Global Economy Continues to Grow, Despite Covid

The global economy continued to grow at a firm pace at the end of 2020. Rising COVID cases and renewed lockdowns in many parts of world have so far inflicted only limited damage on the global economy.

Global and U.S. economy are forecasted to grow 5.8%, and 4.5% in 2021 according to Moody’s Analytics. The U.S. economy fell -31% (Q/Q ann.) in 2Q, before rebounding +33% in 3Q. Forecasts are for 4.6% in 4Q20, 3% 1Q21, and it only gets stronger into 2021.

Consensus expectations are for inflation and interest rates to move higher this year. On a y/y basis, inflation increased 1.4%. Below the Fed’s average inflation target of 2.0%, which implies accommodative monetary policy for the foreseeable future. Commodity inflation is stoking up. Core CPI commodity prices increased 1.7% y/y, the most since April 2012, reflecting a broad reflation theme for goods due to stronger consumer demand but also some supply chain issues due to the pandemic. I expect services demand and prices to strengthen in the second half of year, along with higher rates of vaccination and more fiscal stimulus. Inflation could surpass 2.2% in 2021 even so it would still be modest based on historical average of 3.5%. Worldwide re-opening of global economy, record stimulus, higher commodity prices, dollar weakness, declining unemployment, and wage gains point to higher inflation, and yields.

Fed is committed to lower rates for longer. Short end of the Yield curve will be anchored down but long end will steepen. If the 10 Year-Treasury yield breeches 1.5% level the Fed could change its super easy monetary tone as inflation and economic growth would be stronger than anticipated by the Fed. Current ultra-low rates support higher economic growth and consumer spending.

Unemployment is 6.7%. Continuing jobless claims fell to 5.2 million. Both were at their lowest levels since March, but still several times higher than pre-recession. The latest COVID relief bill extends pandemic unemployment assistance or emergency unemployment compensation through March 2021, averting an income cliff for millions of households and providing stability to consumer spending in early 2021.

Expect higher taxes in the future. Congress can use special budget procedures to pass tax hikes without needing 60 Senate votes to break a filibuster. A simple majority works. Budget reconciliation is how President Clinton passed tax hikes in 1993. First, it is almost certain the top tax rate on regular income will head back to 39.6%. Second, the corporate tax rate, will likely be lifted to 25-28%. Neither of these moves will help the economy grow but will not cause a recession. Third, the limit on state and local tax deductions is likely to double from its current $10,000. Fourth, if passed, capital gains and dividends to be treated as regular income for those earning $1 million plus (a double tax). Changes in tax law will most likely occur January 1, 2022 and not be retroactive. Tax hikes will help plug budget holes created by excesses spending while softening job creation.

© 2018 by Aspetuck Financial Management LLC

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