IN THIS ISSUE:
1. US GDP Comes Roaring Back – Big Year Ahead
2. Fed Sticks With ZIRP Despite Stronger Economy
3. Fed Believes Expected Rise in Inflation Temporary
4. The Trend in Commodities is Also Worth Watching
Overview - $6+ Trillion in New Debt, Fed Policy, Etc.
It was ever so tempting to devote today’s letter to a discussion of President Biden’s latest massive government spending, which he proposed Wednesday night in his “First Hundred Days” speech before Congress. In it, he called for more trillions in government spending and giveaways, in addition to the trillions he has already asked for.
The total he wants so far is a monumental, unprecedented $6 trillion – not including annual budget deficits of $1 trillion or more for the foreseeable future! And he’s made it clear, he is not done yet.
I’ll offer some limited comments and analysis on this travesty below, but I’ll keep them brief since I know I’m “preaching to the choir” with the vast majority of my clients and readers. Then I’ll move on to more market related topics as we go along.
For example, the Fed Open Market Committee (FOMC) which sets monetary policy met last Tuesday and Wednesday and voted unanimously to keep its key interest rate in a range of 0.00%-0.25% – to the surprise of no one. At his press conference afterward, Fed Chairman Jerome Powell assured the financial press the Fed is committed to keeping rates near zero indefinitely, despite acknowledging the economy is heating up and higher inflation is coming.
Yet while the FOMC seems intent on following such an accommodating “Zero Interest Rate Policy” (ZIRP), the growing question/concern is whether the Fed can really tolerate a screaming economy (+6.4% 1Q GDP) and potentially much higher inflation later this year and next. Increasingly, Fed-watchers are asking: When will the Fed have to blink? That’s what we’ll talk about today.
Following that discussion, I’ll share some thoughts regarding spotting rising inflation in the months ahead. While the Fed believes any such rise in inflation will be temporary, we should keep a close eye on it in any event.
Before we get to those discussions, let’s briefly turn our attention to last week’s Gross Domestic Product report for the 1Q, which showed the economy rebounding at the second fastest clip since 2003 in the first three months of this year.
US GDP Comes Roaring Back – Big Year Ahead
Economic activity boomed to start 2021, as widespread vaccinations and more fuel from government spending helped get the US economy closer to where it was before the Covid-19 pandemic struck, the Commerce Department reported Thursday.
Gross Domestic Product, the sum of all goods and services produced in the economy, jumped 6.4% on an annualized basis for the first three months of the year. Outside of the reopening surge in the 3Q of last year, it was the best quarter for GDP since the 3Q of 2003.
Economists surveyed by Dow Jones had been looking for a 6.5% increase in the 1Q, so the actual number was close. In the 4Q of 2020, GDP accelerated at a 4.3% annual pace.
The boost in GDP came across a spectrum of areas, including increased personal consumption, fixed residential and nonresidential investment and government spending. Declines in inventories and exports as well as an increase in imports subtracted from the gain.
Consumers, who account for 68.2% of the economy, accelerated spending by 10.7% in the 1Q, compared with a 2.3% increase in the previous period. The expenditures were largely focused on goods and services, as usual. Spending on durable goods (long-lasting items) alone exploded by 41.4% in the 1Q. Government expenditures and investment increased 6.3%.
Last week’s GDP report for the 1Q was welcomed by the equity markets which rose to new highs. The US Conference Board predicts the US economy will grow by 6% for all of 2021. If this forecast pans out, 2021 will be the strongest year since the early 1980s.
Fed Sticks With ZIRP Despite Stronger Economy
The Federal Reserve on Wednesday of last week kept its easy money policy in place despite an economy which it acknowledged is accelerating. As expected, the US central bank decided to keep short-term interest rates anchored near zero as it continues to buy at least $120 billion of bonds each month.
Despite noting the recent economic strength as well as indications inflation may be on the rise, the policymaking FOMC unanimously voted to make no changes in its policy and gave no indication things will change anytime soon. Fed Chairman Jerome Powell said the economic recovery is “uneven and far from complete.”
Powell added that it’s still not time to talk about reducing policy accommodation, including the asset purchases.
“It will take some time before we see substantial further progress,” which he also said after the policy meeting in March.
The latest post-meeting Committee statement noted that efforts to combat the Covid-19 pandemic have helped boost the economy, though more needs to be done. “Amid progress on vaccinations and strong policy support, indicators of economic activity and employment have strengthened,” the statement said.
The Committee again noted that economic progress is largely dependent on the course of the pandemic. Daily case counts have dropped significantly as the US has been vaccinating close to 3 million people a day. “The ongoing public health crisis continues to weigh on the economy, and risks to the economic outlook remain,” the statement said.
The latest FOMC decision came one day before the Commerce Department released its advance 1Q GDP figure which showed a gain of 6.4%. Even the Fed’s economists expect the US to turn in its best full year of economic growth in decades.
Fed Believes Expected Rise in Inflation Will Be Temporary
In April, we learned the Consumer Price Index also has been on the rise, with March consumer prices rising 2.6%, the fastest year-over-year increase since August 2018. And most forecasters expect more increases over at least the next couple of months. However, as I explained two weeks ago, the current uptick in prices is largely due to several months of very low inflation data this time last year (during the pandemic recession) which dropped out of the 12-month window last month and will again for April and May, before likely getting back to normal.
The Fed is very much aware of the “calendar issues” and believes this latest blip in inflation will be “transitory,” meaning it won’t last long. In his post-meeting press conference last week, Mr. Powell acknowledged inflation pressures could rise in the coming month or two but cautioned: “These one-time increases in prices are likely to only have transitory effects on inflation.”
While the calendar issues are likely to go away soon, inflation can sometimes have a mind of its own. While most analysts expect CPI inflation to remain below 3% on an annual basis just ahead, we can’t rule out something higher than expected if the economy continues to run hot at above 6% in GDP – as most forecasters now expect.
Finally, gold prices have been trending lower since late last summer. This is not a sign inflation is about to get out of control, but we should keep an eye on it nonetheless.
The Trend in Commodities is Also Worth Watching
Most economists and inflation-watchers also pay close attention to trends in commodities prices. One handy way to do this is to follow the Standard & Poor’s GSCI (formerly the Goldman Sachs Commodity Index) which is an index of the prices of a basket of commodities.
The GSCI has risen sharply since the lows seen this time last year in the throws of the COVID recession. It, too, has risen significantly recently partly because of the calendar effect. As you can see in the chart below, several of last year’s lowest readings are falling out of the 12-month window – thus pushing the Index higher than it otherwise would have been.
However, as a decades-long veteran of the commodities markets, I can also assure you the commodity futures markets can also have a mind of their own periodically. While the recent positive calendar effects have pushed up the GSCI more than the fundamentals would suggest, the upward trend is likely to weaken just ahead. The commodities markets bear watching just ahead in any event.
The recent jump in prices in my old stomping ground (commodities) is about more than just the calendar effect. We’ll see what happens just ahead.
Personal Note: Debi and I got to see our newborn Granddaughter last week. She is precious if I do say so myself! She has beautiful blue eyes (from her Grampa). Even though she’s our first grandchild, her Mom and Dad looked like seasoned pros taking care of her. We’re so proud and excited for them!
We plan on visiting them often in College Station this year but must also make room in our schedule for the arrival of our second grandchild in October, when our son and his wife in Dallas are expecting their first child, also a girl.
It’s going to be a busy, busy year for this rookie Grampa! Our thanks to God for these blessings of a lifetime!!
Best personal regards,
Gary D. Halbert
© Halbert Wealth Management
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