Picking up speed
The U.S. economy has surprised nearly everyone as it speeds along, thanks to vaccinations, reopening, and record stimulus. All have contributed to what should be one of the best years for growth ever.
Despite the natural challenges of ramping back up, the economic recovery still seems capable of providing good surprises. As a result of the strides made toward full reopening, rapid vaccine distribution, massive stimulus efforts, and support from the Federal Reserve, we maintain our 2021 forecast for GDP growth of 6.25%-6.75%. Last year’s 3.5% drop in GDP – the worst year since the Great Depression – may not be soon forgotten, but it’s left behind in the dust of 2020.
With various measures of output matching or exceeding pre-pandemic levels, it’s clear last year’s recession is in the rear-view mirror. It may go down as the shortest one in history — even shorter than the six-month recession from the early 1980s.
This economic cycle is on its first lap
Since World War II, economic expansions have lasted an average of five years, with the four most recent economic cycles lasting even longer. Before the pandemic, the most recent expansion was the longest ever at 11 years, and might have continued if COVID-19 hadn’t struck. However, this cycle may not last as long as the previous one, considering this wasn’t your average recession.
Because last year’s recession was most likely the shortest ever, and the economy was supported by historic stimulus, some imbalances weren’t worked off like we tend to see in a normal recession. Corporate debt levels remain high – supported by low interest rates – and stock valuations never really reset. The good news is this new cycle of growth probably has enough going for it to be at least average, which would still give it another four years.
U.S. dollar may struggle to keep up
We began 2021 expecting a weaker U.S. dollar – and that’s what happened – but we think many more years of weakness could be in the cards. We view the “twin deficits” of the U.S. economy — the budget deficit and the current account deficit — as a long-term structural driver that continues to put pressure on the greenback versus major global alternatives. As a historical net importer, the U.S. has usually carried a trade deficit, while the flood of pandemic aid has stretched the budget deficit and ballooned the sum of the twin deficits to all-time highs, as a percentage of GDP.
The Fed’s been very clear with its dovish stance for a long time, which should be another tailwind to a lower-trending dollar. The dollar has also moved in cycles that last for years. It’s currently in the midst of a lower cycle — having made major peaks in 1985, 2001, and 2017, with years of dollar weakness after the peaks. This suggests continued weaker dollar action could still be ahead.
A potentially weaker U.S. dollar would have several benefits, including boosting profits for multi-national corporations and enhancing returns on international investments for dollar based investors. The flipside is that a drastically lower dollar could be inflationary, driving prices of commodities and imported goods higher.
Inflation running hot
Inflation has been the buzzword of 2021 so far. With record fiscal stimulus, supply chain bottlenecks, semiconductor shortages, a potentially tightening labor force, and an economy nearly fully open, the threat of inflation is very real. Given that the core Consumer Price Index (CPI) (excluding volatile food and energy) in May soared to its highest year-over-year change since the 1992, the threat of higher inflation is quite real.
Many worry the Fed is behind the curve and will be forced to hike rates sooner and more aggressively to prevent runaway 1970s-style inflation. While we don’t share these worries. It makes sense that we’d see historically high inflation over the summer months because the CPI was negative three months in a row during last year’s shutdowns, elevating the year-over-year comparisons.
Higher inflation will likely be "transitory" before things get back to normal later this year. Don’t forget, structural forces that kept a lid on inflation for much of the past decade are still in place. Technology, globalization, the Amazon effect, increased productivity and efficiency, automation, and high debt (which puts downward pressure on inflation) are among the major structural forces that have put the brakes on inflation for more than a decade already, and will likely continue to do so.
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