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The U.S. economy is past its fastest growth phase, but like a marathoner it still has plenty in reserve to continue the run. Until the Delta variant reared its ugly head it was thought that conditions would have returned to normal by now, setting the stage for a robust second-half sprint that carried momentum into 2022. The expansion still has legs, but instead of a sprint its pace is downshifting to a jog. The unwelcome revival of the fourth stage of Covid-19, spurred by the Delta variant, created a headwind that has taken some air out of the expansion.
The U.S. economy passed a key milestone in the second quarter as it more than recouped output lost during the Covid-induced recession. On the heels of a 6.5 percent increase, real GDP rose to $19.4 trillion in the April-June period, topping the $19.2 trillion that prevailed in the final quarter before the onset of the pandemic. The six-quarter turnaround is not particularly rapid compared to past recovery cycles - it’s about equal to the average time it took for past nine recoveries to regain their prerecession peaks - but it is impressive considering the depths the economy had to climb out of. The pandemic recession may have been the shortest on record, but it was also the harshest, sending output - and employment - plunging by the greatest amount since the Great Depression.
A heavy dose of political and economic news buffeted the financial markets this week, inciting a good deal of turmoil and leaving more questions than answers at the end of the period. Importantly, the debt-ceiling time bomb was defused, at least for the moment, as the Senate voted on Wednesday to increase the cap by $480 billion. The House is expected to pass the bill after returning to Washington within the next few days. Once President Biden signs it, the bill will avoid a possible Treasury default, amplified market turmoil, and a self-inflicted recession for now. But the increased headroom should last only until the beginning of December. At that point, we may be back to where we started, while also contending with the risk of a government shutdown as the continuing resolution currently funding the government ends on December 3.
As the calendar turns to a new month, all we can say is good riddance to September. The just-completed month delivered some of the most awful news of the year, leaving the Biden administration as well as investors with severe headaches. Stocks turned in their worst performance since March 2020, with the S&P 500 tumbling by nearly 5 percent. The deepest slide was saved for the final week, when the swirl of unfortunate events coalesced into a firestorm. Not surprisingly, the muddled events on Capitol Hill, the proximate cause of the administration’s angst, topped the list and continue to weigh heavily on the financial markets.
This week featured a remarkable string of policymakers prepping anyone within earshot that something not too cheerful was about to take place. The Federal Reserve signaled that it was poised to start removing its emergency support for the economy, the White House directed Federal agencies to prepare for a possible government shutdown, and the Chinese government issued a warning that the nation’s largest real estate developer may default on its debt.
The Delta variant dashed hopes that the economy would have returned to normal by now. But aspirations are delayed not demolished. The virus is taking a toll on growth, but it is not derailing the expansion. Activity will slow in the current quarter from the robust pace seen in the spring and then regain momentum later this year and into 2022.
With the Delta variant generating ever-more uncertainty into the growth outlook investors may be poised to take some risk off the table. Indeed, that appeared to be the case this week, as stock prices fell for five consecutive days, posting its first weekly decline in three weeks. What’s more, the underlying reasons for a more risk-averse mindset remains firmly in place.
The Jackson Hole symposium, featuring the highly anticipated address by Fed Chairman Powell, was the main event in the financial markets this week, but rapidly unfolding geopolitical and health developments stole the headlines and may ultimately render Powell’s message moot. That said, the markets were braced for any indication as to when, and under what circumstance, would the Fed begin to taper its asset purchases, setting in motion the unwinding of emergency support for the economy in effect for the past 18 months. To no surprise, the chairman was noncommittal about the timing but strongly suggested that tapering could begin by the end of the year.
The calendar says that we are smack in the middle of the “dog days of August”, but there’s nothing languid about the barrage of conflicting influences buffeting the economic landscape. To be sure, the swirl of events for which we have hard data primarily took place in July. But the catalyst for much of the turmoil – the upsurge in Covid case counts, led by the Delta variant – just about assures that things got even more complex this month. In keeping with climactic metaphors, it’s fair to say that Delta is throwing a chill on the overheating fears so rampant a few weeks ago.
Has the tapering begun? No, the question is not about monetary policy, but whether the blistering inflation rate seen in recent months is starting to ease up. Of course, the answer to that question feeds directly into the tapering issue that is at the forefront of the Federal Reserve’s current deliberations. Unfortunately, recent events do not make the task any easier. Both the hawks advocating an early tapering of asset purchases and the doves arguing for more patience can draw support from the latest batch of data, as well as unfolding developments.
Amazon is the latest among several high-profile firms to push back return-to-office plans for its corporate workers, highlighting the disruptive impact the surge in Covid cases is having on the labor market. But while the spread of the Delta variant is creating turmoil in the job market, it has yet to slow the growth in corporate hiring. That was clearly evident in the latest jobs report released on Friday. If anything, the reopening of the economy continues to generate a huge demand for labor, and many companies still cannot find enough workers to fill positions. Among small businesses, for example, a record 49 percent of owners have at least one unfilled job opening, according to the National Federation of Independent Businesses.
The Commerce Department closed the books on the second quarter, releasing its first estimate of GDP for the period as well as the all-important report on household income and spending for June. As expected, the economy turned in a robust performance, powered by a muscular pace of consumer and business outlays. Since the results were generally in line with expectations and reflected past events, they had little impact on the financial markets. Instead, investors turned their attention to monetary and fiscal policy developments and, more importantly, to the disturbing upsurge in Covid cases.