The unemployment rate will likely move sideways for a few months as the impact of a rebound in output is offset by people reentering the labor force and further layoffs in state and local government. In addition, measurement issues that are currently suppressing the unemployment rate may fade, particularly if at least part of the current $600 per week in additional unemployment benefits is allowed to lapse on schedule at the end of July. Even with Friday’s better than expected employment report, we expect the unemployment rate to be in double digits until the fourth quarter of 2021.
It should be noted that all of this assumes some additional federal aid will be passed by the Congress over the summer. If no agreement is reached, state and local layoffs will be more severe. In addition, many of the jobs lost in the retail, hospitality and leisure industries were among the lowest paid in the U.S. economy. Since, unemployment benefits are normally calculated as a fraction of normal wages, a return to normal unemployment benefits, without any additional unemployment aid, would likely cause widespread poverty.
Consequently, it must be hoped that a better-than-expected May jobs report doesn’t cause anyone in Washington to argue that further relief is unnecessary.
Data due out this week will include monthly reports on inflation. We expect consumer prices to be unchanged in May following an April plunge, both overall and excluding food and energy. Normally, inflation drifts down in a recession and its aftermath. However, despite the depth of this recession, we expect less of a downdraft on prices this time around both because of extraordinary levels of federal stimulus and because health precautions are boosting the cost of doing business in many industries. Moreover, assuming a vaccine is distributed in the first half of next year, a surge in economic growth could lead to higher inflation, unless both fiscal and monetary authorities have the discipline to gradually withdraw support from a strengthening economy.
This issue may come up in Jerome Powell’s press conference on Wednesday following the conclusion of the June FOMC meeting.
No major policy moves are expected from the Fed at this meeting. However, investors will be very interested in the Fed’s new economic forecasts and whether they expect to raise interest rates at any time in 2021 or 2022. Jay Powell will likely reiterate that the Fed has no intention, as of now, to move to negative interest rates. He may well point out that the very rapid expansion of the Fed’s balance sheet, at a time of massive federal deficits, amounts to very significant monetary stimulus in itself. However, a key question, which he may try to avoid, is whether there is some limit to the Federal Reserve’s appetite for U.S. Treasuries, if the federal government continues to run big deficits even when the economy is clearly on the road to recovery.
This is a question investors should be asking also.
The recent rally in U.S. equities have left the S&P500 down just 1.1% year to date. The current recession, although very deep, is to some extent a “bookended recession”—it started with a virus and should end abruptly with a vaccine. Because of this, the full correction, in the form of a 34% market drop seen between February 19th and March 23rd was probably overdone.
However, even with a better-than-expected May jobs report, the recession is causing major damage to the American economy and U.S. corporations. Moreover, massive fiscal and monetary stimulus today, should mean higher inflation, higher interest rates and higher taxes down the road. Consequently, while investors can celebrate the resilience of their portfolios in this extraordinarily difficult year, they should temper their expectations for strong returns in years ahead. Equally importantly, they should consider broad diversification, both as a way to reduce risk and as an avenue to generate better returns than are likely to be received on broad investments today in U.S. stocks and bonds.
David Kelly is chief global strategist at JPMorgan Funds.