October 31, 2021
MANAGERS AT THE HUB GROUP, a transport company, used to be able to click a few buttons at their headquarters in Illinois and eight weeks later received a new shipping container from China that is ready for use in America. But recently, Phillip Yeager, the company’s president, had a headache. After a long wait in the congested port of Long Beach, his container was finally the next in line to go ashore. However, it could not move because the ship ahead had no undercarriage to move its cargo and blocked the landing area. Mr. Yeager’s team tried to find a chassis for it. Only then could Hub get its container, a month too late.
Multiply it by thousands of containers, and the story helps explain how kinky supply chains are, especially in America, the largest consumer market in the world. This is just one of the cross-cutting forces that mess up the economy. The demand for goods is incredibly strong, but companies struggle to find workers and supplies, which in turn drives up wages and prices, all against a backdrop where the pandemic – the original cause of the bias – is fading, but has not disappeared. And officials ready to end the extraordinary fiscal and monetary stimulus of the past 18 months are throwing another element into the fray. At the end of its November 3rd monetary policy meeting, the Federal Reserve is widely expected to announce plans to reduce and eventually cease its $ 120 billion monthly asset purchases.
All of this makes for a volatile mix, as the GDP for the third quarter published on October 28 shows. The economy grew at an annual rate of 2% compared to the previous months. That was either very impressive or very disappointing, depending on the frame of reference. Compared to projections from the end of 2020, growth in the first three quarters of the year was more than a third faster than expected. Since then, however, the forecasts had zoomed in: at one point, economists were forecasting that third-quarter growth would be more than three times as fast as it actually was.
The fourth quarter could bring a recovery. Consumer confidence fell steeply over the summer, and the Delta variant prevailed. Now Delta is going back and the confidence is recovering which bodes well for shopping and travel during the holiday season. The supply chains, even if they are still far from normal, could improve somewhat. Bank of America analysts believe growth could accelerate to an annualized rate of 6% in the last three months of the year.
Aside from a short-term recovery, how long will it take for the recovery to run out of steam? There are three big reasons to worry that it may be nearing its end: a tight labor market, persistently high inflation, and a rapid fading of stimulus measures. However, there is also reason to believe that the recovery will not be undermined and that growth momentum may remain strong.
Probably the most positive economic development of the past year was the remarkable drop in unemployment. After a recession, the labor market typically takes years to recover. Things looked grim at the height of the pandemic when unemployment rose to 14.7%, the highest rate since the Depression. But the return to work, if not in the office, has been astonishingly strong. At 4.8% in September, the unemployment rate is low at this point in the recovery (see chart 1).
In fact, the focus now is on how difficult it is for companies to hire workers, especially for manual jobs. This could indicate that the recovery is coming to an end and the economy is reaching its limits. However, there remains a certain gap. About 3 million people, 2% of the pre-pandemic workforce, have yet to get back to work. Some may have retired early, but many are on the sidelines because they are concerned about childcare and contracting Covid-19. As those concerns abate – the return to school has gone well and vaccines for serious illnesses have proven effective – they are gradually returning to work.
The surge in inflation is another major concern for the recovery. The consumer spending index, the Fed’s preferred measure, rose 4.4% yoy in September, its highest level in more than three decades. For much of the past year, Fed officials and many other economists have argued that inflation is temporary, an outgrowth of sticky supply chains.
However, the tight labor market complicates the picture. Wages rose 1.5% in the third quarter, compared to the second, the largest increase in at least two decades. While it is to be welcomed that nurses and waiters are getting salary increases, it is feared that rising wages will lead to even more price pressure and ultimately to a dreaded wage-price spiral such as was experienced in the 1970s. But the conditions are completely different. Today far fewer workers are represented by unions and far fewer contracts have cost of living adjustments baked into them. That should weaken the link between inflation and wages. The Fed may have been too optimistic in its assumption that price pressures would ease quickly, but its logic remains compelling. As supply chains slowly return to normal and people return to work, inflation should subside without the need for sharp interest rate hikes.
Linked to this is the last major concern: deprivation of stimuli. With the budget deficit hitting 15% of GDP in 2020, its highest level since World War II, the decline had to be painful. The shift towards smaller deficits will subtract around 2.5 percentage points from growth in the next year, by far the largest fiscal burden in the last two decades, according to the Hutchins Center on Fiscal and Monetary Policy in Washington (see Chart 2).
The monetary cliff won’t be as steep, but it now looms over the economy. The next question after tapering is when the Fed will raise rates. Bank Goldman Sachs believes the first rate hike could happen as early as July.
An end to the stimulation would normally promise little growth. But other factors could dampen the economy. Consumption of goods is about 15% above trend level, partly because people have spent much less money than usual on vacations and restaurants and much more on couches, exercise bikes and important things to stay at home. But with the pandemic now apparently coming to an end, people are buying experience again – a growth spurt as services account for almost 80% of production (see Figure 3).
Even without further economic checks, there is a lot of momentum for spending. Jay Bryson of Wells Fargo, another bank, says household balance sheet strength should be the starting point for any analysis of America’s growth prospects. The share of personal debt in disposable income is almost lower than ever. Companies’ inventories are also close to an all-time low, which implies a considerable need for replenishment if only the companies can receive the goods they need in good time (see Figure 4). “If I know what I know today, I would say that we are still at the beginning of this recovery,” says Bryson.
Mr. Yeager came to a similar conclusion. As retailers rush to replenish their shelves, Hub’s order books are filling quickly. It even had to turn away some potential customers. “We believe the strength will really last until the end of next year and possibly beyond,” he says.