I remain cautious about the economic outlook over the next three to six months, but the outcome of the presidential election could bring an uptick in growth come spring. Nevertheless, we remain in a deep hole that will take years to climb out of. Short-term interest rates are almost certain to remain near zero for two years or longer, removing any upward pressure on deposit rates. The housing market remains robust, helping support mortgage lending, but mortgage rates could creep higher.
COVID Dampens the Holiday Mood
The number of people being diagnosed with COVID has been on the rise for much of October, with the U.S. recording a record number of new cases on Friday. Unless the number of cases miraculously declines soon, holiday travel spending will not provide a boost to the economy; and spending at bars and restaurants will not see their typical seasonal pickup.
Although players in Washington continue to hold discussions about a new stimulus package, each passing day lowers the likelihood that a bill will be passed for households to receive their stimulus checks in time for the holidays. Moreover, even if households do receive stimulus checks, many families are still struggling with unemployment or reduced work hours. Add it all up, and holiday spending will not provide much of a jolt this year.
GDP Recovery Not Imminent
Most estimates for third-quarter GDP growth are in the 30%-35% range at an annualized rate, but that rate of growth is obviously not sustainable. From 2011 through 2019, growth averaged about 2%, and the blue line in the chart above extrapolates that trend through 2025. Even if growth averages 4%, we will not reach the pre-COVID trend until 2023; and I do not think an average growth rate of 4% over 8 consecutive quarters is achievable. Average growth of 3% over the next four years implies we do not reach trend growth until 2025, and even 3% growth is aggressive.
Of course, GDP growth may be stronger in 2021 than the previous chart assumes thanks to a re-opening of the economy and government stimulus. However, I suspect that the stronger growth is in 2021 the weaker it will be in 2022. Plus, demographic and productivity trends imply growth of only 2% or so is achievable in the long run. Any way one looks at the data, the economy will not fully recover for several years.
Labor Market Healing Slowly
The labor market continues to heal, with the number of persons filing new claims for unemployment insurance declining. In the latest week, the number finally dipped below 750,000. Still, prior to the pandemic, fewer than 250,000 per week were filing new claims, so while far below the peak level, initial claims remain much too high in absolute terms. Almost 20 million people, nearly 13% of the labor force, continue to receive some form of unemployment compensation each week.
Given the slack in the labor market and the gap between actual and trend GDP, inflationary pressures will remain nonexistent; and the Federal Reserve will not raise short-term rates until 2023 or beyond. In fact, the Federal Reserve has basically told us not to expect a hike until 2023 or 2024, so this is an easy prediction to make. The upshot is that deposit pricing pressure and interest expenses will remain low for the foreseeable future.
Biden Victory and the Economy
The probability of a Biden victory in the presidential election has risen according to betting markets, and most pundits also predict a Biden victory, lessons of 2016 predictions long forgotten. What is interesting to note is that as the probability of a Biden victory has increased, so too has the yield on the 10-year Treasury, with it having almost hit 90 basis points late last week. Biden has promised increased spending on things like infrastructure under his administration, so the increased borrowing requirements will place upward pressure on rates barring Federal Reserve asset purchases to keep rates low. The widely followed Moody’s economic model predicts higher growth in 2021 under a Biden administration than under a Trump administration, thanks largely to that increase in government spending. I do not think the correlation between yields and a Biden victory is spurious.
A steeping of the yield curve would boost banks’ net interest margin as new loans are made. The net effect on profitability, however, is less clear. If mortgage rates start to creep up, refinancing activity, and the fees associated with it, would slow down. Also, a Biden administration would lead to an increase in regulatory burdens, particularly around consumer lending, as a reinvigorated CFPB steps up its enforcement activities.
The economy will likely hibernate over the winter thanks to reduced travel and holiday spending along with uncertainty around when the next round of stimulus will come. Deposit rates will remain at rock bottom thanks to the Federal Reserve. A Biden administration would lead to a steepening of the yield curve along with lower refinancing activity. What the CFPB does in a Biden administration versus the Trump administration bears watching.
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