Making a full recovery
The US economy expanded 6.5% for the second quarter, primarily driven by consumer spending, which surged 11.8% in the quarter. Business investment increased by 3% as companies resumed spending on equipment – this part of GDP would have likely been stronger had it not been for the shortages we’ve seen across the services and manufacturing sectors for supplies and labor. Those shortages actually came through in a big way as inventory levels declined $165.9b. Investments in new housing also fell for the first time in a year, another supply side issue versus an indication of lower demand (people still want to buy homes but there just aren’t that many homes left on the market anymore and builders can’t build fast enough because they can’t find workers and supplies).
Moral of the story: The size of the economy now exceeds that before the pandemic – this has been an insanely sharp and deep recession followed by an equally sharp and steep recovery driven by the unprecedented amount of monetary and fiscal stimulus that has been pumped into the economy. The recovery should continue as long as the delta variant doesn’t create complete chaos…we’re already seeing mask mandates coming back across several states but hopefully this time we don’t see widespread economic shutdowns.
Inflation station
The June PCE index (the Fed’s preferred measure of inflation) showed a 0.5% increase for the month of June alone, climbing to a 4% annual rate of inflation. This is the highest annual reading for the PCE index since 2008. Spending has especially surged across leisure and hospitality services.
Moral of the story: We’re continuing to see consumer demand at really elevated levels (the Consumer Confidence index inched up again in July, marking a 16-month high) and producers aren’t able to keep up with that demand. Tale as old as time – demand higher than supply means rising prices.
Fed speak
Inflation is very clearly running very well ahead of the Fed’s 2% target, so investors are super focused on how the Fed is going to react to the data coming out of the economy today. Fed Chairman Powell admitted that inflation could turn out to be higher and stickier than initially expected, but still anticipates that it will be temporary. According to his commentary, while inflation will remain high in the “short term” it will subside in the “medium term.” So, we’re clearly working with a lot of specific clarity here.
Moral of the story: Despite GDP returning to pre-COVID levels, the Fed’s policy is still full-throttle, and when they start tapering those accommodative policies, the markets will almost certainly feel the impact. We’re now seeing the beginnings of discussions around tapering policies but the decision on that is still months away. This is one of the biggest wild cards in the markets today so it’s worth watching closely.