In January, most economists expected GDP to lift-off in the first quarter, spike in the second quarter, before leveling off the rest of the year. First quarter GDP growth was expected to be about 4-5%, spiking to 7-8% in the second quarter, with full year average of 5-6%.
Last week, we learned that Q1 GDP growth was 6.4% — stronger than expected. Maybe, that number pulled forward growth from Q2, which will therefore be less that the expected 7-8%. I think the underlying strength of our economy was under-estimated previously but is now being constrained by two short-term inflationary factors.
First, the latest ISM – Services Index came in less than expected, almost entirely due to one reason — job vacancies. The services sector is having trouble finding enough employees to keep growing. Republicans think the unemployed are just spoiled by stimulus money. Democrats point out the almost four million women who left the labor forces last year did so, primarily due to family responsibilities and will necessarily be slow to re-enter the market. The solution to this problem will make the rising minimum wage a moot point and will be inflationary.
Second, the IM – Manufacturing Index also disappointed, almost entirely due to one reason — supply chain problems. The efficiency of “just-in-time” inventory management was lost during the pandemic, when inventory levels were cut so drastically. Factories are also having problems staffing up. Factory workers are more reluctant to work during Covid than service workers. More importantly, our factories import many raw materials or parts from other economies, that are still struggling with Covid and are not opening up yet. The solution to this problem will be to further reverse globalization and will also be inflationary.
Neither of these constraints will damage our economy long-term, but they will retard our growth short-term.
A third short-term inflationary jump is due to the tsunami of liquidity that has flushed thru the economy in response to the pandemic and subsequent economic collapse.
Fed Head Jerry Powell sees these short-term pressures on inflation but doesn’t expect they will be long-term. I sure hope he is right!