Economic Recovery or Economic Overheating?

Audio Description

Eric Winograd, AllianceBernstein's Senior Economist covering the US, Mexico, and Canada, joins The Pulse to discuss the US's rapid recovery from the pandemic recession, the outlook for the labor market, and of course, what's happening with inflation and the Federal Reserve.


00:03 - 00:34

Everybody, welcome to The Pulse where we cover trends in the economy, markets, and asset allocation for long-term investors. I'm Matt Palazzolo, a Senior Investment Strategist at Bernstein and head of our Investment Insights. Our conversation today will be with Eric Winograd, our senior economist with responsibility for the United States in addition to Mexico and Canada. And given that we're now well into a very robust recovery after one of the deepest and quickest economic contractions, it's a great time to get together with Eric for his latest perspective. So let's jump into it. Eric, welcome back to the show.

00:34 - 00:35

Thanks for having me.

00:35 - 00:48

So I certainly want to dig in on inflation, which is a big topic, de jure, and the labor market. But before we do, let's level set everybody, let's provide a big picture. How would you describe the current state of the US economy?

00:49 - 01:33

I think you actually did a pretty good job of it in your intro. We are in the midst of what is a very robust and very rapid recovery after a very sharp, very short-lived, thankfully, recession. This is a unique period in modern economic history. There hasn't been a crisis that was caused by something quite like this pandemic. And to an extent, we are in uncharted waters. But what we can say, based on the evidence so far, is that the recovery has been very robust. That's something that we expect to see continue. I think it is a testament to the power of policy, both from a fiscal and a monetary perspective, that we've been able to bounce back quite as quickly as we have. To be clear, we're not all the way back. There is still work to do and I'm sure we'll get into talking about that. But at least so far, the initial signs are very encouraging.

01:33 - 01:45

You discussed policy. How important was both monetary in the early stages of that contraction and then fiscal policy once we started to come back to us on this course for a recovery to lend us where we are today?

01:45 - 02:21

They've been absolutely critical, absolutely critical. And I think that they still are. Monetary policy and the Fed in particular did an excellent job early in the crisis of preventing things from getting worse, preventing the pandemic from spilling over also into being a financial crisis. And they did that by stabilizing financial markets across a wide range of different asset classes, everything from credit markets to foreign currency, in some cases, by providing liquidity to foreign central banks when it was necessary to limit the global impact of this, really stepping in and making sure that things didn't get worse.

02:21 - 03:21

Monetary policy, though, can only go so far. The best that they could do is stabilize things. And we really did need that fiscal impulse to put us on the path to recovery. Fiscal policy is where you can generate demand, where you can provide income to people who otherwise wouldn't have it. And we shouldn't forget in all the optimism of today, twenty-two million people lost their jobs for some period of time. That's a tenth of population. It's a big number. And one of the most impressive feats from a policy perspective is despite that, aggregate household income was stable and even increased during the crisis because Congress and both the Trump and the Biden administrations have acted with urgency to put money into people's pockets. And that's limited the human misery of this. It has limited the spread of the virus by allowing people to stay home. If you don't have any income, if you're starving, you can't do that. So that's a big part of it. And now as we move into a different phase, it's providing support for the expansion. And so I really think fiscal policy has been the critical variable in defining the bounceback that we've had.

03:22 - 03:39

We could spend a whole episode on the impacts of fiscal policies through this crisis. Bring us up to speed. What, you're twenty, twenty one US GDP growth forecast and then remind our listeners, or for those who didn't know, talk about the reasons why you upgraded that forecast from several months ago.

03:39 - 04:53

So I am now looking for growth in the US this year of around seven percent, which is as large a number as I expect I will write down at any point in my career. That's really that's a lot of growth. It's enough growth that by the end of this year we will not just have gotten back to where we were pre crisis.. We will likely have get in GDP terms at least to where we would have been if the crisis hadn't happened at all. Amazing. It's a measure of the weakness of GDP as a variable, if you will, that that it will tell us that nothing happened. And we know that lots of things did. GDP isn't the be-all-end-all.. But from that perspective, things are going to look very robust, and it is a big upgrade. Coming into this year, my forecast was about half that, which even that, three and a half percent would have been a pretty strong number. But again, fiscal policy here is the determining variable. And Congress passed and the president signed another fiscal rescue package earlier in the year. And it matters that that generated a big upgrade to GDP growth. Again, the biggest single upgrade, I expect, that I will make at any point in my career. You often make big downgrades when an exogenous shock hits the economy, recessions tend to happen suddenly and it forces a big downgrade. You very rarely get a big upgrade. Those tend to be smaller and more incremental. So this really was a unique sort of set of circumstances.

04:53 - 05:14

So fiscal policy played a big role and upgraded your forecast from earlier in the year. I would assume that the COVID cases coming down and the improvement on that front Also, in your mind, allowed for the economy to open up maybe earlier than it would have and to get signs that people are getting back out and spending and economic activity, so that for us is confirmation of what we had expected.

05:14 - 05:53

We came into this year with the idea that by the second half of the year, by the third quarter and beyond, covid would no longer be the dominant variable in the economy, that we would no longer be talking about lockdowns and capacity restrictions and things like that. That process has probably happened a month or two sooner than we would have expected, which, of course, we're all very glad about it. It's wonderful news. But that one or two months isn't a paradigm change the way the fiscal policy was. We had already baked into our forecast some optimism around the progress of vaccinations and things like that. And again, it's wonderful to see confirmation of that, it gives us increased confidence in the forecast. But it wasn't itself a primary driver of the upgrade.

05:53 - 06:08

Washington, DC, is back at it again, negotiating this time related to infrastructure spending. I'm just wondering what your thinking is on the proposals and the potential impact that that would have, an infrastructure spending bill, on the economy over the medium and long term.

06:09 - 06:44

I want to start by drawing a distinction between what they're discussing now and the programs that we've seen passed over the last couple of years. And the last couple of years were really fiscal support packages, if you will, designed to mitigate the impact of the crisis. And the defining feature of them was that the money was spent very quickly, as some of it in the form of unemployment benefits that households received, some of it in the form of government payments for things like increased ventilation in schools and increased testing capacity, and some of it's stimulus checks that were sent directly to people. So when we would talk about the roughly four, four and a half trillion dollars of spending during covid, that's money that was spent or that will be spent very, very quickly.

06:45 - 07:16

The infrastructure spending and the human infrastructure, whatever you want to... however you want to define the bills or the proposals that are under consideration now, are very different. They aren't designed as crisis mitigation tools. They're designed as longer-term investments. And so while the numbers are very large, again, if you combine everything that's been discussed, you're talking again about something like four trillion dollars, that spending would take place over eight to 10 years. So it's a much slower sort of process and it would not require the sort of upgrade to any forecast in any one year that we saw from the spending this year.

07:16 - 07:56

With that distinction out of the way, any sensible economist will tell you that infrastructure spending is a good thing because it's the kind of spending that boosts growth while you are spending the money and also in the future because it should boost productivity. Better roads mean fewer traffic accidents mean fewer traffic delays, means that transportation times for goods and for workers go down so that boost productivity increases the potential growth rate of the economy. And so if the infrastructure spending bills pass, then it would result in a medium term upgrade to growth and really not a similar one to inflation, because, again, if you're boosting productivity, you can enjoy more growth without inflation.

07:56 - 08:48

To be clear, not everything in the bills or in the proposals under discussion meets the traditional definition of infrastructure. There's a general agreement that roads, bridges, tunnels, and I think, even at this point, people think of broadband and 5G as things that are traditional infrastructure, even if they're a little bit different than what they would have been 30 or 40 years ago. Some of the spending proposals are different than that. They are investments in human capital. So improved health and education and things like that, which won't have the same near-term growth payout necessarily, but you would think should have an increased longer-term growth payout. If you have a healthier workforce, if you have people who have to spend less time home sick, less time pursuing medical care and so on, that ought also to boost productivity. But it's a much, much longer time for us. And then so I think that that's part of the reason that that part of the proposal is a little bit more controversial.

08:48 - 09:02

Back to negotiations. I want to move to the labor market. We've now had two below-consensus payroll readings in a row. So what do you believe to be the major influences on those figures to make them come in below what the Street was expecting?

09:02 - 10:07

So the first thing I would say is nobody should really worry very much about consensus unless you are trading very, very short term. And I mean the matter of hours or days at the most, what consensus is or isn't is sort of irrelevant. We're coming out of a period where we're in an unprecedented period, coming out of an unprecedented period. Anybody's idea, anybody's ability really to formulate an intelligent estimate of these numbers is very limited. So at these inflection points and when you're in a period, look, we don't have another period where I can go back and say, well, the last time the economy reopened from a pandemic, the rate of... thankfully, I don't want to ever be able to use this period as comparator either. But I think what that means is that we should all be pretty circumspect about comparing anything to a consensus forecast. I wouldn't even call it a forecast. I'd call it a consensus guess. So if you're investing with anything other than the idea that you're going to be smarter than the market on a two-hour time horizon, what you ought to be thinking about is whether these labor market reports are consistent with or are not consistent with the medium term outlook of an improving economy and an improving labor market. And then, we added 570K jobs last month. That's a pretty good number in normal times.

10:07 - 10:09

That's a pretty good number.

10:09 - 10:16

Yeah, in normal times, that's two or three times what a good number would be. So that's a very strong number. And look, would we like to see the progress be faster, of course we would.

10:17 - 10:54

But there are some competing influences here, right? There are variables that are still suppressing labor supply. I know we're all eager to put COVID in the rearview mirror, but not everybody has. Vaccinations are still ongoing. Not everybody is vaccinated. Not everybody is comfortable that their co-workers are vaccinated. There are still health concerns around this that that may be limiting some people's willingness to go back to work. Schools in many places we're not are not fully open yet and won't be until the fall because in the summer they generally aren't. And so there are still childcare concerns around this. Not every household has the ability to go to work because they do have childcare responsibilities.

10:54 - 12:03

And a third part of this is unemployment benefits. The government has provided extended and in some cases enhanced unemployment benefits that have boosted household income and that have allowed people to be more selective about when and where they want to go back to work. If you have healthcare or child care concerns and you're getting enough from unemployment to allow you to stay out for a few more months, it probably makes sense to do so. For those people who do want to go back, it allows them time to be more selective. If you annualize the most generous available unemployment benefits, it annualizes to something like twenty six thousand dollars a year. For some people, that's not a bad income compared to what is otherwise available. Right. So what we are seeing is that wages are starting to creep up, which I think is a desirable outcome from a policy perspective. That's what we are hoping to see. And as it does, you should see more workers come back. The other good news is that we expect health concerns to fade. We expect child care concerns to fade. And as we move into the fall, those unemployment benefits will also fade away. And so the limited supply of labor should also diminish. And I would expect to see an increase and acceleration in the pace of hiring as the year progresses.

12:03 - 12:18

So if we've seen over the last couple of months five hundred to six hundred thousand jobs added, we might see in the back portion of the year going up to seven hundred fifty, maybe even a million jobs. Is that a're not going to, I'm not going to hold you to it, but in that ballpark, I think that's possible and plausible.

12:18 - 12:39

The way I think about it is this. There are, roughly speaking, eight million people today who are not working, that were working before COVID, plus, were it not for COVID, we would have added another million or two million jobs. So just to make the math easy, let's say there's about 10 million missing jobs. I think it's entirely reasonable to think that we'll make up about half of that, maybe even a little bit more before year-end.

12:39 - 12:53

Related to this topic is inflation. And as I said earlier, this is the topic de jour. So we've seen some elevated readings recently. For our listeners, what camp do you fall into? Is this inflation that we've seen? Is a transitory or is it likely to be more sustained?

12:54 - 13:31

So, again, I'm going to start by defining terms a little bit more clearly. Remember that inflation is a process, not an event. A one-time spike in prices is not inflation. It is just an increase in prices. Inflation is a persistent increase in prices that goes on for a long period of time and that people expect to see continue. So it's premature to call what we have seen so far inflation. What we have seen is an increase in prices. If that were to continue for a long time, then we would have inflation. And my expectation is that we have a couple more months during which we should expect prices to increase.

13:31 - 14:24

There are still supply chain kinks. There are shortages of raw materials. There are shortages of workers, as I said, there are shortages of things like microchips. All of these factors are combining to crimp the supply side of the economy, even as the demand side, fueled by strong household income and a pent-up desire for people to do the things that we haven't been able to do over the course of the last 18 months, as those things on the demand side are in place and the supply side can't quite keep up, we should expect prices to continue to go up for a period of time. But I do expect that as the year progresses, the supply side will rise to that challenge, that the supply chains will un-kink, that will be able to see goods move more freely, not just within the US, but around the world. And that should ease the pressures. And so I do think that prices will not continue to go up at this rate. So that puts me in the camp that this is transitory. I expect inflation will slow. The price increases will slow as the year progresses.

14:24 - 14:35

So let's say you're wrong, let's say you're wrong and that it's more sustained than you think it is. What's the Fed's view? Meaning when do they start to act? What gets them to act and can they be successful?

14:35 - 15:46

So the Fed has told us that their reaction function right now is asymmetric, which means that they are more concerned about the labor market than they are about prices. They actually view higher inflation within limits as a good thing. Remember that inflation has been below their target on average for the last ten years. And so in order to reinforce the credibility of their target, they need to have inflation above target for a period of time because their framework is average inflation target. So I don't think they're worried about inflation at this stage. I think that it will take several months, if not more, to convince them that if it turns out that this is not transitory, that it is not transitory. I don't think they will get there until the economy is fully open and we can get a clear look at things as long. As long as the supply side is constrained. It's reasonable to view this as transitory. Once we settle into a steady state, once we are past the initial spurt of demand for reopening, once businesses are functioning at full speed, then we'll see where prices are. But I don't think that they will come to that conclusion any time soon. I expect that they will stay the course. That doesn't mean they won't do anything right. I expect that they will reduce their QE purchases later this year, but I don't think that they're moving close to rate hikes.

15:46 - 16:04

To what extent did they learn from the last cycle? In the last cycle, I recall that the economy was running pretty well for some period of time and unemployment kept on falling without, at least during that cycle, a meaningful rise in inflation. So do they anchor to that experience to act or not act this time around?

16:05 - 17:01

I think they do. I think the lesson that they took away from the last cycle was that you can run the labor market hotter. You can run the economy hotter than you previously would have thought without generating inflation the way that you would have expected based on the models that they use. And so the experience from that is leading them into a cycle where they are going to be reactive rather than proactive. Remember, the last cycle they raised rates before inflation got to their target. And in retrospect, I think that they will observe that that was a mistake, that they slowed the economy down before it was necessary to do so, and that the cost of doing that was keeping some people out of the labor market or keeping wages lower than they otherwise needed to be. So I think this time around, having learned from that experience, they will be more reactive and to wait until they see inflation rather than acting on a forecast that it will increase. It leaves them more likely to be more patient rather than less patient in the hopes of enticing people back into the labor force in greater numbers than would happen if they raised rates sooner.

17:01 - 17:31

So sticking with the Fed, Eric, for a second, it's not only raising the Fed funds rate, but they also have been doing QE for some time. And you've said that you expect the Federal Reserve to start to taper their purchases at the end of 2021, a little bit out of, not to go back to consensus, but a little bit out of consensus relative to others on the Street. Tell us the importance of that forecast and then also why you think it's a 2021 issue instead of the beginning of 2022.

17:31 - 18:03

So tapering has been in the market's crosshairs for some time. Right. And it's simply the idea that the Fed will reduce the pace of the purchases that it is doing on a monthly basis. Right now, the Fed is buying 80 billion dollars a month worth of Treasury securities and 40 billion dollars a month worth of mortgage-backed securities. So a total of one hundred twenty billion dollars worth of assets. And my expectation is that by the end of this year, they will start to reduce that very, very gradually, probably in increments of 10 or 20 billion per month, and that the process of slowing those purchases down to zero will take the better part of a year.

18:03 - 19:04

So, again, we're talking about a very slow process of unwinding. But I think that the rationale for doing that is that the program was put in place and QE was put in place largely because the economy was in a crisis. And while we may not be at a point where rate hikes are warranted just yet, it's probably appropriate as the economy starts to look more normal for monetary policy to look more normal as well. And in an economy that is closer to equilibrium, I think all else equal, the Fed would prefer to play a less significant role in financial markets and just to be sort of casual about it. If they think the economy can handle rates that are slightly higher, they can afford to take a step back from the market. And if rates move up a little bit, it shouldn't disrupt the outlook. I think that that's the way they will view the situation as the year progresses. To be clear, that forecast is contingent on the labor market improving because they have told us that they will not taper those purchases until they have made substantial progress toward their objective of full employment and price stability. I sort of interpret substantial progress as something like half of the jobs that need to be regained will be regained.

19:04 - 19:22

So the Fed's decisions obviously impact the secondary market. And the biggest proxy for the secondary market, the bond market, is the 10 year Treasury. So my last question to you, share with everybody listening today that your forecast for the 10 year Treasury at the end of two thousand and twenty one, and what are the influences that get you to that forecast?

19:22 - 20:33

So just to level set, the 10-year Treasury is yielding about one and a half percent right now. So, 1.50. My expectation, my forecast is that at year-end it will be about two percent. So a 50 basis point or half a percentage point increase from where we are now. I think that's driven by a combination of variables. The first is simply that the economy is strengthening and it is natural that as growth improves and growth expectations improve, the yield that investors will demand to hold a fixed income asset will go up as it should. I think part of that is that inflation expectations will also rise, because whether I think and whether the Fed thinks that the current rise in prices is transitory or not, the risks of a higher inflationary outcome very clearly have. And so I would expect to see the inflation premium in the bond market also increase, and if those two things are combined with the idea of the Fed taking a step back from the market, I think there's scope for rates to rise. I don't think that rates will rocket. I'm not worried about the sort of taper tantrum episode that we saw in 2013 or a return of the bond market vigilantes from 1994  or anything like that. I think there are still too many global factors that will combine to keep any increase in yields relatively subdued. But I think there's room for rates to go up 50 basis points or so.

20:33 - 20:41

Well, we've covered a lot of ground and we're going to have to leave it there. So thanks for joining us today and for giving us your thoughts on this fluid economy.

20:41 - 20:42

My pleasure. Thanks for having me.

20:42 - 20:59

Thanks to all of you for joining us today. If you've enjoyed this podcast, please subscribe and rate us on Apple Podcasts or Google Play or Spotify or wherever you listen to podcasts, and e-mail us your thoughts or questions or feedback to And be sure to find us on Instagram and Twitter at BernsteinPWM.

21:00 - 21:01

Thanks a lot, Bewell.

21:02 - 21:10

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Matthew D. Palazzolo
Senior National Director, Investment Insights—Investment Strategy Group

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