Fourth Wave Rising
- Keywords:
United States
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Just as the global economy appeared to be on an upswing amid easing pandemic restrictions, a new wave of case counts is clouding the outlook. So far, vaccinations are limiting the number of severe cases requiring hospitalization. Early signs also point to a relatively short wave of cases in some highly vaccinated countries, including the UK and the Netherlands. The U.S. virus death rate has held fairly steady and is well below that of the first two waves, despite a rise in caseloads and hospitalizations. Using global data, we estimate that there is virtually no association between rising case counts and death rates in countries with at least half of the population partly inoculated, compared with a significant positive association in under-vaccinated countries.
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However, inoculation rates are not sufficiently high in most nations and many U.S. states to prevent another upswing in severe illness and remove the threat of new restrictions. Of concern, the percentage of Americans age 12 and older who are fully vaccinated looks to have stalled at just under 60%. While we do not expect many U.S. states to renew aggressive restrictions, even moderate curbs on activity or an increase in consumer anxiety could slow the recovery.
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At the same time, it has become clear that supply-chain disruptions, worker shortages, and soaring prices are constraining the U.S. expansion, spurring a downward revision to our forecast. Supply constraints have resulted in much of the U.S. policy stimulus fueling price gains rather than real spending and production increases. An ebbing fiscal tailwind has also slowed the economy's momentum. While real GDP growth picked up to 6.5% annualized in Q2, that was little better than the prior pace (6.3%) and well below expectations. Monthly indicators suggest growth has moderated so far in Q3 despite easing restrictions. Home sales have retreated from 15-year highs, in part due to blistering price gains eroding affordability (the Case-Shiller index surged 17% y/y in May). While consumer spending accelerated 11.8% annualized in Q2, much of the increase stemmed from March's big jumping-off point due to rebate cheques. Spending volumes were down modestly in the May-June period, with rising prices accounting for all of the nominal increase. While households are catching up on deferred services such as travel and dining, demand for home furnishings has been satiated and autos have been held back by new model shortages.
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We expect GDP growth to moderate to 6.0% in Q3 and to 5.0% in Q4. This is still a fast pace and well above long-run potential of just under 2%. Although spending has shifted to services, more than $2.3 trillion of excess savings will support overall spending for some time. While many states have ended emergency unemployment insurance programs early, some people are finding new jobs and overall employment earnings are on the rise. As well, the first monthly payouts amounting to $14.7 billion from the expanded child tax credit were sent out in July to over 35 million families. Meantime, apart from office and retail construction, business investment is on an upswing. And, construction will get a boost when Congress approves a bipartisan infrastructure deal, currently pegged at just under $1 trillion over five years. Still, the days of stellar GDP gains are likely in the past. The challenging mix of supply shortages, demand-sapping price hikes, and virus uncertainty will counter some of the thrust from excess savings, record wealth, and rising employment.
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The U.S. economy's contraction in the first half of 2020 marked the deepest downturn in the postwar era. But it was also the shortest recession (just two months) on record. And, given the massive policy response, the economy regained its losses within a year. However, it could take until early 2022 to reclaim the trend growth that likely would have occurred in the absence of the crisis.
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The recovery in overall GDP masks deep scars left by the recession and ongoing pandemic. Many industries still haven't recovered, many businesses didn't survive the shutdowns, and the labour market will take much longer than GDP to heal. The latter is not due so much to a lack of demand for workers, but rather because of changes in worker behaviour caused by the pandemic. Many people have taken early retirement, while many former workers are hesitant to return to the labour force due to child care duties, health concerns and extra UI payments. As well, some workers have switched industries, making it difficult for the harder-hit employers, such as restaurants, to re-staff as demand comes storming back. Consequently, nonfarm payrolls are still 6.8 million below pre-pandemic levels (as of June). Business surveys cite worker shortages as a key obstacle to filling a record number of positions. The participation rate has held about 1.7 ppts below pre-virus levels since last summer. More than half of this decline is due to early retirement, according to a study by the Dallas Fed. A sluggish participation rate might grease a further slide in the unemployment rate to below 4% by late 2022 from 5.9% currently, but it will also hold back growth. Of some consolation, the pace of labour market recovery is still likely to surpass that of the last cycle, which may help limit some scarring.
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Worker shortages also risk sustaining higher inflation. At 5.4% y/y in June, the CPI is already rising the fastest in 13 years. A toxic mix of price-rebounds in hard-hit industries, supply-chain bottlenecks, high resource prices, and base-year effects are to blame. Inflation could top 6% by year-end if soaring house prices pressure rents. A record number of small businesses are raising prices and intend to continue doing so. While some commodities, such as lumber and copper, have pulled back, natural gas prices have doubled in the past year, keeping indexes elevated. We expect the CPI rate to average 4.0% in 2022, well above the consensus view of under 3%, and this assumes wage growth stays largely in check.
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Downshifting growth and rising inflation would normally pose a dilemma for the Fed. But remember, it wants higher inflation to compensate for a decade of undershooting the target (though clearly not this high on a sustained basis). The July 28 policy announcement confirmed that the FOMC is still more concerned about growth than "temporary" inflation, though less worried than before given the vaccine rollout and the economy's ability to partially adapt to restrictions. While the Committee could well announce a reduction in asset purchases (currently $120 billion per month) before year-end, it has no intention of lifting policy rates for some time, probably not until early 2023 in our view. Bond investors, too, have bought the transitory-inflation story, pulling 10-year Treasury yields down more than 50 basis points since late March to below 1.2%. The surprising rally led us to trim our forecast, though we still see the 10-year rate drifting to 1.5% by year-end and then to 2.0% in late 2022 as inflation shows a little more persistence than the market expects.
Canada
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As the U.S. climbs down the growth mountain, Canada is on the way up. While monthly GDP contracted in the spring due to a third round of constraints, easing restrictions sparked a 0.7% rebound in June according to Statistics Canada's initial tally. This should keep growth positive in Q2, while setting the stage for a brisk 6% annualized gain in Q3. The pick-up is despite some steam seeping out of the piping-hot housing market, which now accounts for a stunning 10.3% of GDP versus a long-run mean of less than 6% (those realtor fees really do add up). The release valve reflects exploding house prices (the benchmark is up 24% y/y) which are causing some buyer fatigue. But even with a relatively cooler housing market, the economy should grow 6.0% in 2021 and a solid 4.5% next year.
-
The rosy outlook, of course, assumes no serious upturn in hospitalizations and the need for significant new restrictions. Here, Canada's drive toward the top of the global vaccination ladder puts it at lower risk than most other countries of shutting down again. Around 80% of Canadians age 12 and older have received at least one shot, and the country is well on its way to having a similar share fully inoculated by late August. This should reduce stress on the health care system as caseloads inevitably rise due to the recent easing of restrictions.
-
Global growth concerns have breathed new life into the U.S. dollar, knocking the loonie off its perch, though it's still one of the top performing currencies this year. While we trimmed our forecast, we still see the currency strengthening to C$1.20 (US$0.83) by late 2022, partly because the Bank of Canada is likely to move ahead of the Fed in raising policy rates.
-
The Bank of Canada's confidence in the economic outlook has risen alongside rising vaccinations, though it still sees the output gap staying open until the second half of 2022. While the positive sentiment spurred another $1 billion reduction in its QE program to $2 billion per week, the persistent output gap could keep the Bank's finger off the policy-rate trigger for at least another year. Although CPI inflation has turned up to 3.1% in June, it is off a recent high and the core measures are averaging only modestly above the 2% target. While we advanced our call on the Bank's initial rate hike by a few months to October 2022, we still expect a very gradual course of tightening, with just six quarter-point moves taking the policy rate up to a neutral 1.75% by early 2025.
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Sal Guatieri
Senior Economist
Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with two decades experience as a macro economist. With BMO Financial Group since 1994, his m…(..)
View Full Profile >United States
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Just as the global economy appeared to be on an upswing amid easing pandemic restrictions, a new wave of case counts is clouding the outlook. So far, vaccinations are limiting the number of severe cases requiring hospitalization. Early signs also point to a relatively short wave of cases in some highly vaccinated countries, including the UK and the Netherlands. The U.S. virus death rate has held fairly steady and is well below that of the first two waves, despite a rise in caseloads and hospitalizations. Using global data, we estimate that there is virtually no association between rising case counts and death rates in countries with at least half of the population partly inoculated, compared with a significant positive association in under-vaccinated countries.
-
However, inoculation rates are not sufficiently high in most nations and many U.S. states to prevent another upswing in severe illness and remove the threat of new restrictions. Of concern, the percentage of Americans age 12 and older who are fully vaccinated looks to have stalled at just under 60%. While we do not expect many U.S. states to renew aggressive restrictions, even moderate curbs on activity or an increase in consumer anxiety could slow the recovery.
-
At the same time, it has become clear that supply-chain disruptions, worker shortages, and soaring prices are constraining the U.S. expansion, spurring a downward revision to our forecast. Supply constraints have resulted in much of the U.S. policy stimulus fueling price gains rather than real spending and production increases. An ebbing fiscal tailwind has also slowed the economy's momentum. While real GDP growth picked up to 6.5% annualized in Q2, that was little better than the prior pace (6.3%) and well below expectations. Monthly indicators suggest growth has moderated so far in Q3 despite easing restrictions. Home sales have retreated from 15-year highs, in part due to blistering price gains eroding affordability (the Case-Shiller index surged 17% y/y in May). While consumer spending accelerated 11.8% annualized in Q2, much of the increase stemmed from March's big jumping-off point due to rebate cheques. Spending volumes were down modestly in the May-June period, with rising prices accounting for all of the nominal increase. While households are catching up on deferred services such as travel and dining, demand for home furnishings has been satiated and autos have been held back by new model shortages.
-
We expect GDP growth to moderate to 6.0% in Q3 and to 5.0% in Q4. This is still a fast pace and well above long-run potential of just under 2%. Although spending has shifted to services, more than $2.3 trillion of excess savings will support overall spending for some time. While many states have ended emergency unemployment insurance programs early, some people are finding new jobs and overall employment earnings are on the rise. As well, the first monthly payouts amounting to $14.7 billion from the expanded child tax credit were sent out in July to over 35 million families. Meantime, apart from office and retail construction, business investment is on an upswing. And, construction will get a boost when Congress approves a bipartisan infrastructure deal, currently pegged at just under $1 trillion over five years. Still, the days of stellar GDP gains are likely in the past. The challenging mix of supply shortages, demand-sapping price hikes, and virus uncertainty will counter some of the thrust from excess savings, record wealth, and rising employment.
-
The U.S. economy's contraction in the first half of 2020 marked the deepest downturn in the postwar era. But it was also the shortest recession (just two months) on record. And, given the massive policy response, the economy regained its losses within a year. However, it could take until early 2022 to reclaim the trend growth that likely would have occurred in the absence of the crisis.
-
The recovery in overall GDP masks deep scars left by the recession and ongoing pandemic. Many industries still haven't recovered, many businesses didn't survive the shutdowns, and the labour market will take much longer than GDP to heal. The latter is not due so much to a lack of demand for workers, but rather because of changes in worker behaviour caused by the pandemic. Many people have taken early retirement, while many former workers are hesitant to return to the labour force due to child care duties, health concerns and extra UI payments. As well, some workers have switched industries, making it difficult for the harder-hit employers, such as restaurants, to re-staff as demand comes storming back. Consequently, nonfarm payrolls are still 6.8 million below pre-pandemic levels (as of June). Business surveys cite worker shortages as a key obstacle to filling a record number of positions. The participation rate has held about 1.7 ppts below pre-virus levels since last summer. More than half of this decline is due to early retirement, according to a study by the Dallas Fed. A sluggish participation rate might grease a further slide in the unemployment rate to below 4% by late 2022 from 5.9% currently, but it will also hold back growth. Of some consolation, the pace of labour market recovery is still likely to surpass that of the last cycle, which may help limit some scarring.
-
Worker shortages also risk sustaining higher inflation. At 5.4% y/y in June, the CPI is already rising the fastest in 13 years. A toxic mix of price-rebounds in hard-hit industries, supply-chain bottlenecks, high resource prices, and base-year effects are to blame. Inflation could top 6% by year-end if soaring house prices pressure rents. A record number of small businesses are raising prices and intend to continue doing so. While some commodities, such as lumber and copper, have pulled back, natural gas prices have doubled in the past year, keeping indexes elevated. We expect the CPI rate to average 4.0% in 2022, well above the consensus view of under 3%, and this assumes wage growth stays largely in check.
-
Downshifting growth and rising inflation would normally pose a dilemma for the Fed. But remember, it wants higher inflation to compensate for a decade of undershooting the target (though clearly not this high on a sustained basis). The July 28 policy announcement confirmed that the FOMC is still more concerned about growth than "temporary" inflation, though less worried than before given the vaccine rollout and the economy's ability to partially adapt to restrictions. While the Committee could well announce a reduction in asset purchases (currently $120 billion per month) before year-end, it has no intention of lifting policy rates for some time, probably not until early 2023 in our view. Bond investors, too, have bought the transitory-inflation story, pulling 10-year Treasury yields down more than 50 basis points since late March to below 1.2%. The surprising rally led us to trim our forecast, though we still see the 10-year rate drifting to 1.5% by year-end and then to 2.0% in late 2022 as inflation shows a little more persistence than the market expects.
Canada
-
As the U.S. climbs down the growth mountain, Canada is on the way up. While monthly GDP contracted in the spring due to a third round of constraints, easing restrictions sparked a 0.7% rebound in June according to Statistics Canada's initial tally. This should keep growth positive in Q2, while setting the stage for a brisk 6% annualized gain in Q3. The pick-up is despite some steam seeping out of the piping-hot housing market, which now accounts for a stunning 10.3% of GDP versus a long-run mean of less than 6% (those realtor fees really do add up). The release valve reflects exploding house prices (the benchmark is up 24% y/y) which are causing some buyer fatigue. But even with a relatively cooler housing market, the economy should grow 6.0% in 2021 and a solid 4.5% next year.
-
The rosy outlook, of course, assumes no serious upturn in hospitalizations and the need for significant new restrictions. Here, Canada's drive toward the top of the global vaccination ladder puts it at lower risk than most other countries of shutting down again. Around 80% of Canadians age 12 and older have received at least one shot, and the country is well on its way to having a similar share fully inoculated by late August. This should reduce stress on the health care system as caseloads inevitably rise due to the recent easing of restrictions.
-
Global growth concerns have breathed new life into the U.S. dollar, knocking the loonie off its perch, though it's still one of the top performing currencies this year. While we trimmed our forecast, we still see the currency strengthening to C$1.20 (US$0.83) by late 2022, partly because the Bank of Canada is likely to move ahead of the Fed in raising policy rates.
-
The Bank of Canada's confidence in the economic outlook has risen alongside rising vaccinations, though it still sees the output gap staying open until the second half of 2022. While the positive sentiment spurred another $1 billion reduction in its QE program to $2 billion per week, the persistent output gap could keep the Bank's finger off the policy-rate trigger for at least another year. Although CPI inflation has turned up to 3.1% in June, it is off a recent high and the core measures are averaging only modestly above the 2% target. While we advanced our call on the Bank's initial rate hike by a few months to October 2022, we still expect a very gradual course of tightening, with just six quarter-point moves taking the policy rate up to a neutral 1.75% by early 2025.
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