The Broad View
Over the past few decades, economic rebounds have tended to start very slowly. Consumers were financially drained from the preceding recessions and huddled into such defensive crouches that it could take years for upturns to actually feel like upturns.
The recovery from the coronavirus pandemic couldn’t be any more different. Americans are flush with cash and spending with an intensity that was inconceivable a year ago. That’s a testament to the combined force of nationwide vaccinations, immense government support and ferocious household demand. It also highlights one of the bigger contrasts between this recovery and its recent predecessors: Household finances are far sounder today, raising hope that consumers can keep powering growth.
The flip side of this scenario is the recent surge in inflation. Prices have jumped more than projected, prompting the Federal Reserve to say it expects to boost interest rates a bit sooner than previously forecast. The spurt in prices has raised talk that inflation could become a lasting impediment. However, some Capital Group economists think that’s unlikely. They expect the price surge to be temporary — stemming largely from pandemic-related shortages of goods, raw materials and labor — and to dissipate as the global economy reopens fully.
Of the forces driving the economy, the strongest of late has been the nationwide vaccine rollout. New cases of COVID-19 have plummeted, spurring states to peel back pandemic restrictions and Americans to stream back to restaurants, shopping centers and airports. Meanwhile, the lofty savings rate has pushed up household wealth and given consumers the horsepower to ramp up spending.
The result has been a roaring expansion — the Fed predicts GDP could surge 7% this year, its biggest gain since 1984 — and a stock market that crackled higher throughout the first half of 2021. Cyclical sectors have led the way, especially energy and financials that stand to benefit from faster growth. Consumer discretionary stocks appear to be well positioned in light of the consumer spending outlook for the rest of the year.
Looking forward, President Biden’s proposed boosts to infrastructure and other spending could spur the economy further, though it’s unclear if either of his two plans can garner congressional support. A bipartisan group of senators recently announced consensus on a $1.2 trillion infrastructure package, a reduction from Biden’s original $2.3 trillion American Jobs Plan but significant nonetheless. Five centrist Republicans have signed on to the deal, but five more would be needed to overcome a potential filibuster. Biden’s other proposal, the $1.8 trillion American Families Plan, is unlikely to attract Republican votes; Democrats likely would need to pass it through so-called budget reconciliation.
Inflationary pressure doesn’t normally crop up so early in a recovery. But rapidly uncoiling consumer demand has sparked worries about lurking inflation and a repeat of the debilitating price hikes that menaced the economy in the 1970s. The fears stem partly from a Fed policy shift last year that allows inflation to temporarily exceed the central bank’s 2% target, in the belief that spurts of outsize growth can benefit the labor market without touching off a sustained run-up in prices.
Though inflation is expected to spike in the next few months, some Capital Group economists believe it’s a transitory phenomenon concentrated in pandemic-affected areas such as rental cars and airline tickets. Indeed, price hikes have been pronounced in “flexible” categories — goods whose prices can easily be adjusted up or down — while remaining stable in “sticky” areas such as rent, where price shifts are infrequent.
The price spurts stem partly from supply-chain bottlenecks that reflect the difficulty of restarting a global economy that was idle for much of the past year. And the labor shortages that have caused fits for some employers should ease as extended unemployment benefits and other relief programs expire.
As the chart on this page demonstrates, stocks have done well in most inflationary environments. On average, they’ve declined only in periods of deflation and times when inflation pierced 6%.
Fed policymakers signaled in mid-June that they might hike rates twice by the end of 2023 rather than holding off until the following year. And they’re mulling whether to ease up on purchases of Treasury and mortgage bonds.
Even so, the fixed income market took the central bank pronouncement in stride, and the yield on the 10-year Treasury note actually declined during the second quarter. That contrasts with the 2013 “taper tantrum,” when borrowing costs jumped after the Fed suggested it might scale back its bond buying.
Some Capital Group economists believe the central bank could begin to taper asset purchases later this year or early in 2022. Nevertheless, interest rates are likely to remain low. Our economists believe a rate hike is at least 18 months away and that the central bank will signal any action very deliberately beforehand.