Slowing Down: A US Macroeconomic Update

Economic recovery has slowed amid ongoing supply chain issues and mounting inflation. Following a strong outlook earlier in the year as vaccines were more widely administered, global supply chain issues resulted in some setbacks. Thus, US GDP has been adjusted to increase at an annualized rate of 2.1% in the third quarter of 2021.

However, the emergence of new COVID-19 variants resulted in relatively modest setbacks, with only a few added restrictions in some cities, thus keeping reopening efforts in place. Meanwhile, ongoing and intensifying supply chain disruptions have pressured domestic manufacturing activities and driven up retail prices, ultimately driving up inflation.

Labor market

• The rise in nonfarm jobs in the third quarter of 2021 outperformed estimates, gaining 1.9 million nonfarm jobs, with an additional 531,000 jobs added in October alone. This comes as extended unemployment benefits expired in September.
• Rises in leisure and hospitality, professional and business services and transportation and warehousing contributed to quarterly growth. Easing restrictions, increased travel activity and rising vaccination rates enabled such rises. Despite this growth, there are some concerns of continued labor shortages stemming from vaccine mandates.
• As vaccines are continuously rolled out, and as restrictions continue to ease, 11.6% of employed Americans worked remotely in October, down from 13.2% in September and 33.3% in May 2020.
• Outperforming estimates, the unemployment rate declined further to 4.6% in October, marking a 0.2 percentage point decrease from September levels.
• Sectors with the largest gains in employment in October include leisure and hospitality and professional and business services. Government employment was the only sector to exhibit declines in October due to declines in local government education. The Utilities sector stagnated in October while declining over the quarter.

Consumption shift

• Despite rising inflation, personal consumption expenditures (PCE) grew 1.6% over the third quarter of 2021.
• Continuing to surpass pre-pandemic spending levels, year-over-year PCE increased 10.9% in September 2021. This growth in consumer spending has been driven by services spending, particularly for housing and utilities.
• Spending has on durable goods tempered in the third quarter, decelerated by falling consumption of motor vehicles and parts amid ongoing global supply chain issues, thus contributing marginally to spending gains. Meanwhile, nondurable goods drove consumer spending, with nearly half of growth attributed to food and beverages purchased for off-premises consumption.
• Rising healthcare consumption and housing and utilities drove growth in spending on services. In contrast, declining consumption of transportation services decelerated growth in services spending.

Inflation: back in question

• Personal Consumption Expenditures price index (excluding food and energy), the Federal Reserve’s preferred inflation measure, increased 0.5% in the third quarter of 2021. Consequently, year-over-year inflation stands at 3.6% for the year ending in September 2021 but has continued to grow through October.
• Despite the Federal Reserve tapering asset purchases in 2022, inflation is expected to remain elevated into the outlook period. However, the Federal Reserve's recent shift to an average inflation target (AIT) of 2.0%, in the long run, has enabled inflation to run above and below the target for some time.
• Ongoing supply chain disruptions, rising rent and car prices have driven recent price hikes. In particular, growing shipping costs, limited supply of crucial manufacturing inputs and rising fuel and energy costs have continued to place upward pressure on inflation through supply chain issues.
• Although the Federal Reserve had continued to indicate the surging inflation was transitory, testifying before the Senate Banking Committee in November, Federal Reserve Chair Jerome Powell stated there is the risk of more persistent inflation.
• The level of 5-year breakeven inflation continues to remain at elevated levels, eroding real yields.

Residential trends

• The housing price surge has ended, with housing price growth beginning to level off; the number of offers on homes for sale has declined dramatically over the past few months; about a quarter of home sellers are taking price reductions now.
• Owners who had bought houses earlier during the pandemic have begun listing their homes to sell them for a profit due to the sustained high house prices.
• Despite easing residential construction activity, construction of new homes has continued to hold up, totaling between 1.5 million and 1.6 million units under construction during the third quarter, remaining well above pre-pandemic levels.
• Housing starts has declined on an average 1.9% each month in the third quarter, with an additional decline of 2.7% in October, representing a significant slowdown from the rapid growth seen at the end of 2020. However, housing starts remain high due to the continued demand for multifamily construction, partially due to the end of urban flight and return of renters to cities.
• Residential real estate lending strengthened over the third quarter but appears to be easing due to dissipating price pressures. Due to lower risk concerns, banks have eased lending standards for most mortgage categories.

Nonresidential trends

• Nonresidential construction is up 0.2% in September compared to the start of the quarter, primarily driven by utilities and power, highways and streets and water supply.
• Following President Biden signing the $1.0 trillion infrastructure bill into law in the coming months, spending on highway and street construction will increase.
• While manufacturing activity had fallen, resulting in bottomed-out sector construction, manufacturing output has returned to pre-pandemic levels, driving construction activity for manufacturers.
• Sewage and waste disposal construction is up due to rising consumer spending in 2021, driving larger waste volumes, resulting in landfill construction activity. Increasing manufacturing and industrial output has also caused water supply and conservation equipment to service the ramp-up in capacity utilization; regulators have also been driven by expected rate hikes that encourage utility companies to replace outdated equipment.
• Rising rents, low interest rates and a return to cities have continued to drive demand for multifamily commercial real estate construction, reducing risk profile and easing lending standards from banks.

Financial markets

• S&P 500 produced a year-to-date price return of 43.0% in 2021 and a 51.0% return between November 18, 2020, and November 18, 2021. Strong performance for the Dow Jones U.S. Banks Index tempered, producing a year-to-date price return of 27.8% and a 22.9% return during the same one-year period.
• The Federal Reserve will begin tapering asset purchases by $15.0 billion per month starting December 2021. Interest rate hikes are not expected until the second half of 2022, earlier than previously expected due to rising inflation.
• As the US and global economies have recovered, there has been a shift in investment strategy. Notably, money is being shifted out of bloated growth stocks and back toward large-cap value stocks since these are typically established businesses that weathered the pandemic environment, demonstrated pricing power and have a better outlook for their current competitive landscape.

Distribution of risk ratings

• 2019 risk ratings were close to normally distributed.
  • 7% of industries rated as medium-high or greater risk.
• Risk in 2020 was concentrated at the higher end of the scale as the US economy was hit hardest by the pandemic and related regulations.
  • 5% of industries rated as medium-high or greater risk.
• Risk in 2021 is expected to be more moderate as the economy begins to recover and as regulations ease, despite concerns from supply chain disruptions and inflation.
  • 8% of industries rated as medium-high or greater risk
• The risk outlook is expected to improve significantly by 2022 once the economy is fully reopened.
  • 5% of industries rated as medium-high or greater risk.

Sector highlights

• Accommodation and Food Services – The Accommodation and food sector went from the riskiest sector in 2020 to one of the least risky in 2022, driven by economic recovery. Sector employment remains 1.4 million below pre-pandemic levels, as businesses remain challenged by new variants and ongoing consumer concerns, despite a strong vaccine rollout. Most employment growth within the sector has been within food service and drinking places as regulations have eased, benefiting industries such as Chain Restaurants, Bars & Nightclubs and Single Location Full-Service Restaurants. Overall, consumer spending has been driven by growth in food services, further propelling sector recovery.
• Finance and Insurance – Despite overall economic improvement over the third quarter, surging inflation has prompted the Federal Reserve to begin tapering asset purchases in December 2021. While the federal funds rate is still effectively at zero, an interest rate hike is expected in the second half of 2022, earlier than previously expected, due to rising inflation. These higher rates will enable banks to earn more from net interest income, thus benefiting commercial banking and Industrial Banks.
• Construction – Total construction activity has tapered off due to declines in residential construction as house prices have leveled off following surging demand amid low interest rates. Conversely, nonresidential construction activity has returned to growth in the third quarter as the economy has reopened, driving business activity., the Water & Sewer Line Construction industry will likely benefit. Moreover, the recent $1.0 trillion infrastructure bill signed into law in November is expected to drive growth for the Road & Highway Construction and Bridge & Elevated Construction industries in the coming months.
• Retail Trade – Throughout the pandemic and recovery, the Retail Trade sector has been seen as one of the riskiest sectors. Although the E-commerce & Online Auctions industry has been resilient to business closures, recent surging inflation has pressured consumer spending on goods.