Fed standing firm despite more positive outlook - Capital Economics
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Fed standing firm despite more positive outlook

US Economics Weekly
Written by Andrew Hunter
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The rapidly accelerating vaccine rollout means that the economic outlook continues to brighten. But Fed Chair Jerome Powell’s dovish tone in his post-FOMC press conference this week reinforces our view that the Fed will maintain its current ultra-loose policy stance throughout this year, even as economic growth accelerates.

The rapidly accelerating vaccine rollout means that the economic outlook continues to brighten. But Fed Chair Jerome Powell’s dovish tone in his post-FOMC press conference this week reinforces our view that the Fed will maintain its current ultra-loose policy stance throughout this year, even as economic growth accelerates.

Admittedly, we learned this week that GDP growth slowed to 4.0% annualised in the fourth quarter, as pandemic-related restrictions on activity and the fading of earlier fiscal support drove a sharp slowdown in consumption growth. Despite acknowledging that near-term virus induced weakness, however, the Fed’s policy statement on Wednesday signalled greater confidence in the outlook further ahead. A previous line stating that the pandemic posed “considerable risks to the economic outlook over the medium term” was dropped, with Powell confirming that officials now see a more positive outlook as the arrival of highlight-effective vaccines has brought the end of the pandemic within sight.

With 1.2m vaccine shots now being administered each day, President Joe Biden’s target of 100m doses within his first 100 days now looks easily achievable, prompting him to suggest this week that the total could reach 150m, enough to inoculate nearly a quarter of the population. (See Chart 1.) Biden also announced Federal purchases of an additional 200m doses of the Pfizer and Moderna shots, bringing the total confirmed supply up to 600m doses. As Biden highlighted, that will be enough to fully vaccinate nearly the entire US population, and comfortably satisfy most estimates of the required level of “herd immunity”, by the end of the summer. Supplies will rise even further if the vaccine from Johnson & Johnson wins regulatory approval within the coming weeks. With all of those doses produced domestically, the US is also less likely to suffer the supply issues now facing other countries.

Chart 1: Coronavirus Vaccinations

Source: CDC

At the same time, although disposable incomes fell by 9.5% annualised in the fourth quarter, December’s $900bn fiscal package will result in a renewed surge in the first quarter, which will be even stronger if Congress passes yet more stimulus over the coming weeks. Together, we expect the boost from vaccines and fiscal policy to help drive a marked acceleration in GDP growth to an above-consensus 6.5% this year.

But even that may not be enough for the Fed to start bringing forward its plans to tighten monetary policy. Powell’s emphasis on the continued shortfall in employment, and his argument that any significant rebound in inflation this year was most likely to be transitory, suggests the Fed is still firmly focused on providing maximum support to the economy. Powell also dismissed concerns that easy monetary policy was contributing to the recent speculative frenzy in parts of the stock market. In that environment, we don’t expect the Fed to begin tapering its asset purchases until next year, with the first interest rate hike probably delayed until 2024. That should help to ensure that long-term interest rates stay low and economic growth remains well above trend.

The week ahead

We expect the January employment report to show the virus still weighing on the economy, but the weakness in employment probably remained confined to the leisure and hospitality sector. The ISM activity surveys are likely to show that the broader economic recovery remains on track.


Data Previews

ISM Manufacturing Index (Jan.) 10.00 Mon. 1st Feb.

Forecasts

Previous

Median

Capital Economics

Headline index

60.7

60.0

60.0

Manufacturing holding up well

Our model points to a drop in the ISM manufacturing index to 60.0 in January, though that would still be consistent with a strong recovery in manufacturing output.

Even as consumption has dropped back, production has continued to rise solidly, in part because it lagged behind earlier in the recovery, resulting in very lean inventory levels. That won’t have changed in January. The international PMIs and surging global shipping costs indicate that global demand is still strengthening.

Even so, the ISM manufacturing index has overshot the regional Fed surveys in recent months. (See Chart 2.) The national Markit manufacturing PMI did strengthen in January, but only to 59.1, from 57.1. We therefore wouldn’t be surprised to see the ISM index edge down in January, though at 60.0, it would still be consistent with continued strong growth in manufacturing output.

Chart 2: ISM Manufacturing & Regional Fed Indices

Source: Refinitiv

ISM Services Index (Jan.) 10.00 Wed. 3rd Feb.

Forecasts

Previous

Median

Capital Economics

Headline index

57.2

56.9

57.0

Loosening restrictions & stimulus will provide renewed boost

Our model suggests that the ISM services remained at a high level in January. With restrictions now being eased and fiscal stimulus feeding through, activity should start to accelerate again soon.

The Markit services PMI rose sharply in January, hitting 57.5 from 54.8, though that simply reversed most of the drop back seen in December. By contrast, the ISM services index rose slightly last month and, at 57.2, is in line with its average over the past six months. Our model based on the regional Fed surveys suggest it maintained that level in January.

Arguably some of the detail of the ISM services survey may be of greater interest. Notably, the prices paid balance has been accelerating sharply over recent months, perhaps reflecting pandemic-related supply constraints. (See Chart 3.) That’s consistent with a rebound in inflation which so far doesn’t appear too troubling for the Fed, but we will be keeping a close eye to see if that trend continues accelerating in 2021.

Chart 3: Oil Prices & ISM Services Prices Paid

Source: Refinitiv

Employment Report (Jan.) 08.30 Fri. 5th Feb.

Forecasts

Previous

Median

Capital Economics

Change in Non-Farm Payrolls

-140,000

+100,000

0

Unemployment Rate

6.7%

6.7%

6.7%

Average Hourly Earnings

+0.8%(+5.1%)

+0.3%(+5.0%)

+0.4%(+5.3%)

Average Weekly Hours Worked

34.7

34.7

34.7

Labour market treading water

We estimate that non-farm payroll employment was unchanged in January, but the recent fiscal support and drop-back in new virus cases suggest the labour market recovery will resume soon.

The 140,000 fall in payrolls in December was driven by a renewed 498,000 plunge in employment in the leisure & hospitality sector, as the restrictions on bars and restaurants took their toll. The high-frequency data on restaurant dining and mobility have shown signs of stabilising in recent weeks, but still look consistent with leisure-sector employment doing no better than flat-lining, or even falling a little further, in January. (See Chart 4.) That said, there is little evidence the labour market more broadly is succumbing to the latest wave of virus cases, with employment excluding in other sectors continuing to rise in December. The levelling off in initial jobless claims in recent weeks, along with the reasonably solid Markit employment PMIs, suggest that continued in January too.

Overall, we are pencilling in no change in non-farm payrolls, although the annual benchmark revisions represent an additional uncertainty to that forecast. That would suggest the unemployment rate was also broadly unchanged at 6.7%, but the economic improvement we expect over the coming months means we expect it to fall to 4.5% by year-end.

Chart 4: Restaurant Diners & Payrolls

Sources: Refinitiv, OpenTable

International Trade (Dec.) 08.30 Fri. 5th Feb.

Forecasts

Previous

Median

Capital Economics

International trade balance

-$68.1bn

-$66.4bn

-$64.5bn

Exports making up lost ground

The trade deficit looks to have narrowed sharply in December thanks to a surge in exports, which should ensure that the drag on growth from net trade in the fourth quarter fades in the first quarter.

The advance report showed the goods trade deficit narrowing to $82.5bn in December, from $85.5bn, as a 1.4% m/m rise in imports was offset by a 4.6% jump in exports. The strength of exports was broad based, with all major categories seeing gains. By contrast, the rise in imports came despite a 3.2% m/m drop in consumer goods imports, an unsurprising result of the recent slowdown in consumption growth. (See Chart 5.) Assuming services trade continued to recover only very gradually, we expect the overall trade deficit fell to $64.5bn in December, from $68.1bn.

Chart 5: Sales & Consumer Imports (%3m/3m Ann.)

Source: Refinitiv


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Release/Indicator/Event

Time EST (GMT-5)

Previous*

Median*

CE Forecasts*

Mon 1st

ISM Manufacturing Index (Jan)

10.00

60.7

60.0

60.0

Construction Spending (Dec)

10.00

+0.9%

Tue 2nd

No Significant Data Released

Wed 3rd

Change in ADP Employment (Jan)

08.15

-123,000

+75,000

0

ISM Services Index (Jan)

10.00

57.2

56.9

57.0

Thu 4th

Unit Labour Costs (Q4)

08.30

-6.6%

+3.7%

+5.0%

Non-farm Productivity (Q4)

08.30

+4.6%

-3.7%

-2.3%

Initial Jobless Claims (w/e 30th Jan)

08.30

847,000

Factory Orders (Dec)

10.00

+1.0%

+1.5%

Fri 5th

Change in Nonfarm Payrolls (Jan)

08.30

-140,000

+100,000

0

Unemployment Rate (Jan)

08.30

6.7%

6.7%

6.7%

Average Hourly Earnings (Jan)

08.30

+0.8%(+5.1%)

+0.3%(+5.0%)

+0.4%(+5.3%)

Average Weekly Hours Worked (Jan)

08.30

34.7

34.7

34.7

International Trade (Dec)

08.30

-$68.1bn

-$66.4bn

-$64.5bn

Change in Consumer Credit (Dec)

10.00

+$15.3bn

Selected future data releases and events

10th Feb

Consumer Prices (Jan)

08.30

12th Feb

Uni. Of Mich. Consumer Confidence (Feb)

10.00

17th Mar

Fed Policy Announcement

14.00

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts

%q/q ann. (%y/y) unless stated

Q4 2020

Q1 2021

Q2 2021

Q3 2021

Q4 2021

Q1 2022

2020

2021

2022

GDP

+4.0

+5.2

+10.9

+4.2

+4.2

+3.1

(-3.5)

(+6.5)

(+4.0)

CPI Inflation

(+1.3)

(+1.7)

(+3.3)

(+2.5)

(+2.4)

(+2.4)

(+1.3)

(+2.5)

(+2.3)

Core CPI Inflation

(+1.8)

(+1.8)

(+2.8)

(+2.3)

(+2.2)

(+2.2)

(+1.7)

(+2.3)

(+2.2)

Unemp. Rate (%), Period Ave.

6.8

6.4

5.1

4.8

4.5

4.4

8.1

5.2

4.4

Fed Funds Rate, End Period (%)

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

0.00-0.25

10y Treas. Yld., End Period (%)

0.93

1.00

1.00

1.00

1.00

1.00

0.93

1.00

1.00

S&P 500, End Period

3756

3900

4000

4100

4200

4300

3756

4200

4500

$/€, End Period

1.22

1.22

1.23

1.24

1.25

1.26

1.22

1.25

1.30

¥/$, End Period

103

103

102

101

100

99

103

100

95

Sources: Refinitiv, Capital Economics


Andrew Hunter, Senior US Economist, andrew.hunter@capitaleconomics.com