ISQ - January 2021
Key Takeaways
Most likely, the level of GDP will match the fourth quarter of 2019 level by the middle of 2021, but that will still leave us below trend (that is, without the pandemic, output would have been growing due to population growth and productivity gains).
Fiscal support was critical in offsetting the worst of the pandemic, but it added to the federal budget deficit, which had been trending at $1 trillion per year before the pandemic.
At some point, lawmakers should work to have federal debt rising no faster than nominal GDP, keeping the debt to GDP ratio stable or declining over time; however, now is not the time.
Federal aid should focus on supporting the long-term unemployed and small businesses. Federal support will also be important for state and local governments, helping to ease budget strains from lost revenue.
The COVID-19 pandemic had mixed effects on households. Job losses were more concentrated in low-wage service industries. About 40% of those in the bottom 20% of income earners lost jobs in April and May. White collar workers were more easily able to work from home and experienced a more V-shaped recovery in jobs. Consumer spending fell sharply amid the spring lockdowns, but self-imposed isolation (on health concerns) appears to have had a greater impact. Most of the hit was to consumer services, including leisure and hospitality, tourism, spectator events, and restaurants. With a limited ability to spend on these services, spending on durable goods rose above pre-pandemic levels. However, while spending on consumer services picked up off the April lows, activity remained depressed into the fourth quarter.
There is a trade-off between economic activity and efforts to contain the virus. Locking things down to prevent the spread reduces activity. Conversely, opening up the economy allows the virus to spread more widely. The harsh lockdowns in April and May were critical in preventing hospital overload, allowing time to increase hospital capacity, to distribute personal protection equipment, and to develop treatments. As restrictions were eased, infections increased in the summer months, but mostly for young (healthier) adults. The third wave has hit those aged 60 and above (those more susceptible). This surge has led state and local governments to reimpose restrictions on in-person services, which will dampen the pace of economic improvement in early 2021.
Luckily, vaccines are on the way. The effectiveness of potential vaccines was very good in early trials. Their distribution should lead to better improvement in the economy in the second half of the year. However, many people may not accept a vaccine. Others may be reluctant to resume social contact even after being vaccinated. However, savings of mid- and upper-income households increased during the pandemic and people will be eager to travel, to go to music and sporting events, and to resume their previous lifestyles. Most likely, the level of GDP will match the fourth quarter 2019 level by the middle of 2021, but that will still leave us below trend (that is, without the pandemic, output would have been growing due to population growth and productivity gains).
There is a trade-off between economic activity and efforts to contain the virus. Locking things down to prevent the spread reduces activity. Conversely, opening up the economy allows the virus to spread more widely.
The worst of the pandemic was met by the best in monetary and fiscal policy. The Federal Reserve (Fed) quickly lowered short-term interest rates to near 0%, restarted lending facilities that it had employed during the financial crisis and created some new ones along the way. It also expanded the balance sheet (from $4 trillion to $7 trillion) to ensure that there was more than adequate liquidity in the financial system. Lawmakers in Washington passed massive fiscal support, funding healthcare, extending unemployment benefits, offering loans and grants to small business, and aiding state and local governments.
Most Federal Reserve officials expect to keep short-term interest rates low through 2023. The Fed revised its monetary policy goals and strategies in 2020 and signalled that it intends to follow periods where inflation (as measured by the PCE Price Index) is below the 2% target with periods of inflation above 2%. This is no mathematic formula; monetary policy will remain a judgment call. However, it does signal a greater tolerance for somewhat higher inflation. The Fed’s employment goal has been made ‘broad-based and inclusive.’ Low unemployment significantly benefits low-income communities. The Fed will no longer tighten because unemployment falls to a certain level. A key takeaway from the pre-pandemic years is that there is a lot more slack in the labour market than the official figures would suggest. This isn’t a major change from the way the Fed has conducted monetary policy in recent years, but writing it down was an important signal for the financial markets.
A key issue for the Fed in 2021 will be deciding when and how much to reduce monthly asset purchases. The financial markets (especially the stock market) have been sensitive to changes in the Fed’s balance sheet. As the economy recovers, the Fed should return focus to maintaining an adequate level of reserves in the banking system.
Fiscal support was critical in offsetting the worst of the pandemic, but it added to the federal budget deficit, which had been trending at $1 trillion per year before the pandemic. The government has no problem borrowing and the Fed has placed much of the increased debt on its balance sheet. Interest rates are low and even with the added borrowing, interest payments on the debt over the next decade are projected to be lower than before the pandemic. The real danger with fiscal policy is not doing enough to support growth and removing support too soon. Austerity may be an individual virtue, but the government is not a household. The debt does not need to be paid off. At some point, lawmakers should work to have federal debt rising no faster than nominal GDP, keeping the debt to GDP ratio stable or declining over time; however, now is not the time. Tax increases or spending cuts in an economic recovery make that recovery weaker.
As with any economic downturn, there is generally downward pressure on inflation, reflecting increased slack in resource markets. Some prices fell sharply during the lockdown phase and rebounded sharply as the economy reopened, but have since moderated. Input cost pressures related to the supply chain disruptions have been noticeable, but firms generally have difficulty in passing such costs along to the consumer. Strong demand for durable goods added some pressure, but inflation in consumer services has slowed. The shift to working from home has led to strong housing demand and the supply of available homes for sale has been limited. However, high housing price inflation does not show up in the Consumer Price Index. A house has two functions: it’s an asset and it provides shelter. The Bureau of Labor Statistics seeks to measure the price of shelter, not the asset value, and so considers the rental equivalent – and rents have generally risen more slowly in the pandemic.
The labour market is the widest channel for inflation pressure. Average hourly earnings surged during the lockdown, but this was a byproduct of arithmetic. Job losses were concentrated in lower-paying industries and in lower-paying positions within individual firms, which increased the average. For the private sector, the Employment Cost Index (ECI), which is not affected by compositional changes and includes benefit costs, rose 2.4% over the 12 months ending in September, vs. 2.7% in the year before. Productivity figures have also been distorted by the loss of low-wage, low-productivity jobs, but assuming a moderate underlying trend of 1.0-1.5% implies little inflation pressure from labour costs.
The incoming administration will likely focus on healthcare issues, preventing the spread of the virus and distributing vaccines. Economic policy efforts beyond that will depend on the makeup of Congress, but we are unlikely to see major tax increases or big spending plans (other than immediate pandemic-related support). If, as expected, social distancing remains elevated in early 2021, economic growth will be weaker. Federal aid should focus on supporting the long-term unemployed and small businesses.
Federal support will also be important for state and local governments, helping to ease budget strains from lost revenue. These strains were a significant issue in the 2008 financial crisis, despite federal aid in that recession, and dampened the pace of growth in the early years of the economic recovery. State and local governments employ about seven times as many workers as the federal government. In the recovery from the financial crisis, we lost teachers, police and fire personnel, and had only reached the pre-crisis level of state and government payrolls in the year before the pandemic.
The Biden administration will have a longer-term focus on issues such as climate change, income inequality, and antitrust regulation. Trade policy was a major issue in the Trump administration. Tariffs are paid by US consumers and businesses. They raise costs, invite retaliation, disrupt supply chains, and add uncertainty, dampening business investment. Tariffs may be rolled back, but bashing China plays well politically, and the folks in Washington will look ahead to the 2022 mid-term and 2024 elections. Still, we should see more cooperation on the world stage.
The study of past pandemics shows that economic activity eventually recovers after the crisis has passed. Importantly, we should be better prepared for the next one.
Issued by Raymond James Investment Services Limited (Raymond James). The value of investments, and the income from them, can go down as well as up, and you may not recover the amount of your original investment. Past performance is not a reliable indicator of future results. Where an investment involves exposure to a foreign currency, changes in rates of exchange may cause the value of the investment, and the income from it, to go up or down. The taxation associated with a security depends on the individual’s personal circumstances and may be subject to change.
The information contained in this document is for general consideration only and any opinion or forecast reflects the judgment of the Research Department of Raymond James & Associates, Inc. as at the date of issue and is subject to change without notice. You should not take, or refrain from taking, action based on its content and no part of this document should be relied upon or construed as any form of advice or personal recommendation. The research and analysis in this document have been procured, and may have been acted upon, by Raymond James and connected companies for their own purposes, and the results are being made available to you on this understanding. Neither Raymond James nor any connected company accepts responsibility for any direct or indirect or consequential loss suffered by you or any other person as a result of your acting, or deciding not to act, in reliance upon such research and analysis.
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Black MondayOn 19 October 1987, the stock markets experienced a dramatic plunge that prompted many firms to shut down their trading desks and turn off their phones to minimize internal losses. Raymond James refused to do the same. Our desks stayed open to help meet clients’ needs, resulting in our first and only unprofitable quarter since the firm went public in 1983. |
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Who was Raymond James?The Raymond in our name is actually from Edward Raymond, owner of a 15-employee mutual fund sales group, Raymond and Associates, along Florida’s west coast. He sold his company to Bob James on 15 July 1964, on condition that the surviving firm be called Raymond, James & Associates. Three days after the sale, Ed Raymond was involved in a near-fatal automobile accident and never joined the firm. Nonetheless, even after Raymond had passed away, Bob James insisted that his name remain on the door – ahead of James’ own. That was a promise he made to Ed Raymond three days before the accident, and Bob James was a man who kept his promises. |
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Bear Market of 1974The severe bear market of 1974 threatened the existence of Raymond James, which was bleeding capital by the day. Tom James, his father and other leaders took extreme measures to keep the firm afloat, slashing costs, foregoing paychecks and even attempting to sell the firm for just enough capital to protect client assets and retain as many associates as possible. The story could have ended very differently if not for a sharp upturn and continued rebound in the stock markets late in the year. |
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Taking Raymond James PublicWhen consideration was being given to taking Raymond James public, Tom James penned a letter to shareholders (largely employees at the time). ” … the public offering should be considered as a statement of our independence. While this is a psychological rather than an economic rationale, it is nonetheless very important. We have asserted for some time that we are not interested in becoming a small part of a very large corporation. That assertion results mainly from the inclinations of management rather than the economic benefits associated with either alternative. The public stock offering affords us the opportunity to enjoy a little bit of the best of both worlds. While shareholders will be given liquidity at fair market value, we will still have the ability to control our own destiny.” After 40+ years of Tom’s leadership, upon becoming CEO, Paul Reilly was often questioned about whether the company might ultimately surrender its cherished independence and be acquired by some larger entity. His response: “Not while I’m around.” It’s a theme that continues today. |
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