Economic Update โ Third Quarter 2021
Dorothy Jaworski
Senior Vice President
Director of Treasury & Risk Management
Click to view PDF of Economic Update- Quarter 3, 2021
Economic Growth Slows
We were on a roll, until the boat started taking on water.ย GDP growth had been strong, above 6% annualized, in both the first and second quarters of 2021, with GDP recovering then exceeding pre-pandemic levels.ย Consumer spending spiked and business investment improved.ย Sales of physical goods were strong and services like restaurants and hotels were on the upswing.ย Then the cracks started to appear.ย Growth once thought to be on its way above 7% this year probably wonโt make it much above 5%.ย Next year, most expectations are for 3%.
First and foremost, supply chain issues, including slow production, low inventories, and long delivery times, began to accelerate.ย Companies were trying to increase capacity to meet increasing demand but had trouble receiving critical raw materials and parts and also had trouble finding workers with matching skills.ย Retailers are already predicting shortages of everything for the upcoming Christmas shopping season.ย Yes, Christmas will be here before you know it!
Some of the supply chain issues originate in China, where production is slow or halted due to bad weather and renewed covid-19 restrictions.ย The most publicized shortage was that of semiconductor ships for automobiles, where 1.2 million cars in production were delayed.ย Nearly every manufacturer had to shut down production lines and simply wait for chips.ย Computers and phones are suffering similar manufacturing shortages.ย Shipping has been severely affected with ports in China and in the US operating very slowly.ย Overreliance on China for so much of the supply chain is proving to be a major problem.ย There is also a shortage of truck drivers to deliver the goods to end destinations.ย Bad weather and fires are also adding to transportation troubles.
Compounding these issues is a mysterious lack of employees.ย Jobs still lost from the pandemic total 5.7 million.ย Job openings were 10.1 million in June, compared to 8.7 million unemployed, so many jobs will be hard to fill.ย Most companies are reporting difficulty in hiring employees, leading them to offer higher salaries or bonuses.ย The federal unemployment subsidy of $300 per week has been cited as a culprit in keeping people from looking for work; the subsidy ends on September 6th.ย So we could see more workers soon.ย Hopefully, children return to school in-person this fall, helping alleviate some of the child care issues.ย Companies were all formulating back-to-the-office plans, but a spike in covid-19 cases changed all that, pushing back the timetable for months.
The supply chain issues, lack of workers, and continued fear of the virus will set back GDP growth.ย Throw in a few cyberattacks like the ones that temporarily shut down the Colonial Pipeline and JBS Meats, and you have a recipe for work stoppages and product shortages.ย These issues have all led to something we all hate- Inflationโฆ
Inflation Returns
We spent the past 12 years without any serious inflation.ย Then suddenly, all of the increased demand from consumers, supply chain product shortages, lack of workers, delivery delays, and too many dollars chasing too few goods led to an explosion of inflation.ย Prices for materials like lumber and building supplies spiked first, followed by oil and gas prices, food, toys, clothes, new and used cars, appliances and most other commodity prices.ย Thankfully, the spike ended in April and May.ย Prices have remained stable or drifted downward since then, albeit at elevated levels from last year.ย Itโs a classic scenario- prices spike in response to supply/demand dynamics, and production and capacity changes, before settling down once issues are resolved.ย This is what the Federal Reserve means by โtransitory.โ
In early August, I joined a group of friends from the Bank after their annual shopping spree at the outlets.ย They confirmed that, indeed, prices are higher this year and that the stores had fewer products to offer.ย Many stores at the outlets complex had closed.ย The supply chain issues and higher prices are real.ย Clothing was the big winner among the shoppers, most notably pajamas, which confirms the changes in consumer habits since the pandemic began.ย And as usual, they all had a great time shopping and being together!
One reason to think that prices could fall is that China has experienced such problems since 2020 and lost market share to the US and others.ย To reclaim that share, China would lower prices.ย Another technical factor that could keep inflation in check is that the velocity of money, or turnover of dollars through the economy, has fallen to a record low of 1.12.ย Despite high M2 money supply growth, velocity continues on its downward path.
Another area where prices have โgone wildโ is housing.ย Year-over-year increases have been running in the double digits for months, driven by much lower than normal inventories of homes for sale and buyersโ propensity to bid high to compete for the house.ย New home construction has also been lower than usual as building supplies, mainly lumber, shot up in price and worker shortages delayed construction.
Despite all of the inflation fear, which can become a self-fulfilling prophecy, the Fed expects its preferred inflation measure, core PCE, to be 3% in 2021 and 2.1% in 2022, which is hardly runaway inflation by any means.
Rates and the Fed
Long-term rates went on a rollercoaster ride since the beginning of 2021, with the 10 year Treasury yield rising from .91% to 1.74% in April, before spending the next few months dropping back to 1.25%.ย The markets saw the inflation spike and rightly rose, but now may be seeing the cracks in the economy and perhaps have accepted the transitory narrative from the Fed and others.
There are only a few reasons for rates to rise- if we got another spike in inflation, long-lasting inflation, and a large increase in GDP, all of which do not seem very likely.ย There are a few reasons for rates to remain low or fall further, including slowing growth, as seen in the cracks and leaks in the economy, record low velocity of money, lack of loan growth across the banking industry, the continued spiral of new US government debt issuance, recently at 125% of GDP, which will serve to place a huge drag on growth going forward, and the relative value of positive US yields versus negative yields in Europe and Japan.ย Government debt provides a fleeting benefit to growth, but it is not long lasting.
The Federal Reserve has pledged to keep short-term rates near zero until the unemployment rate drops substantially (already down to 5.4% in July) and inflation averages above its 2% target for an extended period of time (in process).ย We do expect them to reduce, or โtaper,โ their current $120 billion per month bond purchase program later this year.ย In my mind, this will correct some of the excess liquidity in the economy; they eased too much while the government was pumping in too much stimulus.ย They say they will end the bond buying before raising rates in late 2022 or 2023.ย But I point you back to 2009 to 2015, which is the last time the economy was recovering from such a painful drop in employment.ย The Fed did not tighten until December, 2015, when all of the lost jobs from the Great Recession had been recovered and the economy had added 4 million new jobs.ย With this latter example, we are long way from tightening, as there are still 5.7 million lost jobs from the Lockdown Recession plus at least 4 million more.ย I would say, look at 2023 or beyond.
End of Summer
We are approaching the end of a long, hot summer.ย I hope everyone got to enjoy some vacation time with family and friends.ย I always cherish these opportunities.ย And I hope it helps the tourism industry, which suffered a $4 trillion decline in 2020 and $1.7 trillion so far in 2021.ย I wonโt miss the heat and humidity and the eleven tornadoes in our area since the end of July, not to mention the periods of horrible flooding.ย I am so proud to be part of Penn Community Bank who quickly joined forces with United Way and helped people recover from these devastating situations.ย I will miss those days on the beach and time spent plotting my return to France, next summer, God willing.
And I think this Ernest Hemingway quote bears repeating in our uncertain times:
โBut you knew there would always be the spring, as you knew the river would flow again after it was frozen.โ
Thanks for reading!
Dorothy Jaworski
Senior Vice President
Director of Treasury & Risk Management
