I would look first for a wage-price spiral.

Risks: The current Delta wave and threats from Omicron have already triggered lockdowns and restrictions in travel. The risk is that those shifts could trigger another round of supply chain disruptions and put more workers on the sidelines. The result would reverse some of the progress we are making in backlogs and exacerbate the upward pressure on inflation absent commodity prices in the near term.

Hawks Flock at Fed Chart 4 shows the forecast for the fed funds rate in 2022. We expect the Fed to announce it will conclude its purchases of Treasury bonds and mortgage-backed securities in March instead of June at the December meeting. That will leave the door open for a liftoff in rates in June. Our forecast includes three rate hikes in 2022.

Fed Chairman Jay Powell formally retired the word “transitory” from the Fed’s language on inflation during his most recent testimony to Congress. He underscored his concern inflation is becoming broad-based. He is not alone. Fed officials as a group have grown far more concerned about the persistence of inflation, even as commodity prices have cooled. This could prompt them to act much more aggressively than currently forecast.

Risks: Chair Powell has said the Fed would be patient but not hesitate to raise rates. The risk is that they panic and raise rates too rapidly as they chase inflation for the first time since the 1980s.

Treasury Bonds Chart 5 shows the forecast for the 10-year Treasury bond. Yields are expected to rise after a setback in response to Omicron. The yield curve has actually flattened in recent weeks. Short-term rates have risen as the Fed’s intent to raise rates has become clear, while long-term rates have fallen, either because bond traders believe the Fed will be successful in reining in inflation or they will overshoot, causing the economy to cool even faster than expected.

Risks: More rapid rate hikes by the Fed could trigger an inversion of the yield curve. That is when short-term rates rise above long-term rates; it can signal a coming recession.

Chart 5

10 year treasury bonds approach 3%

Financial Market Turbulence A lot of financial assets seemed to be priced to perfection in a wholly imperfect world. Rising rates could not only take the steam out of broader equity prices; they could tip the apple cart. The reach for yield has prompted excessive risk taking, upping the ante on a more disruptive market correction in 2022.

The forecast, which includes robust growth with rate hikes, translates to a 6% correction in broader stock market indices. Markets tend to react in a nonlinear fashion to a Fed that is chasing instead of preempting inflation.

Risks: An overshoot on rate hikes by the Fed could destabilize financial markets at home and abroad. Developing markets are especially vulnerable, as they will be forced to raise rates to defend their currencies when the Fed moves. That will increase debt service burdens on a mountain of debt and increase the risk of an outright sovereign debt default.

Bottom Line The pandemic just became a lot more difficult to endure. Hollywood endings don’t tend to come to fruition in the real world, but for now, I would like to believe they are possible. Bill Murray’s character was not able to escape Groundhog day, February 2, until he pivoted away from seeing each day as if there were no tomorrow. With the help of his love interest, Andie MacDowell, he started to see each day as a chance to improve his own life as well as those around him.

He used his time to learn the piano and improve the quality of his own life as well as the lives of those he touched. He even became a hero for his good deeds. But it wasn’t until he fully abandoned his own narcissism, and embraced an unconditional love for MacDowell’s character, that he escaped February 2. Once that occurred, he woke up to Sonny and Cher singing a different tune on the clock radio, and the break of a new day, February 3. There are a lot of lessons in that metaphor for where we are and how to escape it. I would like to believe that we have the capacity to learn them.

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