Where does the US Economy go from here?
There are two clear views – and they are almost diametrically opposed to one another.
And we are seeing the data swing from supporting one view to the other, on an almost daily basis.
One view is that too much money is being pumped into the economy, that inflation is now embedded at worryingly high levels, the Federal Reserve is behind the curve and we need interest rate hikes soon.
The other is growth has already peaked and the negative impact of the new Delta variant is yet to be seen in economic forecasts, and that we may be facing into a slowdown.
What are the facts?
Inflation today is indeed well above target, and has policy makers on edge. Data for June shows prices up over 5 per cent compared to 12 months ago. The US Central Bank’s target is 2 per cent on average. Even taking out some of the more volatile elements like food and energy we still have a 4 per cent inflation rate in the US today. By contrast here in Ireland we’re looking at 2.2 per cent and price increases of about 2 per cent for the Euro area as a whole.
The key question – is it temporary? That’s certainly the view of the administration and the Federal Reserve. They believe that over the coming months improving supply chain bottle-necks and continued re-opening will ease this price pressure. And many of the price increases are simply recapturing ground lost during the pandemic. This means that the Federal Reserve, despite admitting to being somewhat surprised by the higher prices, can stick with its low interest rate policy. However the inflation debate is becoming increasingly politicised as Republicans highlight the rising cost of living for ordinary Americans and raise concerns over a stagflating economy. We should expect inflation to move up the political agenda. Importantly though surveys show that while consumers do expect higher prices in the near term, longer term expectations remain anchored at just over the 2 per cent mark.
And what about economic growth? Figures for the second quarter of this year showed a very robust 6.5 per cent rate of growth. However this was actually lower than forecasters had pencilled in. Consensus was expecting the number to be over 8 per cent. While the US economy is now back to its pre-pandemic level, it is also past its peak rate of growth for this cycle.
Looking into the second half of 2021, we will see a waning of the fiscal package that has been supporting workers and businesses through the crisis. There has also been a knock to consumer confidence from the current surge in prices. This paints a less positive picture for consumer spending overall. But now added into this is the impact of the Delta variant and the roll back we are seeing in the reopening process.
Hospitalisations are back to mid-February levels. We have seen some companies push back on when they would look for staff to return to the office, and major events, like the New York Auto Show, being cancelled, all with a knock -on effect on businesses. Reintroduction of face masks in some areas is also unnerving consumers. Vaccine hesitancy and breakthrough cases are both plausible causes of concern.
Policy makers are alive to the threat Delta could be for the overall economy. At the recent meeting of the US Federal Reserve, chairman Jerome Powell noted how they were monitoring impacts on restaurants and workplaces. The Fed’s current view is that this is a manageable risk, but slow-downs in vaccination rates are a worry. Generally most current economic forecasts don’t factor in a Delta variant knock to the 2021 picture, so if we see a continued upward drift in cases, we could see a wave of economic downgrades.
It's clear we will see a loss of momentum in the US economy in the second half of this year — the question is how much.
Financial markets naturally are very focussed on whether the outlook is more towards Fire (surging inflation, higher interest rates) or Ice (slowing growth, undermining profit forecasts).
Economists seem quite divided.
However the general population is more clear on where the risks are. A survey by Monmouth University in New Jersey last week pointed to inflation being the key concern for only 5 per cent of households, while Covid and the overall economy were the biggest concern for nearly 30 per cent of US households.
And in terms of where the real risks lay — this seems about right.