Read the March Economic Currents in PDF.
A summer day with friends and family gathered for a cookout. Lawn chairs strewn across the backyard. The sound of my neighbor’s jazz quartet riffing in the distance. My husband is firing up the grill, experimenting with one of his new recipes. A glass of wine in hand and the confidence to share a warm embrace with our guests.
Prospects for the U.S. and global economy are improving. Vaccinations are ramping up faster than many expected. We will have more than enough vaccines for anyone who wants one by May. Uptake remains an uphill battle, given the misinformation flooding social media.
The risk is that we reopen too early and suffer a fourth wave of infections before the vaccine can reach enough arms. An inability to contain the virus has already cost us more in stimulus and aid than other countries.
The U.S. is poised to lead the global economy out of the most recent wave of infections and double-dip recessions abroad. We will cross our previous peak in activity in the second quarter. Additional stimulus means we will move above the growth path we were on prior to the pandemic.
Employment lags overall growth and is not expected to recoup what has been lost to the crisis until well into 2022. Some workers will be displaced permanently. Inflation will pick up but concerns about overdosing on stimulus are overblown. The world is suffering from disinflation and the threat of deflation, not inflation.
The Federal Reserve would like a little higher inflation. That would allow it to raise rates. The goal is to eliminate the risk of deflation and provide leeway to cut rates during the next recession.
What I thought I would do once the pandemic subsided has changed. That reflects the reality that we may have to work harder to manage, rather than eradicate, a virus that is mutating faster than we can stem contagion with vaccinations. A bout of cancer has also sharpened my focus on what matters most to me. Casual get-togethers lifted my spirits and kept me sane in the pre-pandemic world. I still want to board a flight, explore the world and make new connections. That may take longer.
The company that I keep has tempered but not quelled my optimism. I have spent much of the last two weeks in meetings with economists and policy makers representing more than 25 countries and every major industry. They are not exactly the most cheerful people to hang with; economics is the dismal science. That said, there is a light at the end of the tunnel and a path to take beyond the pandemic; the concern is what happens next.
Will we overdose on stimulus and trigger an unwanted inflationary spiral? Or will the pent-up demand we release be transitory along with the supply shocks it triggers? How long will it take for employment to regain the jobs lost, let alone what might have been? How deep are the wounds inflicted by the pandemic? Will they leave permanent scars on the complexion of the labor force?
Those are just a few of the questions we pondered. Our meetings took place under Chatham House Rules, which means that I cannot cite any one person or organization. What I can do is share how the lessons learned shaped our forecast. A fall in hospitalizations and fatalities, and a ramp-up in vaccinations offer reasons for hope.
This edition of Economic Currents
provides a roundup of our expectations for the U.S. and global economies. It is divided into three parts. The first lays out the potential timeline for reopening. The second provides a roundup of what that timeline means for the global outlook, with special attention for the U.S. The third assesses the risk of a surge in inflation. Bond market participants worry that fiscal stimulus, coupled with easy monetary policy, will deliver a costly surge in inflation. The risk of that is low. The greater concern is whether the Fed will retain the independence it needs to contain an unwanted inflation.
A Timeline on Reopening
The drop in COVID cases and hospitalizations around the world has occurred more rapidly than expected. A combination of mitigation efforts, behavioral changes and ramp up of vaccinations for the most vulnerable have all helped.
Epidemiologists worry we are not out of the woods yet. The emergence of more contagious and more lethal variants that affect children as well as adults means we need to remain vigilant. States trying to reopen before milestones on contagion are achieved have upped the ante on another outbreak and lockdowns.
Countries that more effectively contained outbreaks were able to reopen and stay open longer than those that did not. One of my foreign colleagues dines in restaurants frequently and even gives briefings to live audiences, things that are little more than a distant memory for me.
Much of Europe, the U.K. and Japan suffered a W-shaped pullback in economic activity during the late fall and early winter. The spread of more contagious variants was rapid and costly. The U.S. dodged that bullet with another round of aid and stimulus in late December. Retail sales and employment rebounded in January after contracting at the end of 2020. Stimulus checks are the primary reason for those gains.
The goal is for businesses to remain open once they reopen, to recall workers and to keep them in their jobs longer. The new administration has promised there will be enough vaccines by May to vaccinate any adult who wants one.
Uptake is a problem. We need to vaccinate much of
the adult population to achieve the 70% herd immunity
required to suppress transmission. That is a heavy lift.
Most polls suggest that the willingness to take a vaccine
has risen from about 50% to more than 60% of adults in
recent months. Positive news on clinical trials is credited
for those gains. However, research
in The New England
Journal of Medicine
shows that uncertainty about taking
a vaccine remains high.
One problem is that pollsters often collapse categories
of responses; only about 40% of adults say they will
“definitely” get vaccinated, while 21% say they will
“probably” get vaccinated. The largest concern is
, which is harder to quell. Getting children
vaccinated will be another challenge. The same people
who refuse vaccinations for themselves are likely to
oppose them for their children.
Resistance to the vaccine is not unique to the U.S. The
shift from working toward herd immunity, to managing
instead of eradicating outbreaks, is not helping.
“Vaccine nationalism,” or hoarding of vaccines, is
another hurdle. Some 16% of the world’s population
in the world’s wealthiest countries own 50% of the
current vaccine supplies. Even wealthy countries such
as Canada and Japan have had trouble getting access
because of constraints imposed by the countries that
produce them. This could delay the resumption of
international travel and commerce.
We expect the U.S. economy to reopen more rapidly.
The risk is that could trigger another surge in infections
driven by more contagious variants this spring and
summer. That has left us with two scenarios for
reopening. One allows for a robust and sustained
reopening. The other includes a fourth wave.
U.S. Leads Global Gains
The global economy is expected to grow at a 5.8% pace
in 2021 after contracting an estimated 3.7% in 2020.
Much of the growth occurs in the second half of the year.
The first quarter was the weakest with lockdowns to
prevent the spread of more contagious variants.
China is doing better, driven by strong gains in
manufacturing. The country became a larger player in
the global economy last year when it grew its export
base. China is hoping to capitalize on those gains going
forward. Consumer spending is still lagging; spending
during the Lunar New Year was particularly weak. The
government has renewed efforts to curb credit growth
and guard against asset price bubbles.
The number one concern in every meeting I attended was
what China may do to Taiwan. The fear is that China
could do to the world’s computer chip supplier what it did
to Hong Kong. That would ensure its dominance of the
global supply chain. Chip shortages have already caused
backlogs and production cuts in the manufacturing
sector, most noticeably in vehicles.
The shift back to services from goods spending should
allow for some resolution to current supply chain
bottlenecks, but it will stress resources in the service
sector. It is important to note that pent-up demand in
the service sector will be unleashed differently than we
have seen in the goods sector during previous recoveries.
Haircuts skipped and meals not eaten in restaurants
during lockdowns can’t easily be recouped.
The U.S. is expected to lead global growth as stimulus
offsets the cost of missteps on the road to herd immunity.
It would cost less if we didn’t have setbacks triggered by
premature openings and repeated lockdowns. Growth
could hit 6.4% in 2021, a whopping 1.4% more than we
estimated a month ago. That would make it the strongest
year since 1984, as long as we don’t suffer a fourth wave.
Good news on the progress of vaccines and a larger
stimulus package are the reasons for the upgrade.
Chart 1 compares that rosy scenario with an interrupted
pace of reopening over the spring and summer. Additional
stimulus has put us on track to exceed the trajectory of
growth we were on before the pandemic. That will be a
major milestone if we can achieve it.
Employment will take another year to reach its previous
peak. We are still 9.5 million jobs in the hole, mostly in the
service sector. This is at the same time that the share of
workers enduring long-term unemployment (more than 27
weeks) or forced to accept part-time work has swelled.
Employment surprised to the upside in February. However, many misread those gains. Revisions to December employment revealed an economy that was starting to contract, underscoring the fragility of the recovery. Another round of stimulus was required to reverse those losses in January and February.
Consumers are expected to lead overall gains with what many are terming “revenge spending.” That is spending on all the things we couldn’t buy when we were stuck at home. That is not the same magnitude of pent-up demand we see when we try to catch up on goods spending. It is nonetheless significant and will no doubt shift our priorities from upgrading our homes and buying bigticket items back toward services.
Most of the savings built up during the crisis was concentrated in the weathiest households. They do not spend as much out of their saving as everyone else. They may take more luxurious vacations, but are unlikely to take more vacations.
Uneven vaccination strategies across countries and the risk of more contagious variants suggest domestic leisure travel will pick up more rapidly than business and international travel. I am booking travel for 2022.
Rising mortgage rates, coupled with some return to offices, suggest that the boom in home buying and building will cool. First-time buyers are replacing vacation home buyers. That trend should accelerate as more supply comes on line.
Some baby boomers have held off listing their homes for fear of contagion during the pandemic. Those listings, combined with a completion of construction backlogs and an easing of impulsive purchases, should boost inventories, which dropped to a record low in 2020. Increased supply should alleviate bidding wars and the surge in prices.
Business Investment Picks Up
Investment in technology is expected to continue to overshadow investment in more traditional equipment. We are seeing a sharp increase in investment in new technologies, which are being used to improve online retail and to automate jobs in both the service sector and in manufacturing plants.
Commercial real estate is mixed. Most companies are trying to reduce their footprint in urban centers, which is having spillover effects on everything from downtown apartment rents to restaurants, bars and office space.
Smaller office spaces in suburban markets have
seen greater demand, along with industrial space.
Warehousing is still a very big business to accommodate
more online retail and the need by manufacturers to
hedge against supply chain disruptions.
Government Spending Accelerates
The Senate approved a $1.9 trillion stimulus bill with some
changes from the House of Representatives’ version.
Moderate Democrats insisted on holding unemployment
supplements to $300 per week and extending them until
September instead of October, phasing out $1400 direct
checks for some households and dropping the $15 per
hour minimum wage component. The package passed on
a party-line vote.
Much of the aid will be used to fill financial holes
triggered by the crisis, including backlogged rent and
utility bills. Chicago landlords have already reported
that stimulus checks were used by low-wage households
to pay back and forward months of rent. Funds will be
allocated to ramp up vaccination efforts and to safely
reopen schools. That means smaller classrooms, more
masking, upgrades to infrastructure and cleaning,
including ventilation systems, and more personnel to help
students recoup education hours lost to the pandemic.
Many low-wage households lost one year of education as
dropouts surged. Those students will have to be brought
back into the system, lest we suffer an even larger blow
to potential economic growth. Math scores, which require
more in-person learning, have suffered the most.
Transfers to the states, including much of the funding
for schools, hospitals and even broadband, will take
longer to disperse. One of the largest mistakes that
casual forecasters make is on the timing of when outlays
show up as spending by the government. We still have
nearly one trillion that has been approved but yet to be
spent from previous stimulus packages. It will take time,
for instance, to spend the funds earmarked to expand
broadband access to rural areas.
This is one of many reasons that checks directly paid
to households have gained so much traction during the
pandemic. It was often the only money that the most
financially stressed households could access quickly to
cover the basics of food and shelter.
It would have been better to have more targeted payouts
but our antiquated state unemployment insurance
systems failed us. There are funds to upgrade those
systems and prevent the fraud that further bogged down
the ability of states to allocate payments to those hardest
hit by the crisis.
Trade Deficit Widens
More rapid growth in the U.S., coupled with lagging
growth abroad, ensures that the trade deficit will
continue to widen in 2021 and 2022. China has become
an even larger export platform post-pandemic than it
was prior. Part of that is due to the outsize role it plays
in the production of PPE. Another reason is that moving
manufacturing facilities back to the U.S. never occurred.
The largest near-term concern for trade is Taiwan, given
its key role in the computer chip market. Most of the
bottlenecks are expected to be cleared by midyear,
barring a conflict with China over Taiwan.
A Flare in Inflation?
Chart 2 shows our forecast for inflation over the next two
years. A sharp deceleration in inflation at the onset of
the crisis in 2020, coupled with a rebound in oil prices,
sets the stage for a temporary jump in the Personal
Consumption Expenditures (PCE) index. We expect it to
move above the Fed’s 2% target this year for the first
time since 2018. Those increases should dissipate over the
summer as year-on-year comparisons get easier.
Disruptions in the supply chain and strong demand, aided by another round of stimulus, virtually assure some kind of spike in certain prices. Airfares and hotel room prices at popular vacation destinations will no doubt jump the minute people feel safe enough to travel; algorithms that track supply and demand are designed to ensure they do.
The question is whether those increases will be temporary
or systemic. There are more reasons to believe the former.
Much of the surge in demand for services is expected to
be tempered by a moderation in demand for goods. The
shift should alleviate upward pressure on goods prices,
while it allows some reflation in the service sector.
Price hikes have a hard time sticking unless they
are accompanied by wage gains. That requires low
unemployment with a lot more participation in the labor
market than we are likely to see at the onset of the surge
Wage gains against the backdrop of strong productivity
growth should show up more in profits than in prices.
A rush to automate and the fact that we have learned
to better use existing technologies should provide a
temporary boost to productivity growth. This is what
occurred in the wake of Y2K when the rush to upgrade
computer systems boosted productivity even after
Separately, much of the rest of the world is still fighting
decelerating instead of accelerating inflation. This will act
as a another offset to inflation in the U.S., despite recent
weakness in the dollar.
A Too-Patient Fed?
Bond market participants have recently voiced a concern
tied to a shift in strategy at the Federal Reserve. They
see the Fed now seeking to spur inflation instead of
suppressing it, after years of failing to reach their own
2% inflation target. This has stoked concerns that the Fed
will allow a costly overshoot in inflation.
Upon review of the Fed’s policy-setting rules, which
started well in advance of the pandemic, officials
discovered they were wrong in their estimates for
full employment and inflation. Overall measures of
unemployment understated the slack in the labor
market, most notably among the most marginalized and
Wages and inflation didn’t firm until more of the primeage
labor market was participating and actually being
hired. Even then, inflation pressure remained subdued.
In response, the Fed has adopted a more nuanced
approach to its full employment and inflation targets. The
goal now is “average inflation targeting,” which allows
for long periods of undershooting on inflation with shorter
and more contained periods of overshooting.
The goal is to wait until inflation meets the 2% inflation
target and appears to be on track to overshoot for
a period, before raising rates. Fed officials will “look
through” the jump in year-over-year measures of inflation
due to weak inflation during the height of the crisis in
the spring of 2020. They are also prepared to ignore a
transitory rise in inflation that results from unleashing
pent-up demand in services.
The Fed has said it would stop asset purchases and the
expansion of its balance sheet before it raises interest
rates. The timing will depend heavily upon how rapidly
employment picks up. That could occur by the start of
What could go wrong? Congress could become a little
too comfortable with the Fed’s low rate policies and
undermine the Fed’s independence once it gets back to
raising rates. It wouldn’t be the first time a government
has usurped the independence of the central bank and
triggered a worrisome rise in debt and inflation. At least a
portion of the rise in Treasury bond yields in recent weeks
reflects concerns about how we will pay for what we are
borrowing during this crisis.
We see a light at the end of the tunnel and with that
light comes a sense of euphoria. The key is to not let
that euphoria get in the way of achieving the final goal.
That is not just seeing but crossing the finish line of the
pandemic. We literally cannot afford another major
setback in infections.
This is the moment when we could triumph, not least by
averting another tragedy. I know, it is not easy to be
patient and take the time to get the reopening of the
economy right. After all the surgeries and cancer I have
fought this year, the extra seems small relative to the
Copyright © 2021 Diane Swonk – All rights reserved. The information provided herein is believed to be obtained from sources deemed to be accurate, timely and reliable. However, no assurance is given in that respect. The reader should not rely on this information in making economic, financial, investment or any other decisions. This communication does not constitute an offer or solicitation, or solicitation of any offer to buy or sell any security, investment or other product. Likewise, this communication serves to provide certain opinions on current market conditions, economic policy or trends and is not a recommendation to engage in, or refrain from engaging, in a particular course of action.