4Q20 real GDP grew at a 4.3% q/q seasonally adjusted annual rate, with increases in consumption, housing, business fixed investment, inventories and exports, partially offset by declines in government spending and increasing imports. Still, economic output remains 2.4% below peak 4Q19 real GDP. U.S. economic data for March has shown that U.S. growth is set to surge. After last week’s very bullish Manufacturing PMI at 64.7%, a 37-year high, the ISM Services PMI reached an all-time high of 63.7. This is notable as services was hit particularly hard by the pandemic and is expected to be an important contributor to the growth surge going forward. Importantly, the Services Prices Paid index rose to 74, versus 71.8 in February, indicating that inflation pressures are continuing to increase as the economy reopens.
The March Jobs report was much stronger than expected and suggests an even more powerful recovery than implied by the Fed’s recently upgraded outlooks. Non-farm payrolls rose 916,000 in March, well ahead of a consensus expectation of +658,000. Revisions added 156,000 to the job gains for January and February. With these job gains, the U.S. has now recovered 14.0 million, or 62%, of the 22.4 million jobs lost in the pandemic. The unemployment rate fell to 6.0% from 6.2%, in line with consensus expectations, and the labor force rose by 347,000 in March, showing a continued decline in pandemic effects on the labor market.
The 4Q20 earnings season wrapped up with 497 companies having reported (99.7% of market cap). Our current estimate for 4Q20 earnings is $38.70 with EPS declining 1.2% y/y. Thus far, 79% of companies have beaten on EPS estimates, and 67% have beaten on revenue estimates. Further economic recovery, positive vaccine developments and a weaker dollar helped 4Q earnings, but lower oil prices were a headwind. Earnings grew in technology and health care, while financials, energy and industrials struggled the most.
Inflation continues to run below the FOMC’s 2% target, as the headline PCE price index rose 0.2% and the core PCE deflator rose 0.1% in February. Year-over-year core PCE decelerated to 1.4% (1.5% prior). Headline CPI for February rose +0.4% m/m and +1.7% y/y, while core inflation came in below expectations at +0.1% m/m and +1.2% y/y. While these prints show somewhat subdued inflation, the surge in the ISM Prices Paid Index in February, indicating pricing pressure on production inputs, and the OPEC+ decision to keep supply unchanged suggest higher inflation ahead.
The FOMC maintained the federal funds target rate in a range of 0.00%-0.25% and left the pace of asset purchases unchanged. In addition, the median federal funds rate outlook—as measured by the “dot plot”—continues to imply no rate adjustments through 2023. In the Fed’s Summary of Economic Projections, expectations for 4Q21 were materially upgraded with Real GDP growth estimates boosted from 4.2% to 6.5% y/y, growth of the PCE deflator increased to 2.4% and a reduction in the unemployment rate estimate from 5% to 4.5%. Despite the Fed’s continued dovish tone, growing signs of a strengthening economy and rising inflation pressures have now pushed the 10yr Treasury up by 73 bps from the start of the year.
- The emergence of COVID-19 variants and vaccine delays could slow the economic reopening.
- Inflation could spike in the medium term.
- Rising yields could foment equity market volatility.
- U.S. equity investors can benefit from the recovery with cyclical exposure.
- Fixed income investors may underweight bonds and maintain short duration in a rising rate environment.
- Long-term growth prospects and cyclicality support international equities.
Originally Posted on April 12, 2021
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