Macro View of the Economic Environment: Economic Update Q3 2021
The big bounce in the economy from pandemic lows early in the year has now faded into a vacuum of uncertainty. Thus far, we have seen a big bounce in the US economy. US GDP rose at an estimated annualized rate of 5.7% during the third quarter of 2021. We have also seen a big bounce in inflation. The CPI (Consumer Price Index) has risen 5.3% through August. Finally, early in the year we saw a big bounce in interest rates. While interest rates have fallen and are now hovering below their March highs, the economy and inflation rate continue run high. We continue to believe inflation will be transitory; however, we have extended our timeframe of when that will begin to happen. We originally believed the definition of “transitory” was “months”, now we believe “transitory” refers to “quarters”. While raw material costs have declined from historical highs, supply chain bottlenecks and the lack of workers in certain sectors have impacted the costs associated with getting product to the consumer. Other factors include waning support for future pandemic relief, the stalled infrastructure bill, and the timing of the Federal Reserve’s tapering. All of these things will resolve themselves over time, but the timing of when they do remains elusive.
As reported last quarter, the US Economy is in full recovery mode from the pandemic. However, our leading indicators are indicating a slowdown in 2022. Having said that, the growth rates for 2021 have been abnormally high in part because 2020 is the basis for comparison and, as we all know, 2020 was a horrible year economically. A similar dynamic is unlikely for 2022, given that 2021 will be the comparison. While the economy will slow, compared to 2021, we do not see a recession. Instead, the economy will slow and experience a soft-landing before taking off again through 2023 and into 2024. Near term, finding skilled labor will be the challenge for many businesses given the existing historical high job openings and low labor force participation metrics.
Retail Sales
Which make up over 70% of US GDP – US Total Retail Sales in the 12 months through August were 15.3% above the year-ago level which puts the metric in unprecedented territory. This type of growth is unsustainable, and we believe we will see slowing in 2022. Two factors appear to be playing a role in this transition. First, the savings that consumers accumulated during the 2020 lockdowns and stimulus distributions have been drawn down leaving less to spend in 2022-2023. For example, US Personal Savings was at $1.2 trillion in 2019Q4, quadrupled to $4.8 trillion in 2020Q2 before retreating to $1.7 trillion in 2021Q2. Second, because of rising prices (inflation), the consumer is choosing to spend their money “now” when prices are “low” versus waiting to purchase an item and potentially having to pay more for it. The result will be less consumer spending in 2022. The US Consumer Price Index (consumer inflation) in August was 5.3% above year-ago levels. We anticipate that, as supply chain issues are resolved, inflation will moderate around the 2% range through 2022.
Construction
Single-unit housing continues to be strong, however back-to-back declines in the metric indicate slowing growth in 2022. US Single-Unit Housing Starts are up 25% above year-ago levels. Supporting this trend is historically low-interest rates, pandemic-induced remote work that has allowed consumers to relocate, and wage increases that have improved workers’ financial situations. However, this has also contributed to soaring home prices which has begun to dampen new home demand. We continue to believe this metric will continue to rise over the foreseeable future through 2023 but at a slower pace. Non-residential (office) construction continues to lag but is showing initial signs of improvement.
Manufacturing
Consumer consumption was strong during the quarter however, shortages of raw materials and increasing supply chain disruptions continue to plague the manufacturing industry’s ability to provide goods the consumer demands. Producer inflation (US PPI) rose more sharply in recent months than anticipated resulting in manufacturers having to pay more for their raw material. It appears some of the increased costs will be passed along to consumers. We anticipate the issues within the supply chain will continue for the near term into 2023 with the potential for a mild recession (i.e. soft landing) in mid-2023.