April 29, 2022
GDP growth surprisingly contracted by 1.4% in the first quarter after having surged by 6.9% in the fourth quarter. But consumer and business spending remained strong. The reason why GDP fell in that quarter is that much of that consumer and business spending was on imported products rather than domestic ones. Thus, supply constraints appear to have significantly weakened first quarter GDP growth. And, in fact, with COVID spreading rapidly in China and lockdowns potentially spreading from Shanghai to Beijing, those supply constraints could be getting worse. But the supply constraints should eventually end and when they do they will boost GDP by as much then as they slowed growth in 2021 and in the early part of 2022. We had expected the supply constraints to diminish as the year progressed, but now with the drop in Q1 GDP growth and the developments in China, we anticipate most of the reduction in supply chain imbalances to occur in 2023 rather than 2022. Given all this we have reduced our 2022 GDP forecast from 3.5% to 2.0%. We expect GDP growth of 2.5% in 2023 as the reduction in supply chain imbalances to provide a tailwind to growth.
Given the GDP forecast above, we expect the unemployment rate to decline to 3.2% by the end of 2022. The Fed considers the full employment threshold to be 4.0%. That rate has already been achieved.
Given the recent rapid increase in money supply growth, the core CPI inflation rate rose 5.5% in 2021. Given continuing rapid growth in the money supply, the dramatic increase in gas prices, and the surge in food prices the core CPI to climb by 6.4% this year and 5.8% in 2022.
Following the March FOMC meeting the Fed suggested that it could tighten at each of the remaining FOMC gatherings in this year. Recent speeches by Fed officials suggest that the Fed may be aiming for a neutral funds rate of about 2.5% by yearned. If so, it will require several 0.5% increases in the funds rate along the way. We now expect the funds rate to reach 2.5% by the end of this year and 3.5% by the end of 2023,. Even so its policy would still be accommodative because with the projected core CPI inflation rate for 2022 of 6.4%, the real rate would be -3.9% (2.5% – 6.4%).
Stephen Slifer
NumberNomics
Charleston, SC
Steve –
How tight will be the linkage between transient inflation in the second quarter
to 5.3% and the 30 year Treasury rate?
Hi Frank,
I was trying to figure out what you meant by transient inflation in the second quarter of 5.3%. But then I went to the forecast table and there it was! Your eagle eyes picked up something that didn’t look right and questioned it. It turns out that the correct number is 3.6%. I just updated the table so it is now correct. Thanks for catching it!
I think for bond yields to move higher we probably need some sign that GDP growth is going to be a lot stronger than people believe at the moment, or that the actual CPI data in the months ahead show more upward pressure than they anticipate. Right now those inflation expectations for the next 10-years (measured as the difference between the nominal yield on the 10-year and its inflation-adjusted equivalent) is 2.3%. If it gets higher than that bond yields will likely climb a bit. By yearend I am looking for them to climb slightly from 1.6% today to 1.8% by yearend. Higher, but still very low historically.
Best.
Steve
Does the trillions of dollars the fed has flooded the economy with have a direct effect on the GDP?
HI Jeffrey.
Thanks for your question. The answer is yes, but it is important to understand the process. When the Fed buys U.S. Treasury securities it buys them from its primary dealers which are generally a bunch of very large banks. Let’s assume they buy $1.0 million of securities. The banks give the Fed the securities. The Fed puts the $1.0 payment for those securities into the bank’s “reserves” account. (Think of a reserves account as that bank’s checking account,) So the proceeds have moved from the Fed to the banking system. But banks presumably want to put that $1.0 million to work so they lend it to you or me or some business. Once that happens you or have get the $1.0 million placed into our checking accounts. At this point, the money supply rises (the M-2 measure basically consists of checking account balances, savings accounts, money funds and the like — all very liquid, spendable funds). But we borrowed from the bank because we wanted to do something with that money — buy a house or a car, purchase new technology to make my firm more productive, etc. Basically, we spend the money. It is at this point that GDP rises. We are buying something and so that lifts the consumer spending or investment spending components of GDP.
The basic answer is yes, but it is not exactly a direct process. In 2008-09 the Fed bought a large volume of securities, but banks were so busy repairing their balance sheets that they funds never got lent out to consumers or businesses. In short, the process got short-circuited and never had the desired effect. This time the funds are being lent out and money supply growth is soaring — 24% in the past year. M-2 typically grows by about 6%. 24% growth is unprecedented which is why, this time, the Fed’s actions are stimulating the economy and why inflation is almost certain to rise.
Best.
Steve Slifer
Thanks for the explanation, Steve.
I’m trying to wrap my brain around how to prepare for what’s coming.
Thanks,
JLP
Steve –
How is the line in your table titled “Yield Curve” calculated?
It doesn’t seem to represent the difference between 10 and 30 year nominal bond
rates, because that is currently only 0.34%, down from 0.8% at the end of
February 2021.
It is the difference between the yield on the 10-year note and the fed funds rate. When talking about the “yield curve” most economists will look at the spread between the 2-year and the 10-year. I use the funds rate because people tend to talk about the funds rate rather than the 2-year, so it seems to be easier for them to understand. The point of looking at the yield curve is because when it inverts (meaning short rates are higher than long rates) it is a pretty good indicator that the Fed has tightened “too much” and that recession will occur within a year or so. If you look back at history either the 10-year/2-year spread or the 10-year/FF will give you essentially the same answer.
Doesn’t simple math tell us that with the unprecedented creation of new currency (i.e. a bunch of 1s and 0s with no hard asset backing) injected into the economy, that inflation MUST be persistent? I don’t understand any scenario where this type of action, never before done in any economy in history, can result in anything but persistent, long-term inflation. If I’m wrong please tell me why.
Hi Chuck,
Thanks for your question. These crypto-currencies are not “money” in the sense that they can be “created”. They are a commodity much like gold or soybean futures. When we buy any of those things we pay for it. Money comes out of our checking account to make the purchase and ends up in somebody else’s account. No money is created. It is just transferred from one owner to another. You might say that there are bitcoin “miners” who create the bitcoins. True. But that is like a farmer growing another crop.
Having said all that I do believe that out-of-control growth in the money supply is the source of the problem. The M-2 measure of money should grow at about a 6.0% pace — roughly in line with nominal GDP growth. When the recession hit and we shut down the economy in March and April 2020, M-2 growth exploded and it has continued to grow rapidly since. The year-over-year increase in M-2 today has slowed but is still 9.9% — far in excess of what is needed. Each month that M-2 grows at a rate in excess of 6.0% the surplus liquidity in the economy continues to climb. Today there is about $4.0 trillion of surplus liquidity floating around in the economy. No wonder we have an inflation problem. Too much money chasing too few goods. I will send a couple of M-2 charts to your e-mail address. It is hard to see how inflation will get back in check any time soon.
Steve Slifer