The American economy will continue to boom in the second half of the year following what we expect will be 7.8% growth through the first six months.
We expect that growth in the second quarter will accelerate above 9%.
While growth will almost certainly peak in the second quarter at our revised 9.2% forecast, rising wages among workers down the income ladder will bolster economic conditions. At the same time, Congress will most likely approve a $1.2 trillion infrastructure project and will likely approve another $1.5 trillion to $2 trillion in spending for fiscal year 2022-23 as the Federal Reserve prepares to begin scaling back its monetary accommodation.
We expect that growth in the second quarter will accelerate above 9%, driven by rising incomes among the poor and working classes, generous fiscal aid and an economic reopening.
While it is almost certain that the second quarter will be the apex of nominal growth in the current expansion, there are sufficient catalysts in the second half of the year—rising wages, a nearly $100 billion child tax credit, prodigious excess savings and strong capital expenditures—that will produce growth well above the long-term rate of 1.8%.
We still expect a growth rate above 7% this year, down provisionally below our year-ahead forecast of 7.5%.
Wages and the labor market
One of the more surprising dynamics in the economy recently is the improved wage outlook for workers whose pay has stagnated in recent decades. Over the past three months, wages have improved for those in lower-paying service sector jobs to the point where those gains will be translated into direct spending that supports overall economic activity and the reopening of the service sector.
But even with those gains, the economy remains 6.7 million jobs short of its pre-pandemic level, which is a reflection of the deep shock that workers have endured in the pandemic.
Wage gains have been particularly strong in lower-paying transportation and warehousing jobs, which are up by 17.7%, and in leisure and hospitality jobs, where wages have advanced by 15.1%.
These gains have to do with a confluence of events—policy support, availability of child care and schools reopening—that has increased the reservation wage of lower-income cohorts. With some federal unemployment benefits set to expire in September and schools reopening, there will be an increase in workers returning to the labor force. That return will send the unemployment rate down from the current 5.9% to our year-end target of 4.7%, with risk of a much lower rate.
On a quarterly basis, we expect monthly job gains above 700,000 in the current quarter and nearly 660,000 during the final three months of the year, both with risk of a quicker pace of growth.
Although that will certainly cause wage pressures to abate, the gains made over the past three months and through the current quarter will support improved economic activity as those with a higher marginal propensity to consume spend that income.
To be sure, demographic pressures are catching up with the labor market: The accelerating retirement of baby boomers and difficulty returning to work for some workers will keep a lid on any prospective increase in the overall employment-to-population ratio despite what will be an improvement in the prime-age 25-54 worker cohort.
Risks to the outlook
The major risk to our forecast is twofold: First, the emergence of the coronavirus delta variant could cause a retrenchment in normal social and economic risk-taking and slow the reopening of the economy.
The U.S. economy is operating at around 92% of its pre-pandemic level, according to Moody’s, so the risks remain manageable at this point with respect to the direction of growth, employment and inflation.
If there is a risk linked to overall economic activity, it has to do with the trade channel.
In addition, if there is a risk linked to overall economic activity, it has to do with the trade channel. External demand may not grow as quickly as we would have expected this year—our global growth forecast stands at 6%—given the slow rate of vaccination among emerging economies and modern states like Japan and Australia.
The second risk, which we are monitoring closely, is the strong jump in inflation linked to global supply constraints. We have revised up our forecast of the Consumer Price Index to average above 4% this year, and the policy-sensitive core personal consumption expenditures index to 2.6% before migrating back toward 2% next year.
The surge in prices, which has been caused by a general imbalance between demand and supply, should begin to abate later this year. Inside the data, the areas of the economy that saw historically large declines early in the pandemic have reversed. Increases in energy prices, used vehicles, lodging and airfares have all played an outsized role in driving prices higher.
The rise in prices has been driven by a number of one-time factors like supply constraints, yet in some cases, prices remain below pre-pandemic levels. Over time, prices will move back toward the central bank’s target of 2% growth, and that does not demand immediate policy remediation such as an increase in interest rates. Rather, the Federal Reserve is far more likely to reduce the pace of its $120 billion in monthly asset purchases next year in a gradual and orderly fashion to avoid any large policy-induced shock.
It is likely that the Federal Reserve will use its monetary symposium at Jackson Hole, Wyo. in late August to signal the timing and magnitude of such action. We expect that it will be formalized in the September statement. We do not expect any increase in the policy rate until the latter portion of 2023, when we anticipate the Fed will hike the federal funds rate by 25 basis points at the September and December FOMC meetings.
Investors should anticipate that the front end of the yield curve will be anchored by a policy rate between zero and 25 basis points and expect a modest migration of the 10-year yield toward 1.9% because of robust domestic growth throughout the remainder of the year.
In some respects, this year may well be remembered as the year of fiscal policy. From the $1.9 trillion American Rescue Plan, the $900 billion in implementation of the 2020 Consolidated Appropriations Act, the prospective $1.2 trillion bipartisan infrastructure agreement, as well as a probable fiscal year 2022-2023 budget agreement that we think will arrive somewhere between $1.5 trillion and $2 trillion, all support the robust recovery.
In some respects, this year may well be remembered as the year of fiscal policy.
While there will be a fiscal overhang next year and in 2023 as many of those measures end, there is plenty of fiscal firepower still working its way through the economy to support above-trend growth.
The infrastructure plan is a case in point of the enduring impact of fiscal support for the economy. Over the eight-year time frame of the proposed package, should it actually happen, the combined state spending, federal baseline spending and new spending would result in $2.5 trillion in infrastructure investments at a minimum. We think this could boost long-term economic growth by 0.5%, lift productivity and raise living standards, all without fueling inflation.
Fixed business investment
One of the more welcome and unexpected recent developments is the burst of productivity-enhancing fixed business investment. Despite elevated levels of gross corporate debt, the shock unleashed by the pandemic and the collapse in capital expenditures early in the pandemic, fixed business investment is booming.
With more than $2 trillion in cash on corporate balance sheets sitting idle, we remain bullish on productivity-enhancing capital expenditures this year and next. New orders for core capital goods have surged to roughly $100 billion, and we expect an inflation-adjusted increase in capital goods orders of above 9% in the second half of the year. This increase could very well move higher should additional fiscal support come about.
For more information on how the coronavirus pandemic is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.