December 3, 2021
GDP growth slipped to 2.1% in the third quarter as an increase in COVID cases dampened the pace of consumer spending, and as supply constraints limited the ability of firms to produce. But COVID cases have fallen 55% since reaching a peak in early September. Supply constraints will eventually end and when they do they will boost GDP by as much then as they slowed growth in third quarter. Employment growth slowed during the summer, but weekly data on initial unemployment gains suggest that employment growth has begun to accelerate. At the same time firms are investing heavily in technology to help them boost productivity growth and become more efficient in the future. As a result, we expect GDP to rebound to an 8.0% pace in the fourth quarter and continue at a 4.9% rate in 2022. If that is the case, 2021 and 2022 growth rates would be the fastest annual growth rates in forty years.
GDP got back to its pre-pandemic level in the second quarter of this year. However, the Fed seems to be comparing it to some projected growth path that it would have presumably attained if the recession had never occurred. On that basis, GDP will completely erase the impact of the recession in Q2 of next year.
Given the GDP forecast above, we expect the unemployment rate to decline to 4.0% by January, and to 3.2% by the end of 2022. The Fed considers the full employment threshold to be 4.0%. That rate will be achieved by January.
Given the recent rapid increase in money supply growth, the core inflation rate should rise from 1.6% last year to 5.1% in 2021 and 4.7% in 2022.
The Fed has pledged to keep the funds rate close to 0% until mid-2022, but the combination of 4.7% GDP growth next year combined with the continuation of inflation significantly above the Fed’s 2.0% target should force it to boost the funds rate to 0.75% by the end of next year and 1.75% by the end of 2023. The Fed thinks a “neutral” funds rate is 2.5%. It is unlikely to reach that level until Q3 of 2024. A moderate pickup in the core CPI should boost the 10-year note rate from 1.5% currently to 2.6% by the end of 2022.