Growth set to accelerate after Delta downshift

November 11, 2021 – Over the course of the last month, a treasure trove of economic data and policy announcements have resulted in quite a few changes to our outlook. Incoming data has largely exceeded our expectations, with 531,000 jobs added in October after an upward revision to September’s employment growth.¹ In addition, third quarter gross domestic product (GDP) growth held up better than we had forecast. On the policy front this month, the Federal Reserve announced that it will begin slowing its pace of asset purchases. The stronger job gains and higher inflation readings over the last month feed into our revised view that the Fed will begin increasing short-term interest rates beginning in Q4 of next year, one quarter earlier than we were forecasting last month.

We now expect the economy to expand at a 2.4 percent annualized pace in Q4 and accelerate further to 3.6 percent in Q1 of next year. After downshifting to just 1.6 percent in Q3, real consumer spending is expected to accelerate to 4.0 percent in Q4 as services spending continues to recover (Fig. 2). On an annual basis, robust consumer spending and business investment will support an increase in GDP growth to 5.3 percent year-over-year (YoY) this year. Next year, we expect the economy to expand at a 3.1 percent pace (YoY) with more modest consumer spending and business investment. As supply chain issues begin to subside, inventory rebuilding will likely help drive 2022 growth above the long-run average of the last expansion. Growth in calendar year 2023 is expected to return close to the long-run average rate at 2.7 percent.

Highlights:

• Job gains accelerate in October
• Inventory rebuilding to support growth
• Searching for the first rate hike from the Fed

Services spending to support Q4 consumption

To date, the consumer spending recovery has been primarily led by robust goods spending while the services recovery has been sluggish (Fig. 2). Looking ahead, we expect inflation-adjusted services spending to return to its pre-pandemic peak in Q4. As consumers shift their demand to a wider range of goods and services, the pace of consumer spending should moderate in 2022. Real consumer spending is likely to rise 3.2 percent YoY next year. After stacking on 3.2 percent inflation, nominal consumer spending is expected to rise 6.5 percent YoY in 2022. Aside from the continued inflation pressures, more modest income gains along with the resumption of federal student loan payments in February may also erode some of the disposable income available for millions of consumers early next year.

Inventory rebuilding to support growth

The economy expanded at a 2.0 percent (annualized) pace in Q3; however, most of that growth came from inventory rebuilding, which contributed 2.1 percentage points to topline growth.² Our expectation is that restocking will add another 1.2 percentage points to Q4 GDP growth and 1.3 percentage points to Q1-2022 GDP growth as manufacturers and transport agencies work to service the snap-back in demand. We still expect that by Q2 of next year, supply chain issues will subside.

Tapering without the tantrum

The Fed began removing its accommodative monetary policy by tapering asset purchases this month, as expected. Unlike the 2013 taper tantrum, there was little bond market turmoil this time around. In the Fed’s announcement, it left the door open to accelerate tapering should inflation metrics surge higher and the economy move closer to full employment. Bond markets continue to signal that two rate hikes are likely out of the Fed late next year. We think markets are currently putting too much emphasis on inflation rather than the full employment aspect of the Fed’s dual mandate. We have, however, moved up our timeline for the first rate hike to Q4 of 2022 in light of stronger inflation and job gains.

Risks to the outlook

A number of risks through the end of this year remain on our radar, including inflation pressures further eroding the purchasing power of consumers and denting confidence. The potential for a government shutdown on Dec. 3ʳᵈ, ongoing supply chain issues resulting in goods shortages, and the potential for another wave of COVID cases are additional risks. Even with all the potential factors that could derail the Q4 rebound, we see the balance of risks to our outlook tilted towards the upside now that vaccines are available to school-aged children and remaining fiscal support is likely to carry consumer spending higher.

Notes:

• ¹ Bureau of Labor Statistics, U.S. Department of Labor
• ² Bureau of Economic Analysis, U.S. Department of Commerce

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