Economic Outlook: Inflation Infection
Michael Gregory, Head of U.S. Economics, BMO Capital Markets, recently discussed the economy, including the implications of the COVID-19 variants, the surge in inflation and supply chain bottlenecks, and the current labor market. Watch the full discussion.
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[00:00:10] Todd Senger: Welcome, everyone. I'm Todd Senger, Head of BMO's Diversified Industries Group. I'd like to thank you for your interest in today's event. One of our key principles at BMO is adding value to our clients through thought leadership.
In some conversation each day, we're confident that you're talking about COVID-19 variants, labor challenges, surging inflation, rising interest rates, and how long will this economic recovery last? In today's discussion, we are excited for our speaker to share his views on all of these topics. We are hopeful that you will find value in the information presented.
Before I introduce our speaker, I want to address a few housekeeping items. Feel free to ask a question at any time during today's presentation. You will see a Q&A box located on the right-hand side of your video monitor where you can enter a question and simply click "Ask the button".
The questions are confidential and not seen by anyone but our presenter. Today's event is being recorded and will be shared following today's conversation. Now, for a brief introduction on our speaker. Michael Gregory is Deputy Chief Economist and Head of US Economics for BMO Capital Markets. He manages our team responsible for forecasting and analyzing the North American economy in financial markets.
Michael, as always, a big thanks for you being here today. With that said, over to you.
[00:02:00] Michael Gregory: Thanks, Todd. Hello, everybody and welcome. I'm going to be talking for about 45 minutes in this presentation or maybe a little bit less than that, and we'll have time for a Q&A session afterwards. As Todd mentioned, please enter your questions.
Some of you have already asked us some questions when you registered and I did see those and, in fact, I tried to incorporate some of the answers actually into my presentation. Hopefully, I'll be able to address them then.
Let's just start off. The title of my talk 'Inflation Infection'. I thought it was an appropriate title given we're still living with COVID, but more importantly, increasingly living with rising inflation. Before we begin, it's worth to take stock where we are right now. If you go to the first slide, please.
We just recently got some information on the fourth quarter for GDP, we grew 6.9% annualized, exceptionally strong results, and we've already made up all the ground loss during the recession by the second quarter of last year and now we've almost made up all the ground left to get back on the trend that we would've been on if not for the recession.
The question is, are we going to get past that line in the first quarter? We probably need growth at around 4% to actually, what economists call, close the output gap. We don't think we'll quite get there in the first quarter. The first quarter is looking kind of challenging and we'll see that actually with the job numbers that are due on Friday. They'll be for January, we're expecting not a very impressive number.
In fact, I wouldn't be surprised if we had a slight negative because we are at this point now where some of the headwinds affecting the economy are starting to be felt a little bit more severely now. They're temporary, but they're still being felt. Next slide, please.
Well, of course, the biggest headwind that we've been living with now for, I believe that's been over two years. The first case was reported in January of 2020, so it's been like two years in the making. The good news is the Omicron wave does seem to be subsiding substantially. Cases are still elevated and a lot of people are still getting sick, but hospitalizations are down, and with some lags, so too will death.
This was not as severe in terms of health outcomes as previous waves and so as long as we stay the course here, this will become less and less of an impediment for economic activity. If you go to the next slide, please.
Omicron, despite the fact we didn't have any restrictions this wave, still was a damper on activity, and we see that most profoundly in terms of absenteeism. The Bureau of Economic Analysis-- I'll tell you, the Census Bureau rather did a survey that went from the end of December to around January 10th and they concluded some 8.8 million Americans were absent because either they were sick with COVID or they were caring for somebody that was sick, and that's how profound the impact was.
That was having an impact on production. It was having an impact on the availability of goods on the store shells which I'm sure some of you just see on a day-to-day basis. It did have an impact despite the fact there were no restrictions plus people were imposing their own restrictions on their own behaviors. We saw seated diners actually fall quite noticeably over the last several weeks.
People are flying less and that's not because they can't fly or they can't dine out. They choose not to because of the pandemic, and on top of that, we still have the lingering impact of the case rates in other countries that is affecting global supply chain. Overall, the economy is feeling the impact of Omicron despite there are no restrictions, and we have to get over that before we can look ahead to stronger growth for the remainder of this year. Next slide, please.
In the meantime, we've seen inflation just soar. The primary catalyst for that has been the bottlenecks that we've been experiencing primarily for the past year or so. We happen to think, the kind of rates we're seeing now-- By the way, we're looking at 40-year highs in terms of inflation, at least for headline inflation at 7%, core inflation at 5.5% isn't quite a 40-year high. Technically, it's a 30-year high, but only a tenth away from hitting that 40-year high. We suspect that we will get there in the months ahead because it doesn't look like inflation has yet peaked.
Part of that is the impact of Omicron on exacerbating labor shortages and product shortages. Part of that is that we had very strong momentum heading out of last year. Look at the last three months of the year. Headline inflation was running at around a 9% annualized rate, core inflation was running about a 7% annualized rate. That's the strong momentum we have. Combine that with Omicron's impact on bottlenecks. Finally, the old nemesis for inflation, oil prices are drifting up as well. We're pushing $90, and they're highs we haven't seen since 2014 before prices collapsed.
The good news is that we will likely see inflation crest in the months ahead. As the temperatures warm up, the snow melts, so depending on where you are in the country, and Omicron cases continue to subside, which I think they will, I think inflation is also going to come down a bit, simply because last spring we had these huge spikes in prices because of reopening. In this year, we're not going to get them. Therefore, when you compare on a year-to-year basis, inflation will be marked down.
The one thing I wanted to leave you with before we continue here is a lot of people, they think about bottlenecks pushing up inflation. They think only on the supply side of the equation, constrained supply, whether it's because of the pandemic or whatever, but there's another dimension to these bottlenecks, and it's demand.
One of the things I'm going to leave you with today is that it is this demand side that has also exacerbated inflation. If demand wasn't as strong as it was, even if you have constrained supply, the bottleneck pressures on inflation would not been as profound. It's because we also had strong demand that we had these issues. Next slide, please.
I think if you want to focus on this mix of demand and supply putting up inflation, you can look no further than the impact of the shortage of semiconductors or microchips on automobile prices. We all know that they're an important part of vehicles these days and because of the shortage, we've ended up with a limited supply.
You drive by any dealer lounge, it's starting to get a little filled up again now but for a while, they were looking pretty bare. That's bid up the price of new vehicles. People are often paying not only the full sticker price but there's usually some surcharges and things attached to that. People are paying above list in many cases for new vehicles.
Needless to say, when you have limited supply of new vehicles, people turn to the used segment and we've seen a spike in prices there. Even though it's fallen off a little bit, it's starting to heat up yet again. The important thing is here that even though there was constrained supply of both new and used vehicles at the same time which is why the prices were going up, the fact is demand for vehicles was also pretty strong.
People were driving instead of taking transit and people had a little bit more cash in the bank, and instead of going on a trip or doing something traveling overseas or something like that, they were buying vehicles or wanted to buy vehicles. The demand was there, constrained supply.
Again, the same sort of thing was affecting on the rental car segment as well, where around last summer we had near 100% increase in rental car fees. Again, the fleets misjudged how strong demand would come back and were caught flatfooted a bit and were trying to get new vehicles just like everyone else was out there. As a result, they became in short supply and prices went up. Let's go to the next slide, please.
You think about microchips, they're not just an issue for the auto sector. They're an issue for many products throughout the economy including all consumer products and smart appliances that we all have in our homes these days. That's something to keep in mind. It was quite ubiquitous in terms of the impact. The shortage was on the availability, not just of vehicles, but of many goods throughout the economy.
Also, importantly, to keep in mind, this wasn't just about the pandemic affecting production of microchips. Even before we had the pandemic, we had another thing we were worrying about, was the trade war between China and the United States, and part of that had the United States restricting exports into the US of microchips from China.
Another dimension of this shortage, again, beyond the pandemic and beyond the trade war, was climate change. Our extreme weather events. We had the ice storm in Texas, that freaky ice storm which affected the global supply chain but more profoundly, we've had a massive drought in Taiwan where two-thirds of the world's microchips are actually manufactured.
As some of you may know, it takes an awful lot of water to make microchips, and as a result, we've had this impact where even though the demand for chips have gone up, because the demand for the products that have the chips in them have gone up, the supply hasn't been there. We've been working with razor-thin supplies on hand. When there's any kind of disruption out there anywhere, it ends up choking off the production process, and we end up with the kind of shortages we're seeing now. Next slide, please.
You think about, well, it's microchips affecting automobiles and other products, but it's not just microchips, it's an input of anything you can think of that seem to be in relatively short supply, whether it's raw materials or semi-finished materials that go into construction and things like that. All of them have been in relatively short supply, in part, mostly due to the pandemic.
In fact, because of that, we've seen producer prices surge to elevated levels. On the raw material side, we had record highs recently just topping over 60% on a year-over-year basis for the full array of raw materials. We talk about record highs, the PPI dates back to 1946. When you look at semi-finished goes, the inputs to production, apart from a brief period in '74, '75, this too is the highest inflation rates we've seen since the end of the Second World War. Of course, this is like pressure in the pipeline that's going to continue to get unleashed on consumers to the extent it can. Next slide, please.
We talk about the input prices going up and putting pressure on margins of companies, but not only is it getting more expensive to make goods, it's also getting a lot more expensive to distribute those goods. We saw at one point this summer where the cost of shipping a container typically around the world had jumped more than 500% on a year-over-year basis. That's come down, but yes, now they're only growing, doubling. That's still a remarkable increase that we are seeing, and at the same time, even shipping goods domestically via a truck has escalated to levels we haven't seen at all before.
Now, one of the issues that was causing these kind of pressures were the logjams we were having at the ports, which the administration worked with the ports themselves and the unions there to try and get them work in 24/7, which has alleviated some of the problem, but folks, the longshoreman has contract come due on July 1st. Historically, there's always a little bit of a slowdown in activity heading into those contract negotiations, and the American Trucking Association has said that they have a record high, 80,000, shortage of truckers.
Again, we're dealing with these bottlenecks, but it's going to happen slowly, and a lot of these bottlenecks are going to remain in place through the remainder of this year. Next slide.
Talk about distribution cost. Talk about input cost. Well, the other thing we have to deal with are labor costs, and not only are getting materials a hard time because of shortages, so too is labor. Right now, there is some just 10.9 million job openings across the country.
Yes, we backed off from the record high of 11.1 we had a while ago, but still that's an unprecedented level.
When you think about there's just about under-- there's over 6 million people officially unemployed across the country. In other words, there's like 1.7 jobs available for everyone who's officially looking for a job. Now, of course, there's a skills mismatch problem there, so you really can't look at that, but it gives you the sense how tight those labor markets are.
When you look at other business surveys, particularly among independent small businesses, they too are reporting record high levels of vacancies and inability to get the people in the door. Next slide, please.
I don't have to tell anybody on this call, not only is it hard attracting workers, retaining them is also an issue. People are calling this the great resignation where we're seeing tremendous amount of churn in the labor market. The latest figures we have are that 4.3 million people quit their jobs in the latest month, that's December. That's not quite the 4.4 million record high we had, but still that's an elevated level. Employees are feeling emboldened these days.
When you look at the conference board's labor market differential which is a gauge of perception of how strong the labor market is and how easy it is to find a job, that's pushing up near record highs apart from that brief period around the tech bubble. In other words, for many workers, most workers, these are the strongest labor market conditions they have experienced in their lives. As a result, many are taking advantage.
When I talk to businesses and they talk about keeping workers on the assembly line, it's not even a case now of workers leaving for a dollar or two per hour, you're hearing cases of $5 and $10 more per hour. Of course, this further adds to the buildup of cost pressures and presumably inflation pressures down the road. Next slide, please.
This begs the question and I think someone asked that when they signed up, so where have all the workers gone? Yes, we've got the output is higher than was before, but the labor force is still what it was before. It's actually grown a little bit since the pandemic, so where are all the workers gone? Well, one thing is clear is that the labor force participation rate has fallen quite sharply, and it has been very slow to rebound.
To put this into some perspective, if we had the same participation rate we had before the pandemic, and allowing, of course, for the fact the population's grown a little bit, the labor force would be almost 4 million people larger than it is right now. Now, the government surveys through the Bureau of Labor Statistics, they show that about 1.1 million people say-- and these are people who were either working before the pandemic or were looking for work before the pandemic, have stopped looking, therefore they're not included in the labor force anymore. 1.1 million say it's because of the pandemic. They've got caregiving issues, they've got health concerns. It begs the question, that other 2.8 million, where did they go?
Well, I do think that the amount of people who are reporting is due to the pandemic is probably underreported. Other surveys suggest that number is a lot bigger than just the 1.1 million, but the larger factor appears to be early retirements. That doesn't seem to be for people that are 55 and over, more of them are retiring before they reach 65 or whatever than had been the case previously. Perhaps until very recently, those retirement nest eggs were nicely well padded, and of course, older workers, perhaps they'll have a little more concern with respect to their health during a pandemic.
Also, there's another theme that's unfolded as well, where we've seen this migration of people moving to more affordable housing, often, out of the urban into suburban areas or even exurban areas. That is, often, or sometimes, been associated with moving from two income households down to one income household, in part, because of childcare concerns and things like that, obviously, related to the pandemic. The question is, how soon or how permanent are these themes?
The other thing to keep in mind is, up until these benefits end, we had some pretty generous income support programs that a lot of people were able-- even when those programs ended and we didn't see this rush of people returning back to the labor force, maybe were going to live off their bank accounts for a little while, or be a little more picky about what jobs they would pick if they were looking at all. Next slide, please.
The other thing I wanted to leave you with too is that when you think about labor force participation, you also think about also the population itself, because it's that labor force participation that's applied to the population, and even America's population is actually, in the last year, only grew 0.3%. The slowest rate in 70 years. Now, unfortunately, part of that was due to an increase in deaths, either due to the pandemic, COVID pandemic, or to the opioid epidemic.
Both of those took a toll on population growth in the US but also has weighed down population growth has been reduced immigration flows, legal immigration flows. Presumably, that means illegal immigration flows too. It's not just one year, if you look at 5 and 10-year trends, so you smooth out what we've seen in 2020 and 2021, the fact is that we are still having the slowest population growth we've seen since the 1950s, either on a 5-year trend or a 10-year trend.
This is a problem that's not going to go away anytime soon. It's a problem, as you see from the chart, is pumping up wages. When you look at some key metrics, we're seeing the kind of wage inflation rates we haven't seen since the 1980s. Notice, we've got the highest inflation rates we've seen in 40 years. We're now seeing the highest wage inflation rates we've seen in the 1940s. Wages and prices, both going up, folks, we know what that's called. We're going to talk about in a second.
If you look at those metrics I just threw down or jotted down on that slide, the one as an economist that bothers me the most are unit labor costs. Unit labor costs can measure broad wages in the economy but they adjust for productivity. You look what's happening now is that wages are growing above and beyond the gains we're seeing in productivity in the economy as a trend basis. One of the wages that are most closely correlated with inflation are unit labor costs. It does seem that we are starting to see a germination here of a wage-price spiral in the economy. Next slide, please.
In fact, when you take a look at small business surveys, independent business surveys, you are seeing record high levels of firms that are either raising their wages or plan to raise their wages, and on the other side, are raising their prices or planning to raise their prices. In other words, what we're seeing now is a change in behavior. An inflation-type behavior setting in.
Businesses are trying to protect their margins, which is expected, and feeling a little more emboldened than they would have about the ability to do that because their competitors are doing it too. This is something that I think, over the past several months, has really begun to worry the Fed. It's not only behavior. If you go to the next slide.
Actual expectations of what inflation's going to be in the future have also gone up. It's gone up as what it's priced into the bond market and it's gone up compared to what the consumers are thinking about. This is increasingly factoring in, as I mentioned before, into behavior. Now, it's not like people are expecting inflation to be high for a very long time but for the next year, two or three, there is this expectation that we have not entered this period where inflation will be elevated compared to where we were for the past few years. Next slide, please.
Now, so far, I've talked about the bottleneck creating inflation and then the supply aspect of that, but there's all-- I'm going to focus a bit on that demand side. Now, when you think about what's gone in this pandemic, there's been an awful lot of government support, income support that many, many people needed, many families needed and then many other families didn't need it as much as that first group.
At the same time, most Americans were able to continue working during the pandemic, some couldn't and that's unfortunate, but most could. Here we have a situation. Most people were earning the kind of incomes they had before, topped up with the government's large S, and at the same time, the ability to spend that income was restrained either because of restrictions or because of product shortages or because they're just choosing not to until the pandemic goes away, and the net result has been this huge buildup of excess savings.
What I mean by excess is that consumers were saving about 7.5% of their income before the pandemic. If you assume they would've continued doing that, anything above and beyond that is in excess. Guess what, that totaled some $2.4 trillion over the past couple of years. That's more than 10% of the economy. The question is, how much of that is actually available to be spent and continue to fuel demand?
We know some of this is flipped in or moved into the housing market in forms of down payment. Some of it is moved into permanent savings into the stock market and another retirement savings and things like that. The question is, how much money is really out there? It's interesting that lately, we started to see consumers begin to tap those excess savings just a bit. If you go to the next slide.
We're not sure how much liquidity is still out there. Well, rather than look at household balance sheet, you look at my balance sheet, rather the balance sheet of my employer, and all the other financial institutions in the country, and what you find is between businesses and consumers, both. You look at all the deposits that exist within the banking system, plus all that liquidity sitting around in retail money funds, and you're finding that the total and aggregate is over $4 trillion. That's more than 17% of the economy.
Again, this is money in excess of the roughly 7.5% growth we were seeing for these aggregates before the pandemic. This is money that some of it will stay there permanently, but some of it will be used to spend on goods and services, but more importantly, for the Fed, some of that money will used to keep paying higher prices for longer than what otherwise be the case, because it always assume that inflation is almost a little bit of a self-correcting phenomenon.
Inflation goes up, it erodes purchasing power. Eventually, it dampens demand, but not when there's offsetting wages, which we are seeing, and not when consumers and businesses can tap the excess liquidity to keep paying higher wages, higher prices for a lot longer, higher-priced materials, whatever the case may be. It does seem that we do have a pretty impressing inflation problem that is risking at least getting out of hand. Next slide, please.
In addition to all of this liquidity that's out there, one part of the economy, the government continues to add its share in terms of spending in the economy. True, we'll probably see the deficit fall this year compared to what it was last year, but those yellow bars you see there are the projections for the CBO. In fact, they're late again in giving their latest projections.
They don't include yet the impact of the Infrastructure Investment and Jobs Act, which is going to add a little bit to the deficit, make those bars a little bit longer, but the more significant part of that is the Build Back Better Act which was not expected really over 10 years to add a lot to the deficit, but as everyone know, and this is the bone of contention for Senator Manchin in the Senate, is that it's expected to add a lot to the deficit over the next few years and then as some of these programs are expected to expire, it's going to improve the deficit in those out years, and that's why accounting that way has been an issue for that Senator. In fact, we've always accounted for it that way.
Forget, folks, those tax cuts that kicked in 2018. For personal taxes, they actually reverse in three years' time according to the law. Again, that was the method that was used to ensure that tax cut was fit within budget rules at the time.
Apart from bigger deficits, the more significant impact is all of the spending, apart from adding to pressures in the economy, is also leaving a legacy of very high debt levels. In fact, it was just reported that the debt clock, in fact, if some of you are in New York City, there's that debt clock in Midtown that you can see. It just rolled past the $30 trillion mark for the first time, we now have more debt than we did the last high we had, which is in 1946 when we were paying all the bills for the Second World War.
Deficits in debt, not a lot of politicians are talking about it, but hopefully, we will get that in the not too distant future. Next slide, please.
I talk about demand side. We've started to see some changing dynamics on that demand side. Initially, we saw this huge run-up in goods demand, in part, because people couldn't consume services, so there was a lot of substitution, groceries instead of restaurants, flat-screen TVs instead of vacations, that kind of thing. That's what really added to the pressure we saw on goods prices and inputs to goods production throughout the global economy but that started to slow down a little bit, in part, because we're seeing a natural switch back into services.
People are taking vacations instead of buying more flat-screen TVs but more importantly, and also importantly, is the fact that there's a shortage of goods out there and people who wanted to buy cars have to wait a little bit longer. The key thing for us though, we think there's enough liquidity out there that middle line, that total line can continue to grow at a very robust rate continuing to pressure global supply chains as they attempt to correct themselves. Next slide, please.
I thought I would just take a quick little detour here just to show you a little microcosm of this issue of strong demand, growing demand, constrained supply, and how that really impacts prices, and how it may not be resolved quickly.
Do that microcosm in terms of the housing sector. We've seen housing sales just soar during the pandemic, we know the story there. People, working from home, they needed bigger abodes, they wanted to move in less dense areas, so from the urban to the suburban, to the exurban, to the rural. Some of the hottest real estate markets were in rural areas across the country.
Then as I say, that hoovered up all of the available supply of homes so you end up with this imbalance in real estate. I talk to a lot of realtors across the country and they worry about business being down not because the demand isn't there, there's no product to be sold. Of course, we all know the remedy to that. Next slide, please.
We just keep building more homes and that's exactly what we've been doing, but you can see where the constraints begin to impact here. Currently, if you look at the level of homes under construction, they are the highest they've been in almost 50 years.
Even higher during the housing bubble we had that led to the great recession. It's taking longer to build a house, why? Because materials are taking longer to get to the job site, workers are harder to find, so it's just simply taking longer.
Because it's taking longer, builders are still seeking their permits but if you look at the amount of permits that are sitting around in their portfolio that they haven't started to dig in homes yet for, they're also at a record high. You have these strong demand, limited supply owing to these constraints, and what's the net result? You don't need be an economist to understand what happens there. Next slide, please.
What you're seeing is record-high increases in home prices. It's funny, we fought back in the last cycle. If we saw these kind of home price increases, we all be worried that people are getting in over their heads, speculation. [unintelligible 00:33:13] is a little bit of speculation, a little bit of people getting over their heads. The fact is this is legitimate, demand exceeding supply and the supply being constrained because of the pandemic and other factors.
When we think demand is going to remain relatively robust, sturdy, if you'd like, over the next several years. The millennials are now in that part of their lives, where they expect to be into the homeownership part of it. Let's face it. If you had plans to buy a house in the next year, two or three, you might as well buy it sooner rather than later, because in one or two years, three years time, that house may be 10 or 20 or 25% higher than what it is right now.
The key thing is though this house price inflation, very small part of-- relatively small part of the economy does ripple through into the inflation metrics. It ripples through into how much rents go up, and importantly, owners equivalent rent, which is an important component of the CPI. Also even home insurance premiums. If your home is worth more, you're going to have to pay more to ensure it.
As some of these other supply bottleneck pressures fade, we're going to continue to get inflation pressures coming from the housing sector, next slide.
Getting back to the demand side. Get away from this little microcosm. Consumer spending remains strong. We think business investment also going to remain strong. Again, it has been strong and we've seen particularly on the intellectual property side and the equipment side, very strong growth in outlays, and a large part of that is a spillover from labor shortages and businesses are automating where they can, investing in IT, other kinds of technology in order to become more efficient, more importantly, to mitigate the impact of labor shortages.
One area of the economy which has lagged behind, obviously, is on the structure side. We're still building more warehouses and data centers. Admittedly, we're not building any new hotels or restaurants this yet, but where the weakness of that really is in the oil sector where oil production remains well below where it was before. Quite frankly, I doubt whether anytime soon we'll be returning back to the peak oil production we had in America before the pandemic. Next slide.
Well, if you're worried about infrastructure outlays and general construction outlays lagging behind the economy, you don't have to worry because the Infrastructure Investment and Job's Act is going to add some, I'll miss this, titled to add some $1.2 trillion dollars of spending over the next five to seven years and now.
One thing about politicians that do like to embellish things just a little bit, and there really isn't $1.2 trillion of new spending going on. There's more like 550 billion of some of the money that Congress always does approve anyway, for surface transportation, which they do every five years, or every six years depending on the situation, they kind of roll that into the infrastructure built out to make a little bigger than otherwise would be. Fair enough, but even at $550 billion over five years, that's still almost 3% of GDP going to spread out over that period.
From fixing bridges to internet upgrades to our utilities, infrastructure, so there's a lot to go on. Again, yes, we may deal with some of the shortages we're having on building materials but quite frankly, the demand is not going to be going away anytime soon, and therefore prices may continue to go up and definitely won't be returning back to where they were before. Next slide, please.
Last piece to the puzzle is we are expecting US exports to pick up. Last year, we saw the trade deficit hit a record high as the fact that US growth was much stronger than the growth in most of our trading partners and as a result, we ended up importing more than we were exporting, and it causes record deficit.
Looking ahead to this year, we think a lot of these countries are going to catch up like Canada and Mexico, particularly, which are the two largest export markets for the US, and that will help to turn the trade deficit around, still elevated, but at least no longer hitting those record highs.
If we go to the next slide, and we sum up everything, the outlook for a still sturdy consumer spending, a legacy of still high outlays by the government, very strong business outlays, decent export growth, all those things added together, and we're looking for continued sturdy expansion in the economy going forward.
Now, the first quarter as I alluded to before, it's not going to look good. We think we're looking at about 1% annualized growth, again reflecting the impact of Omicron on the absenteeism and just people pulling back temporarily from going to restaurants and things like that, but it's also reflecting a little bit the end of the expanded child tax credit which at $15 or $16 billion every month was adding a little bit of extra hoof to consumer spending.
However, we do think once we get over that little headwind or big headwind but still temporary headwind, we'll back to 3% to 4% growth for the middle quarters of this year before we tuck in just under 3%. On average, we're looking for growth around 3.5% this year, 2.5% for next year. 2.5 may seem a bit slow compared to where we've been, particularly near 7% in the fourth quarter alone, but keep in mind that the speed limit for the US economy is roughly just under 2%. Anything above that noticeably is still a relatively good performance and it means that any inflation pressures that exists in the economy are going to continue to percolate a little bit until we get growth a little closer to our run rate which is roughly around, again, just around 2% or slightly below.
Now, even though the overall economy's doing well, as we all know, it's not the same thing, and when you look at the individual sectors and industries of the economy. If you go to the next slide, please. People are calling this the K-shaped recovery. There are certain industries that are doing exceptionally well. Others that are still lagging behind of this. By the way, these figures are for the third quarter. We don't have yet the fourth-quarter figures by industry just for the national economy, but all of these will probably have improved somewhat when they come out for the fourth quarter.
For leading the parade, are all the sectors that were very amenable to work from home and in particular the one that garnered the most support as technology was adopted more rapidly during the pandemic was the information sector, finance and insurance also leading the parade. Until recently, we had record stock markets. We had this booming housing sector which all bodes well for that sector.
Agriculture was a lot higher up the rankings earlier in the recovery but it faded a little back because of the drought experienced in the Midwest. Then finally, goods production is in there as you would expect given the huge demand we've seen on the other side of the ledger. The weakness are all those crowd-dependent sectors, arts, entertainment and recreation, food services, and accommodation. The transportation side of transportation and warehousing, warehousing is doing exceptionally well, but not the transportation side of that sector and, of course, the mining sector which includes oil lagging behind because we simply are not producing as much oil as we did before the pandemic. Next slide, please.
The kind of growth we are expecting, above-potential growth will continue to tighten up the labor market. We're expecting by the end of the summer, we'll recover all the jobs lost during the recession. By the end of this year and into next year, we'll be looking at unemployment rates below where we were before the pandemic.
We think as this year unfolds, the Fed is going to feel as they've already indicated, they're well on their way to achieving one of their goals of maximum employment. Not quite there exactly yet, but we're well on the way there. In fact, the ability to get there is actually jeopardized now by high inflation, and therefore the Fed is maybe-- Still has maximum employment in mind, but wants maximum employment over the long haul, and the only way you're going to get at that is by ensuring that inflation does not get out of hand in the short haul. All right. Next slide, please.
That's exactly what happens, the risk to price stability have increased quite significantly. As I mentioned at the outset of my presentation, we're looking for inflation to crest this winter, and during the spring begin to ebb a little bit. Now, we still get the benefit, the disinflationary benefit of the demographics and aging society. We get the benefits of globalization, not as much as it was before the pandemic and the trade war, but nevertheless, re-globalization, if you'd like, will continue to exert a bit of disinflationary pressure, and of course, technological change, which, in fact, has been accelerated because of the pandemic.
A new thing I think has entered into sort of the more secular trends affecting inflation, and that is climate change and carbon pricing. I think that's going to be something that's going to add to the longer-term upward pressure on prices. Give you a quick example. The last I checked, there were five separate bills being bandied about in Congress that as part of them would introduce a carbon border adjustment, sort of a border carbon adjustment which would mean goods coming into America would have some tax on them to reflect the fact that not all countries have the same standards as the US and US doesn't even have a national carbon price yet.
We do think that when the dust settles at the end of this year, we'll probably get inflation rates under 4% and by the end of next year, back under 3%, but quite frankly, that assumes that the Fed does the right thing in the interim because if they don't, we won't get that kind of outcome. Next slide, please.
In fact, some of you that follow the Fed they've really changed their tune over the past several months. They basically said blatantly, "Our goal here is to prevent higher inflation from becoming entrenched," and why are they worried about that? For two reasons. Number one. As I mentioned to you before, we're starting to see expectations and behavior be influenced by current high rates of inflation.
People are a little bit doubtful that it's going to go back to 2% in a hurry or under 2% where we had it before. To give you a little interesting fact is that we're looking at 40-year highs in inflation. 51% of Americans are under the age of 40, which means that the slight majority of the population are seeing the highest inflation rates they have seen in their entire lifetimes. How can that not influence your behavior and expectations just a little bit?
Moreover, you have older Americans that remember the days of double-digit inflation or are currently on fixed incomes that awful worry about inflation for legitimate reasons. How can your expectations and your behaviors not be influenced by what we're seeing now? The Fed wants to assure you that you don't have to worry about it. We've got the situation in check and they're going to act.
The other thing is become a paranoid, and hopefully, you've taken this away from my presentation is that it's become very clear that the bottleneck-driven inflation is not going to be adequately checked until we deal with the demand side of the equation. Basically, we got to try and curb demand a little bit. Think of housing, cut demand a little bit by raising interest rates. In fact, that is why the Fed has said that they are prepared and they are poised to start tightening by next meeting.
From my last slide-- Next one, please. Might as well finish off on what our Fed call-- By the way, the Fed call, and some of you may follow our forecast, have changed quite a lot as has for many shops, and we're expecting the beginning of liftoff in March, three consecutive rate hikes, in mid-March, early May, and then mid-June, and then move to a quarterly pattern. We think we'll get these rates going up until we reach the midpoint of the FMC's longer-term rates or just roughly around 2.5%.
I haven't talked about it yet, but the Fed has also signaled that a lot sooner than what they had done the previous episode, that they will begin to shrink their massive balance sheet that they built up as they printed money to pay for all those bonds they have been buying to keep interest rates low. We think that that runoff or what people call quantitative tightening will occur as early as July. The net risk for us is that we will see those interest rates rise in the runoff at even a faster rate sooner than what we had previously.
Of course, with the Fed acting plus higher inflation plus those persistently large budget deficits still nagging at us, all suggest that long-term interest rates will rise as well.
I'm going to stop right here. Go to the next slide, please. Start thinking about some questions for the next several minutes. I'm just looking here, some came over the chat. First question that came out here was, "Has the stimulus affected demand and prices as much as supply?" You know what? If I had to pick, I would say it's 50/50. I think demand has been just as powerful and influenced on what we've seen maybe at most I think it may be 60 for supply, 40% for demand. It's roughly about equal shares. It's been so profound, and you hear that with a lot of the businesses I speak to and it's like the shortages, the way they just keep popping up and people likening it to a game of whack-a-mole which, of course, you play at the carnival. As soon as you hammer down one mole or one bottleneck pressure or one shortage another one pops up. I'll give you a quick example, the auto sector been worried about microchips for quarters and quarters and quarters. You know what the latest issue is? Shortages of magnesium. Magnesium is used to harden aluminum in the production process and there's now issues with respect to magnesium supply. Again, whack that mole down.
The second question. "What policy changes may the government make to encourage people to remain in work?" Oh, that's interesting. Obviously, we have an issue here with labor force participation. Firstly, we got to get the pandemic under wraps and I think we're probably heading in a position here where people will feel a lot more comfortable from a health perspective, at least, rejoining the labor force.
The other issue though has been capacity in childcare spaces. A lot of childcare workers have been getting sick. A lot of facilities are closed, so capacity is not where it was before. Now, I think it was dropped if I recall in the latest incarnation of Build Back Better, but at one point there was a policy on the table, a measure on the table that try to help support affordable childcare across the country. I think that is a critical component of increasing participation of parents and women in the economy.
The other thing of that too, quite frankly, is dealing with immigration. I know we try and do this every several years and finally get economically beneficial immigration reform. We seem to get there, then we pull back, and I think that's become critically important longer-term for the US economy. These are the kind of thing I think the policy moves that will pay off.
The other one is, in the event that we don't get the kind of labor force participation or population growth, is to invest in productivity-enhancing policies. I do think, for the infrastructure bill, for example, you don't like seeing $1.2 trillion or more government spending, but it's government spending earmarked for infrastructure, which, of course, tends to improve the or grow the economic pie so we can grow faster down the road without having inflation.
Next question. "What extent is improving the US economy at risk of continuing strength of the US dollar?" Good, good, good question. A couple things, obviously, improving exports in a shrinking trade deficit is part of the driver of growth over the next little while, and to the extent you get a strong US dollar, it does dampen that somewhat. Obviously, it's not positive for growth.
The other aspect too, which is a little bit on selling at least from my risk standpoint is a strong US dollar is not only looked upon favorably by other countries around the world. In many emerging markets, they're dealing with inflation rates that are unacceptably high for them. They've already started raising interest rates in Mexico, for example, and that strong US dollar tends to be a problem for them, which, of course, you begin to worry about issues about financial contagion and things like that which, of course, is a risk. Obviously, a stronger US dollar is not an overall benefit to a robust recovery.
Now, the next question. Oh, good one. "What is the major reason for the decrease in oil production?" Considering we're living with $90 oil almost, why don't we ramp this up more? I do think the oil companies themselves are treating things a little bit differently. Let's face it. The current administration is not as amenable to the oil sector as the previous one was. I think more and more institutional investors are putting on an ESG type lens when they're looking at their investments. As a result, I think oil companies and explorers in that are being a little more cautious in how they approach development.
Now, there's nothing like higher prices to egg on a little bit more production. I doubt if we get back which many people believe back above $100 a barrel for double TEI, whether that'll even get back yet to the level of oil production that we had previously. This is not only a US oil production, we're seeing an impact globally on mining output and other oil production, simply because of-- Again, people are more and more have sort of health concerns-- not heath, our climate concerns, our planet concerns, climate concerns. That is something that is rippling through the global economy.
Last question before we turn things back over to Todd. "Will interest rates dampen housing prices at all?" Yes, of course, they will. One thing about markets, when they're drum-tight, what the housing market is, all it takes is a little bit of easing back in demand or a little bit of increasing of supply, and it does have a disproportionate impact on price inflation.
I do think as we get higher mortgage rates rippling into a softer demand but still sturdy demand but softer than it is right now for housing, and though supply eventually do come on stream when you finally do complete all those homes, that we will get home price inflation cooling off. I do think home prices will continue to run faster than the general inflation rate for the foreseeable future.
With that, there's some more questions, but flipping in an email or whatever, we'll try and get to you as soon as we can. With that, I'll turn things back over to Todd for some closing comments. Mr. Todd.
[00:54:24] Todd Senger: Thank you, Michael. I appreciate it. Great questions and dialogue. I'd like to thank you, Michael, again for being here today and for all of our guests, thanks for taking the time. It means a lot. We appreciate the investment in us.
Feel free to reach out to your BMO relationship team or myself if you have any additional thoughts or questions, we'd be happy to track it down for you. I'd also encourage you to visit our website bmoharris.com/commercia. Bmoharris.com/commerciall, where we share our latest outlooks either from Michael or others, as well as other thought leadership content.
We will be sending you a brief survey from our BMO invites email and would appreciate your anonymous feedback. It will help us to continue to evolve our events as well as our thought leadership so that everything we do is relevant for you. With that, thank you for your time. Thank you for your partnership, and thanks for what you do for us. Enjoy the rest of your day. Thanks, everybody. See you.
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Michael Gregory, CFA
Deputy Chief Economist & Managing Director
Michael is part of the team responsible for forecasting and analyzing the North American economy and financial markets. He has spent his career working in either ec…(..)
View Full Profile >Michael Gregory, Head of U.S. Economics, BMO Capital Markets, recently discussed the economy, including the implications of the COVID-19 variants, the surge in inflation and supply chain bottlenecks, and the current labor market. Watch the full discussion.
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