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.
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