Growing up in Dublin, my parents were of the firm belief that the streets of the city were safer without David behind the wheel of a car. Consequently, I first learned to drive in my early 20s on the back roads and highways of Michigan, with my future wife, Sari, as my instructor. There were a number of perils associated with this including my tendency to ignore all traffic signs when focused on the task of steering the car or my habit of stalling out due a chronic inability to synchronize the application of the clutch and the accelerator. It didn’t help that Sari would burst into a fit of giggles at the moments when I put us in the greatest and most imminent danger and was in particular need of quick and level-headed advice.

One especially tricky feat was trying to slow down the car while driving downhill in the snow.  This was in the days before anti-lock brakes and Sari told me I was to “pump the brakes.” Easier said than done, however. Apply too little pressure and the vehicle would sail straight into the intersection. Apply too much and the brakes would lock, resulting in a quick and dramatic spin into the ditch.

Slowing down an economy that is growing too fast is also a tricky business. A few months ago, prospects for a quick end to the pandemic and a combination of very easy monetary and fiscal policy suggested that the economy wouldn’t slow enough going into 2022, with inflation and interest rates potentially spiraling higher.

Today, the Omicron variant, along with tighter fiscal and monetary policy are pumping the brakes on the U.S. economy. But the question is whether this braking pressure is about right, allowing the economy to coast to a soft landing and an extended expansion or whether the economic drag might prove too much, leading to a more dramatic and less happy outcome.

On the virus, the good news is that Omicron is clearly much milder than earlier variants and the medical risk associated with catching Covid-19, particularly for those who are fully vaccinated, is far less than was the case at the start of the pandemic. There is reason to hope that, once this wave wanes, and if no more lethal variant takes over, society can finally return to close to normality.  However, Omicron is also, by far, the most contagious of the variants and this has led to very widespread illness across the country. This has resulted in numerous cancelations of events and activities and is, once again, hitting demand in the leisure, entertainment, travel and restaurant industries, as indicated by high-frequency data. It will also lead to widespread absenteeism in early 2022, applying a significant drag to the economy in the first quarter, following a very strong fourth quarter.

On fiscal policy, the Administration was unable to forge a compromise to pass the Build Back Better bill before the end of last year. While negotiations will continue, the most important immediate effect of this will be to end the mid-month payments of advance child tax credits to roughly 35 million families, which had commenced last July. The IRS reports that these payments totaled roughly $15 billion per month and their sudden cessation could curtail recently booming spending on food and other household basics. More broadly, according to the Congressional Budget Office’s current estimates, without any further legislation, the federal budget deficit could fall from $2.8 trillion, or 12.4% of GDP last fiscal year to $1.2 trillion or 4.7% of GDP this fiscal year, implying a very significant fiscal drag.

There are, of course, some offsetting factors. Social security recipients are seeing a 5.9% cost-of-living adjustment in their checks starting this month, the highest annual increase since 1983. Twenty-one states implemented an increase in their minimum wage entering 2022 and wages in general continue to rise quickly, as should be evident in this Friday’s December jobs report. In addition, income tax refunds should be strong this year as taxpayers benefit from enhancements to the earned income tax credit and dependent care credit, as well as the part of the enhanced child tax credit that they did not receive in monthly payments.

Even with this, however, we now expect U.S. real GDP to grow by just 2.5% in the first quarter following a more than 7% annualized surge in the fourth. Payroll job growth, which we believe may have exceeded 400,000 in December, could see a sharp slowdown in January before recovering later in the quarter as the pandemic eases. This temporary slowdown in activity, combined with the dampening effect Omicron is having on demand around the globe, should reduce overall inflation pressure entering 2022.

That being said, we still expect core personal consumption deflator inflation to run well above the Federal Reserve’s 2% long-term goal throughout 2022. Provided the Omicron wave crests and falls in the next few weeks, we expect the Fed to stick with its plan to phase out bond purchases by the middle of March and begin a series of quarterly, 25-basis point federal funds rate hikes starting in June.

For investors, Omicron and the lack of further fiscal stimulus could mean a change in emphasis in 2022. For some time, we have argued that U.S. value stocks and developed country international equities, which are both more cyclical than U.S. growth stocks, should benefit from very strong economic momentum exiting the pandemic. However, this economic surge looks weaker today than as of three months ago.

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