In two weeks, in Daytona Beach, Florida, 40 cars will compete for the most coveted prize in NASCAR. As the cars slowly circle the track in the pace laps before the green flag drops, the noise of engines revving will give notice to all of the speed to come. In a similar fashion, while the U.S. economy has slowed to a crawl over the winter, there are growing reasons to expect a sharp acceleration in the months ahead.
The most important economic release this week will be the January jobs report, due out on Friday. It will likely make grim reading, reflecting the continued impact of the pandemic on the U.S. economy. However, in the year ahead, mass vaccination should end the pandemic, at least as a major disruptive force to our lives and the economy. This, combined with massive fiscal stimulus and very low growth in the working age population, should lead to a very sharp decline in the unemployment rate. While this outcome would be a huge positive for society as a whole, policy-makers will need to play close attention to the state of the labor market in judging when to normalize policy. Investors will also need to be alert, as a fast-recovering economy could undermine the low-inflation, low-interest rate environment that has supported financial markets for many years.
Overall, payroll employment may have risen slightly in January, as much of the firing due to the winter wave of the pandemic likely occurred in December. However, a payroll gain of less than 100,000, following the loss of 140,000 jobs in the prior month, would make a very minimal contribution to replacing the almost 10 million jobs lost since the start of the pandemic. The unemployment rate may have ticked up by 0.1% in January to 6.8%. However, this understates the degree of distress in the labor market, since almost 4 million people have left the labor force since the fourth quarter of 2019 and are thus excluded from the unemployment rate calculation. If they were added back in, the unemployment rate would now be over 9%.
Job growth will likely continue to be slow over the rest of the winter. However, starting this spring, hiring should begin to accelerate and, despite re-entrants to the labor market, the unemployment rate is likely to fall at a pace unmatched in post-war recoveries. This should reflect the collective impacts of an end to the pandemic, massive fiscal stimulus and historically slow growth in the working age population.
On the pandemic, despite frustration at the pace of the vaccine rollout and worries about mutations in the virus, America seems to be on the road to herd immunity. As of January 31, according to the CDC, 31.1 million doses had been administered, including more than 1.5 million doses in each of the last four days. At this pace, it still seems realistic to expect that every American adult who wants the vaccine will be able to receive it by the end of July. In addition, based on the current terrible cumulative death toll, assuming a 0.5% true mortality rate and allowing for the lag between infection and mortality, close to 100 million Americans should now have acquired some natural resistance to Covid-19. In combination, this suggests that over 30% of Americans now have some immunity and that this number could climb to 50% by the end of March and close to 80% by the end of July.
This level of herd immunity should lead to a sharp decline in cases and, with better testing and tracing, most Americans with immunity will likely feel free to resume normal life. For the economy, this should lead to a dramatic increase in business in the restaurant, travel, leisure, hospitality and personal and health services businesses, spurring sharp gains in employment, particularly in late 2021 and early 2022.
Overlaid on top of this natural surge in economic activity should be powerful fiscal stimulus. While a group of 10 Republican senators have proposed a smaller package than the $1.9 trillion bill suggested by the President, Democrats in Congress are likely to use the reconciliation process to push through something closer to the President’s proposal. By Washington standards, the process is likely to be quick, with a bill most likely arriving on the President’s desk for signature by mid-March when current enhanced unemployment benefits are set to run out.
As we noted in The Investment Implications of the Biden Rescue Plan, most of the money in this bill will likely be spent between now and the end of September. This has the potential to boost nominal GDP growth to more than 10% year-over-year by the fourth quarter and into early 2022. A statistical model of the relationship between real GDP growth and employment suggests that this could boost payroll employment by close to 10 million jobs by the second quarter of 2022.
It needs to be emphasized, of course, that this historical relationship is not that strong a guide in a very rapidly growing economy and that the inevitable delays in restarting and setting up businesses could delay this hiring. Conversely, however, the industries that have seen the largest job loss should be relatively easy to restart. If a restaurant was doing a booming business at the corner of Washington and Main before the pandemic, it should be able to do a booming business in its wake and, whether the establishment is being run by its old owners or by new owners, the need to quickly hire cooks and wait staff will be obvious.
This strong job growth could have an amplified impact on the unemployment rate because of weak growth in the working age population. Census Bureau projections suggest that, assuming normal net immigration patterns of just over 1 million immigrants per year, the U.S. population aged 18-64 would have grown by roughly 0.2% per year in 2020, 2021 and 2022. However, visa statistics confirm that immigration has collapsed during the pandemic and is unlikely to return to normal until the pandemic is over. Because of this, it is reasonable to assume that, even with re-entrants to the labor force from the most affected industries, the labor force by the second quarter of 2022 may be no higher than it was in the fourth quarter of 2019.
This is where the math gets interesting. As noted earlier, the labor force is currently roughly 4 million people lower than it was at the end of 2019. However, starting with today’s unemployment rate of 6.7%, adding 10 million jobs to the economy and 4 million people to the labor force cuts the unemployment rate to 2.8%.
Of course, the unemployment rate is very unlikely to fall this low. A scarcity of workers would likely boost wage growth and slow hiring. Immigration might ramp up faster and the availability of good-paying jobs could lure retirees back into the job market. However, the exercise is useful because it re-emphasizes the potential for the combination of pandemic recovery and massive fiscal stimulus to overheat the economy.
For policy makers, it will be important to watch the pace of improvement, and be willing to tighten policy as the economy approaches full employment. However, there is little reason to believe that politicians with an eye to the 2022 mid-term elections will be in any mood to embrace tax increases or spending cuts. In addition, as Jay Powell made very clear in his post-FOMC press conference last week, the Fed has no intention of tightening policy prematurely and could regard a rise in inflation as the pandemic ends as being purely transitory in nature.
For investors, given the potential for economic acceleration and the reluctance of policy makers to apply the brakes in good time, risks remain tilted towards higher inflation and long-term interest rates in the year ahead. Even in today’s slow economy, it is worth making sure that portfolios are well positioned for faster times ahead.
David Kelly is chief global strategist at JPMorgan Funds.