The Pandemic-induced recession is rapidly becoming a distant memory as the economy continues to show remarkable signs of regaining its footing. Consumer spending is now back to its pre-pandemic level, and if the economy continues on this path, it will be likely that the economy will move into a new expansion by the end of this month.
As the May jobs number was released today, we noticed that the unemployment rate dropped to 5.8%, and 559,000 jobs were added. While economists expected an increase of 671,000, the jobs number looks to be in a “goldilocks” range, not too hot and not too cold. Had there been a sharply higher number, markets would have likely taken that as the economy was running hotter than expected, and the Fed may pull back monetary policy sooner than anticipated.
Much of the data being reported for April and May exhibits what is known as the base-rate effect. This is because the numbers were so low when the economy was shut down that any number being reported now, a year later, is showing significant gains.
Inflation is still my main concern as it poses the most risk to a portfolio for various reasons. For one, if inflation rises faster than expected and the Fed is forced to raise rates, stocks and bonds will both be hit. Stocks will look expensive when cashflows/earnings are discounted back to the present at a higher interest rate, and bond prices are inversely related to interest rates. If rates rise, bond prices fall.
Most economists and market participants believe inflation will moderate later this year. This could happen if Americans maintain a savings rate that currently stands at double the pre-pandemic level and there is no more income stimulus. I believe the probability that the savings rate stays high is low, and we already know that most families with children will be getting an additional $3000-$3600 per child for the tax year 2021. I believe once the economy is back on solid footing and people are confident in the stability of their income, the savings rate will come down.
Personal consumption is now above the pre-pandemic levels, mainly due to the infusion of liquidity into household balance sheets. I would expect that spending will increase throughout the remainder of the year as vaccinations continue and Covid-19 cases continue to dwindle.
Based on the current economic landscape, I believe inflation will be transitory only if we see a massive increase in productivity, robust GDP growth, or a higher-than-normal savings rate that persists. Currently, this seems unlikely but not impossible.
