How can this be, when the last round of fiscal stimulus expired in the summer and the virus numbers began spiraling out of control once the cold weather hit? This is where conventional analysis of this past year, mapping it to prior economic contractions, fails miserably. Unlike 2000 or 2008, there were no noticeable imbalances in the economy at the end of 2019. Consumers had healthy balance sheets and strong job prospects, and while employment has yet to fully recover due to health concerns in many services sectors, household wealth, as measured by the Federal Reserve, is at all-time highs. Housing is booming and the stock market is at a record. Despite about 10 million fewer people employed than pre-pandemic, households in aggregate have saved more money due to generous stimulus checks and an inability to spend on things like restaurants and vacations.
There were two major developments that could have altered the nature of the recovery in the fourth quarter, and both came in early November. The first, the U.S. elections, resulted in a new government without a strong mandate to change the nature of the economy. In terms of economic impact in our polarized political climate, it was a dud. The second development was most certainly not a dud. Multiple vaccine candidates passed Phase Three trials with surprisingly high efficacy. These vaccines are only just now entering the arms of Americans, and while they do nothing to stop the current surge of virus cases brought on by the holidays and the colder weather, businesses and other economic actors can now see a light at the end of the tunnel and plan accordingly. The news from November was decidedly bullish for the future prospects of the U.S. economy.
Turning to the rest of the world, we highlighted last quarter how various countries and regions were responding differently to the coronavirus and how different economic policy choices had impacted growth. Those trends largely held in the fourth quarter as well. China and Asia more broadly have largely filled the gap in growth earlier in the year due to targeted stimulus and effective virus suppression. Japan’s recovery has been weaker, however, due to less policy space for stimulus entering this crisis. Europe has continued to struggle, operating with generally better health outcomes against a slower recovery due to greater restrictions and less fiscal and monetary support than in the U.S. Additionally, despite finally reaching an agreement for the UK to leave the European Union, the deal looks more like a Hard Brexit than anything else, doing little to ease the uncertainty that has weighed on growth in the region for years. Emerging markets outside of Asia have had a difficult time balancing their economies and public health while lacking the institutional credibility to deliver the needed economic stimulus to fill the gap.
2020 has been nothing if not volatile, both socially, politically, and in our line of work – markets and the economy. While 2021 will hopefully look much better (and come with less volatility), things will not evolve in a straight line or be based on prior recovery playbooks. We believe an active process designed to be flexible in a changing environment yet grounded in multi-disciplinary research is crucial to exploiting those opportunities as they arise.
Here are the things we are paying attention to in the coming months.
Covid and Vaccines
Near term, as the U.S. and Europe manage their latest wave of infections, we expect growth to slow. But as vaccines are distributed around the world and new technologies pass through the approval process, restrictions are set to ease again and the recovery to continue. Monitoring the pace of vaccine distribution will be key to assessing the growth trajectory in the first quarter and beyond. And keep an eye on the variants of Covid-19 in the UK, South Africa, and now the U.S. Early indications are that the existing vaccines are effective, but if these new strains are truly easier to spread, that means true herd immunity will be pushed back.
The runoff Senate elections in Georgia and the contested transition have caused the Biden administration to keep the 2021 policy agenda quiet. Handling the Covid outbreak will be job number one, but what about other legislative priorities? More stimulus, certainly (see below), and that may be all the new government can muster in this polarized political climate. But many other items were promised on the campaign trail last year, including accelerants to the recovery in 2021, like a major infrastructure package, as well as those that could dampen business sentiment and slow the recovery, such as antitrust enforcement actions or tax increases. We will know a lot more on this front after January 20th.
It may seem unbelievable, but the stimulus cannon is not out of ammo just yet. On the fiscal side, victory for Democrats in both runoff Senate elections in Georgia gives them a very narrow governing majority for the next two years. That opens the door for more stimulus in 2021, on top of the bill just signed in December. It won’t be as large as it was early in the pandemic, but that is not a concern; we know a lot more about Covid and can operate at much higher levels of economic activity. On the monetary side, major central banks, including the Fed, are on easing autopilot, continuing to expand their balance sheets in 2021. Maintaining their extraordinary levels of accommodation despite the green shoots ahead amounts to de facto stimulus that will keep financial conditions supportive. Add in the excess savings at the consumer level and there is upside pressure to growth this year.
Consumer Spending Patterns
Consumers, in the aggregate, have a lot of money, but with concerns about health top of mind for many, there are not many places to spend it. While retail sales are back to their pre-Covid trend levels, the composition has changed dramatically. Gone is the spending on vacations, restaurants, and massages, and in their place, people are buying furniture, fitness equipment, and streaming services. As more people get vaccinated, we are paying close attention to the consumer’s shifting consumption patterns, and how much of that excess savings from last year will be spent.
And finally, the outlier – inflation. True to the post-2008 script, some economists and many market participants are worried about inflation increasing as growth rebounds. Recent readings, not just in the U.S. but globally, have been soft. In 2021, however, year-over-year comparisons are set to get easier, and pent-up demand for services could drive demand-push inflation in some sectors as the economy reopens. The Fed has telegraphed that they will look through these elevated readings, but that may prove easier said than done. While this is by no means our base case for 2021, it is worth keeping a sharp eye on inflation dynamics as growth picks up.
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