Global and U.S. Economic Commentary
The global economy continued its strong path to recovery, expanding last quarter at its fastest pace in over 15 years. Vaccination rollouts, the easing of stringency measures, monetary and fiscal stimulus, have contributed it's robust broad recovery.
The International Monetary Fund expects the world economy to grow by 6%, and the United States set to expand by 6.6% in 2021. The U.S. economy is expected to grow at the fastest pace in nearly four decades this year. U.S. economic growth is projected to grow at 4.3% for 2022, above trend line expansionary growth, according to TD Economics.
The global composite PMI, a timely proxy for global GDP growth, has peaked and receded. Yet the latest reading is historically consistent with 6.5% annual global real GDP growth. I expect growth to continue to remain above trend line as pent-up demand is unleashed, before leveling off in the new year. The OECD U.S. Composite Leading Indicator points to continued recovery ahead, it also suggests that the pace of the rebound will likely moderate, as fiscal stimulus wanes while demand/supply imbalances take longer to work out.
The Conference Board’s Leading Economic Index point to continued fast growth in the US. Lagging, Coincident, and leading indicators are consistent with strong growth, and suggest continued fast economic expansion in 2H 2021.
The ISM Manufacturing PMI pulled back in June. While this is off its peak in March, it is still near its highest level since February 2018, and consistent with above-trend growth in manufacturing output. The ISM estimates that the latest PMI corresponds to 5.0% real GDP annualized growth, which is more than double the pace in 2019, before the pandemic struck. Most economic indicators show slowing but still growth ahead the above trend line that historically supported above average earnings growth.
I think the recent decline in bond yields is signaling that the inflation burst is transitory, and that the Delta variant will temporarily slow global growth. I think bond yields are not a reliable signal because of automatic bond purchases by the Fed, Foreigners, and Pension funds are not an economic bet. I think the most recent decline in yields is due to technical issues related to liquidity and forced buying. A dramatic softening in economic activity is not what bond market is signaling. Credit market spreads, a more reliable economic signal then Ten-Years Treasury yield, supports my view.
The unemployment rate unexpectedly rose to 5.9% in June. The current unemployment rate suggest that the recovery still had a long way to go. Job growth in June rose as businesses looked to keep up with a rapidly recovering economy -- which is a positive sign for the second half and the recovery -- but not so much that it would trigger an accelerated timeline for the Federal Reserve to start tapering.
The U.S. has a record number of jobs available—over 9 million. People are earning more staying home than if they go back to work. With this many jobs open, unemployment rate should be below 5%. Moreover, layoffs are at record lows! Fed Chair says strong job creation coming this Fall. The end to extra unemployment benefits could boost employment by two million workers according to Jeffries research. School re-openings will help people on unemployment return to work. Unemployment rate should decline further putting more pressure on the Fed to start tapering sooner.
Inflation is everywhere: commodities, housing, wages, energy, etc. Fed’s best inflation gauge, Core PCE, is way above its 2% goal at 6.6% Y-O-Y! Headline inflation is up 5.4% year-over-year. The biggest Y-O-Y gain since August 2008. Inflation seems to have peaked in March but will remain elevated as long there are shortages and rising wages. Wages were up 3.6% year over year. Wage inflation tends to stick. It cannot be taken back. The percentage of businesses reporting inflation as the biggest problem surged to the highest level in over a decade in June’s NFIB survey. Besides wage pressures, if velocity of money increases this Fall, a lot more money being lent and spent, then inflation pressure will persist.
President Biden agreed to a bipartisan framework for an infrastructure that will not increase country’s debt and taxes and at last address the country’s aging infrastructure. The infrastructure plan seeks to improve the nation’s roads, bridges, and broadband. The framework will include $579 billion in new spending. If the Progressives in Congress do not vote for it then there may not be any infrastructure spending any time soon.
Fiscal and Monetary policy which has been a tail wind for the U.S. economy and stock market will turn into a headwind next year.