Outlook and Market Review – Fourth Quarter 2020

Based on the Bureau of Economic Analysis revised estimate, the U. S. economy grew 4.1% in the fourth quarter of 2020 following the post-COVID recession bounce of 33.4% in the third quarter. For all of 2020 the economy shrank 2.4%. Fourth quarter growth of 4.1% is above the long run growth trend and would be a good number in a normal period, but post-recession bounces are normally higher. In the self-imposed COVID recession, a strong recovery requires a full opening of the economy that will only occur with herd immunity from full vaccinations. Estimates vary as to when such a full recovery will take place, depending on whether new variants of the virus or other mutations are controlled. Meanwhile, the goods sectors are doing well while the service sectors are struggling due to in-person limits and lockdowns. This balance will shift as the recovery gains steam.

Even without additional government stimulus plans in 2021, consumers have the wherewithal to spend when openings occur. While almost nine million jobs have been lost in the COVID recession, unemployment remains consistent with a normal recession. Many workers who lost their jobs had all or most of their income replaced through expanded unemployment insurance compensation and federal stimulus payments in 2020. The saving rate reached historic levels during 2020 and in the aggregate the economy has approximately $1.5 trillion in excess savings going into 2021. Asset price gains have also added to consumer wealth. Consumer pent up demand, easy money, low interest rates and short term optimism should drive very healthy consumer spending when the economy fully opens. The expected stimulus package of $1.9 trillion (approximately 10% of the annual U.S. GDP) will provide a stimulus jolt in the second and third quarters of 2012.

Fixed investment, which has not been a large contributor to growth in the past, added 3.1% to fourth quarter GDP growth. The gain was widespread across all components. Inventory investment added 1.1% to growth as firms anticipated a continuation of strong sales figures. Changes in the workplace and new technology are likely to promote added investment in 2021.

International trade continues to be a drag on GDP and prospects for the future are not improving. U.S. demand for foreign products is relatively price inelastic and very income elastic, suggesting that imports will continue to far exceed exports as the economy recovers. Higher oil prices will also make the trade balance worse. This is likely to be a longer term problem as the new administration seeks higher fossil fuel prices in order to promote alternative energy sources.
The level of short-term interest rates remains low with a Fed commitment to keep the Fed Fud rate at its current near-zero levels for another year or so. Nevertheless, long term rates are beginning to move higher and the yield curve is now steeper. The 10-year Treasury yield was 0.69% at the end of May, 20203 and 1.10% in January of 2021. The recent 30 basis point increase in the 10-year Treasury yield in February of 2021 flustered the market, with the increase attributed to higher market inflation expectations. Even so, while the yield curve is steeper, the 10-year Treasury yield of 1.5% remains low by historical standards.

Inflation remains low and well below the Fed’s target of 2%, but conditions for expected inflation are building. Excess demand price pressures are likely when the economy opens up and pent up demand for goods and services hits the markets. Expected increases in fiscal deficit spending on one hand along with reduced production due to increased regulation adds to the higher inflation scenario. Respondents to the Institute of Supply Management survey are already reporting price pressures as suppliers try to catch up to growing demand. Cost-push inflation elements are likely from the New Green Deal initiative due to disruptions in the automotive and the oil and energy sectors. Finally, massive increases in the money supply have been offset by reductions in the velocity of money, but when consumers spend more the velocity will pick up. Since employment lags GDP growth, the Fed may not be quick to take appropriate steps to prevent inflation if it targets full employment.