As expected, the advance estimate of 3Q21 Gross Domestic Product showed a sharp slowing in growth. More timely data suggest that the economy regained some momentum into early 4Q21. Still, there are important questions regarding the labor market, inflation pressures, and Federal Reserve policy over the near term.
Real GDP rose at a 2.0% annual rate in the third quarter. A slower rate of inventory reduction added 2.1 percentage points. Final Sales (which excluded the change in inventories) fell at a 0.1% pace, but that was held back by a wider trade deficit. Domestic Final Sales (which excludes net exports) rose at a 1.0% annual rate. The government contribution to GDP is government consumption and investment (goods and services, such as military aircraft, education, and so on), not transfer payments (unemployment benefits and other transfers add indirectly to GDP growth, but not directly through the government component of GDP). If we exclude government, we’re left with Private Domestic Final Purchases, the real meat and potatoes of the economy – up at a 1.1% annual rate. Consumer spending rose at a 1.6% annual rate (vs. 11.7% in the first half of the year), while business fixed investment rose 1.8% (vs. +11.1% in the first half). Certainly, some moderation in these key GDP components was expected after the blistering pace of the first half of the year, but the slowdown was more than anticipated. Yet, that softness can be pinned on the rise of the Delta variant, which dampened the recovery in services, and the semiconductor issue in autos (final sales of motor vehicles fell at a 51.9% annual rate. September personal spending figures and the early retail sales info for October point to a pickup in 4Q21. Residential fixed investment fell at a 7.7% annual rate (+5.5% y/y), reflecting supply constraints.
The Employment Cost Index is the preferred measure of labor cost pressures. Average hourly earnings suffer from compositional changes, such as faster or slower growth in lower-paying jobs, while the ECI keeps the composition steady and includes benefits costs. For private-sector workers, the ECI rose 1.4% in the three months ending in September, up 4.1% y/y (vs. 3.1% y/y in June and +2.4% y/y a year ago). That’s certain to get the Fed’s attention. Depending on how much firms can pass along higher labor costs (and pricing power varies considerably across industries), this will add to inflation pressure.
Supply chain difficulties have been made worse by the shift in demand from services to goods, which now appears to be longer-lasting. Spending on goods was expected to wane as services recovered, and that may still happen. The Delta variant likely prevented many from spending on close-contact services, but many are likely to remain reluctant even after COVID cases fade. There isn’t likely to be much of a reprieve in the demand for goods in the near term.
Some of the strength in consumer spending was fueled by government largess at the start of the year. However, many households held on to the direct deposits that were made in January and March. Surveys suggest a precautionary motive. Some was used to pay down debt, leaving those households in a better financial position. Still, checking and savings account balances remain elevated. In addition, private-sector wages and salaries rose at a 10.2% annual rate in 3Q21, following a 9.1% increase in 2Q21. That’s fuel for consumer spending. Personal income did fall with the end of extended unemployment benefits, but that’s a one-time shift.
While consumer demand is expected to strengthen, the labor market may be a binding constraint on growth. It’s an odd mix. The October Employment Report (due November 5) will show nonfarm payrolls still millions below the pre-pandemic level. Yet, labor market conditions are tight. Labor force participation is below where we were at the end of 2019 and it’s unclear whether we’ll see those that exited return. The start of the school year was expected to lead to an increase in female labor force participation. That hasn’t happened. Childcare remains a key constraint, more expensive and less available now than before the pandemic – and that’s not going to change anytime soon. Those that opted for early retirement last year are unlikely to came back. Many of those in low-paying jobs are reluctant to return. During the last decade, the labor market had more slack than was implied by the unemployment rate. Extra slack may still be out there, but it’s unclear whether it can or will be tapped.
The pop in the Employment Cost Index will get the attention of Federal Reserve policymakers. For the Fed, the fear has been that supply chain pressures could be longer-lasting (which they are), leading to increased inflation expectations (which are rising). The 2-year Treasury yield and the federal funds futures market have been pricing in an earlier lift-off in short-term interest rates. The 10-year Treasury yield has come down about, believing that the Fed will act sooner to get inflation under control. The risk of a policy error is rising at a time when Powell’s renomination as Chair remains up in the air.
Recent Economic Data
The Employment Cost Index (for civilian workers) rose 1.3% in the three months ending in September, up 3.7% y/y (vs. +2.9% y/y in June and +2.4% y/y a year earlier.
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Real GDP rose at a 2.0% annual rate in the advance estimate for 3Q21, reflecting drags from the Delta variant and the semiconductor issue in autos, but boosted by 2.1 percentage points due to a smaller decline in inventories. Consumer spending rose at 1.6% annual rate, while business fixed investment rose 1.8%.
Personal income fell 1.0% in September, reflecting a 73.2% plunge in unemployment insurance payments. Private-sector wages and salaries rose 0.9% (+10.5% y/y). Personal spending rose 0.6% (+10.9% y/y), up 0.3% (+6.2% y/y) adjusting for inflation.
The PCE Price Index rose 0.3% in September (+4.4% y/y), up 0.2% ex-food & energy (+3.6% y/y).
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Durable goods orders fell 0.4% in September, reflecting a 27.9% decline in civilian aircraft orders. Ex- transportation, orders rose 0.4%, with orders for nondefense capital goods ex-aircraft up 0.8%.
The U.S. merchandise trade deficit rose to a record $96.3 billion in the advance estimate for September.
The Conference Board’s Consumer Confidence Index rose to 113.8 in October (vs. 109.8 in September), reflecting easing concerns about the Delta variant. Short-term inflation concerns rose to a 13-year high, but “the impact on confidence was muted” (a contrast to the University of Michigan survey).
Gauging the Recovery
The New York Fed’s Weekly Economic Index edged up to +3.85% for the week ending October 16, vs. +7.91% a week earlier (revised from 7.67%). The WEI is scaled to y/y GDP growth (+4.9% y/y in 3Q21).
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Breakeven inflation rates (the spread between inflation-adjusted and fixed-rate Treasuries) continue to suggest an elevated near-term inflation outlook. The 5- to 10-year outlook remains receded in the latest week, reflecting the belief that the Fed will raise rates sooner to keep inflation in check.
Jobless claims fell by 10,000, to 281,000 (a pandemic low) in the week ending October 23. Unadjusted claims are approaching the pre-pandemic levels of 2018 and 2019, consistent with a tight labor market.
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Chicago Fed Advance Retail Trade Summary (CARTS): up 0.2% in the second week of October, following a 1.2% gain in the previous week. October retail sales (ex-autos) were projected to rise 2.3% from September.
The University of Michigan’s Consumer Sentiment Index edged up to 71.7 in the mid-month assessment for September (vs. 71.4 at mid-month and 72.8 in August). Inflation expectations rose. The report noted that “the positive impact of higher income expectations and the receding coronavirus has been offset by higher rates of inflation and falling confidence in government economic policies.”
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