Economy Q1 2021

Today, the opposite is true. Vaccines are available, and the infection rate has dropped well below prior peak levels. At the current pace of vaccination, healthcare experts are saying we will be close to “herd immunity” by mid-summer, allowing for further loosening of restrictions. With a new administration and a slim majority in Congress, the Democrats have rolled out an enormous fiscal package to support growth and are expected to pass more legislation later this year. The benefits of the recent fiscal package are targeted towards lower and medium income families who are most likely to spend it. Further fiscal stimulus packages are likely to be partially funded with higher taxes, but we expect any tax increases to be phased in gradually.

As restrictions are lifted and more people are vaccinated, businesses are poised to reopen and consumers are eager to travel and spend more freely for leisure and business. Short-term interest rates are low and expected to stay low at least until 2022. Longer-term rates have risen though financial conditions (i.e. availability of credit) are still supportive of consumer spending and corporate borrowing.

Job growth is accelerating, particularly for low wage service jobs, and the unemployment rate is falling. We believe these conditions will translate to robust growth this year, perhaps exceeding the Federal Reserve’s estimate of 6.5% GDP growth by the end of the year. This rate of growth is indicative of a vast improvement in economic conditions from a year ago.

As always, risk and uncertainty remain. Two areas we are watching closely are employment and inflation; both are key in determining the pace of
economic growth as well as future returns for stocks, bonds and commodities. On the employment front, we see relatively tight conditions for low wage employees. Many businesses are having trouble hiring low income employees who are currently receiving more in unemployment assistance than they would receive if they returned to work. Either these benefits need to run out or employers will need to offer higher wages to incentivize
low wage earners back to work. With benefits extended into September, this dynamic is likely to remain, particularly as demand for workers increases in the months ahead. The unemployment rate stands at about 6.5% right now, and the Federal Reserve projects it will fall to 4.5% by year end and 3.5% by next year, reaching close to “full employment.”

As the economic recovery accelerates, inflation is expected to rise as well. The Federal Reserve estimates broad inflation will hit 2.5% by year end. In addition to higher wages, we expect to see higher prices for energy, travel and manufactured goods in the coming months. Oil prices are now about $60 per barrel versus mid-$40 last year, which translates to higher gas prices. We also expect manufacturers will continue to experience bottlenecks as lean inventories result in further supply constraints for things like furniture, industrial equipment, and technology hardware. Inflation measures may appear elevated because of the low level they are moving from when compared to the reported rate at this time a year ago. The topic of inflation is likely to remain in the headlines of the financial press and on the minds of investors. However, we are not expecting a sustained rise in inflation pressures that would lead to anything close to the severe shock that took place in the 1970s. While much has been written about the massive supply of money created by the Fed’s quantitative easing and Treasury’s fiscal stimulus, the velocity of money is relatively low. Enormous sums of cash are sitting on deposit with banks, which are required to hold more capital to satisfy tighter regulatory requirements. Corporations are also holding large amounts of cash as they manage balance sheets to weather an uncertain economy while taking advantage of low borrowing costs. Because this cash is being saved and not spent, it constrains the pace at which money is changing hands – the velocity. Until the velocity of money picks up, we expect inflation to stay close to the 2.5% range forecasted by the Fed.

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