2022 Outlook – A Year of Relative Calm
During the latter portions of the year, it is our custom to create the economic outlook for the upcoming year. A turning of the calendar page doesn’t represent radical change in the tone and tenor of the economy, rather it is a time for introspection, a time to think of where we are economically and how we got here. It is a time to consider the highest probability of future events.
2021 was certainly a year for the record books. It was a year when the economy grew by the highest rate we have seen in decades. It was a year when that old threat—inflation—made a comeback like we haven’t seen in nearly 40 years. It was a year of high government deficits and of the world starting to conquer COVID. Wonderous medical vaccines were developed and distributed throughout our nation.
2021: Strong Growth, Upward Push in Inflation—The Year in Retrospect
2021 will go down in history as a year with very strong growth. As it appears, our “real” GDP grew by about 6% in 2021, coupled with high inflation of 6.8%. This surge in both volume and pricing came from an economy recovering from a deep downturn, spurred by government fiscal and monetary stimulus programs. The economy spent most of the year recovering from the mandated health-related shutdown. From a macroeconomic standpoint, the government took the COVID issue to heart, in my opinion, perhaps too much so.
To drive the post-COVID economic recovery, the government provided upward of $5 trillion in fiscal stimulus spending. Not to be outdone, the Federal Reserve attended the stimulus party by driving interest rates near 0% and purchasing upward of $120 billion of Treasury and mortgage bonds monthly, infusing significant liquidity into the financial system. These spending packages were designed to stimulate final demand, and they both succeeded.
With final demand rising, we now understand that the economy ran into a problem—that supplies of many goods and services declined during the downturn, and, in several cases, didn’t reopen. A number of businesses had shuttered for good. Supplies of many items became constrained. The reach of the supply constraint was global. With government stimulus spurring demand, a supply/demand imbalance for a variety of goods and services occurred. This imbalance led to rising inflationary pressure.
Final demand grew, as did the jobs market. The unemployment rate closed 2021 around 4.2%; down to less than half the unemployment rate seen during the worst of the pandemic.1 Additionally, wages have increased—the average hourly wage is up 5.9% over the last year.2 This upward move in wages, the largest in years, was swallowed by inflation, which was 6.8% for the year. Essentially, the purchasing power of the hourly-wage worker stayed about the same from the previous year.
In the meantime, asset price inflation saw very strong moves, with stock prices rising by roughly 25% and home values rising 19% this past year.3 Those with asset values did well this past year. Those workers who didn’t own a home or a stock portfolio and lived paycheck-to-paycheck didn’t fare as well. It appears a case can be made that 2021 was another year of the widening of wealth dispersion in our country.
2022 Outlook: I Expect a Year of Relative Calm
This background discussion leads us to our outlook for 2022. The pandemic-related problems that we continue to face appear to be losing their sting. Evidence is present showing the mortality rate of the newer COVID strains appears to be less virulent than earlier varieties.
With that in mind, I believe both consumer and business behaviors are starting to treat COVID as a factor in life that probably isn’t going away soon, but most believe mortality rates are leveling off as our society learns how to deal with the problem. Consequently, while a factor worth mentioning, I don’t expect COVID to be THE driving factor in economic activity as it has been over the last two years. I think that roller-coaster is starting to level off.
Both the fiscal and monetary stimulus packages, which spurred strong final demand and GDP growth in 2021 as mentioned above, are being modified as we move into 2022. These strong government stimulus tailwinds should become mere breezes or actual headwinds as we enter the new year. That should lead to lower overall GDP growth rates but less intense inflationary pressure. These trends are built into our outlook for 2022—a year that we believe will still be economically positive, but less manic than was the case in 2021.
As stated, major government-driven stimulus spending and central bank activities are set to change. The upcoming infrastructure bill of $1 trillion is to be spent over a 10-year period. While not peanuts, an additional $100 billion in fiscal stimulus may not be enough to move the needle significantly in a $22 trillion economy. The Fed has already announced that the “taper” of bond purchases has begun. Additionally, the Fed now expects to launch a new interest rate increase cycle in 2022. We currently expect the Fed to start raising interest rates in the summer of the year.
Below please find our best thoughts, of how the economy may perform in 2022.
Our estimates of the upcoming year – in numbers:
After coming off the rebound of late 2020-2021 and the end of government-induced demand growth, economic growth is set to slow to a more sustainable but still reasonable rate. This leads to our call that “real” GDP growth should run at 3% next year, down from this year’s 6% rate. If we look at the major nongovernment segments listed above, we can see all growth rates slowing, but not falling into negative territory. Consequently, I suggest we will see another year of positive, non-recession economic growth in 2022.
2022: While Relatively Calm, A Year of Change, Nonetheless
The labor market (job creation) should continue to advance next year, albeit at a lesser pace than we saw in 2021. I have targeted the unemployment rate to be 3.7% by the end of the year. Due to a surge in retirements (both planned and premature) in 2021, the labor market may reach “full employment” characteristics in 2022, leading to potential, robust wage growth. We expect to see wage rates rise at 5%+ annual rates next year, outstripping inflation pressure, which may lead to a possible contraction in corporate profit margins, depending on worker productivity gains.
While we expect to see inflation rates slow next year, to 3% by the end of 2022, this rate will still be higher than the Fed’s “target” range of 2%. But remember we are coming off a 6.8% inflation rate in 2021, with the rate slowing as economic growth (final demand) slows. With the expected rise in interest rates, I suggest growth in housing activity will also slow next year, helping drive overall inflation rates downward.
We are also gaining a “whiff” of increased cost-push inflation pressure and suspect that the long-term shift of macro-profit allocation is shifting away from capital toward labor. The Fed appears to be getting the same “whiff.” If this proves out, it will represent a major macro-economic driver as we move forward. I am seeing more evidence that the days of disinflation and deflationary pressures may be largely behind us.
Key “Swing” Factors of the 2022 Outlook
- Moderated U.S. “real” GDP growth. It has averaged 3.1% since the end of World War II. We are looking for 3% growth in 2022, with growth moderating from 2021’s explosive 6% growth.
- Inflation growth should slow to 3% in 2022. Over the long run, U.S. inflation has averaged 3.7%. Consequently, we suggest 2022 will more closely economically resemble a “normal” year than either 2020 or 2021.
- “Normal” economy activity. Over the long term (since the end of WWII), nominal GDP growth in the U.S. has averaged 6.8% (See U.S. Nominal GDP chart). At an expected growth rate of 6.0%, economic activity in 2022 will feel like a more “normal” year than either 2020 or 2021.
- Expected Fed policy change away from ultra-ease. The Fed should take a more balanced approach. Plan on the Fed to raise interest rates three times next year to Fed Funds rate at 0.8% by end of 2022.
- Slower housing growth rates. The upward move in short-term interest rates may translate to higher mortgage rates, acting as a “governor” to housing activity. We don’t expect to see housing contract but rather slow its growth rate, from 8% in 2021 to 1% in 20224.
- Rise in personal consumption expenditures. Representing upward of 70% of GDP activity, personal consumption expenditures are expected to rise by 3% in 2022; a little slower growth than the average growth rate of 4.2% since the year 2000. This slightly slower rate of growth is being influenced by the relative maturity of the business cycle and the improvement in the jobs market though 5%+ wage growth rates. Also affecting consumption will be the expected increase in interest rates. Lastly, consumer sentiment is coming into 2022 at a low ebb, affecting consumer’s willingness to transact.
- Nonresidential fixed investment growth. We expect slightly slower growth than has been the case, on average, over the last 10 years. While this area has grown by 4.2%, on average, since 2000, rising interest rates may place a slight dampener on business fixed spending plans. Producers durable goods purchases are coming off the boil of a 12%+ growth rate in 2021, clearly an unsustainable rate of growth.
- Inflationary expectations have risen dramatically. A recent New York Federal Reserve poll shows people expect inflation of 6% over the next year, and 4% annually, on average, over the next three years (See Inflation Expectations chart). I suspect these expectations will not be met. But if these expectations aren’t met, economic behavior might start to reflect higher inflation, leading to the risk of a self-fulfilling outcome.
- New inventory controls. In accordance with these changes, we may see more companies adopting a new inventory control system. “Just in time” inventory might become “Just in case” inventory. Expect to see a significant inventory build up to occur in 2022.
- Challenged profit margins. With rising costs, including rising labor expenses, profit margins might be challenged in several industries, and not so much in others. The ability to pass along cost increases by raising prices may define winners and losers in 2022.
- Mid-term election year. Remember that 2022 is a mid-term election year. Will the Republicans take control of either the House or the Senate? Taxes normally don’t increase dramatically during election years, so I think a bill favoring a more broad-based tax increase could be in the cards for 2022.
Labor Productivity Growth is Key to Blunting Inflation’s Impact
While we think inflation will be less of a problem in 2022 than in 2021, it is still a factor that will earn headlines. Which factor may blunt rising cost structures in the private sector? Labor productivity is key to businesses being able to absorb higher cost structure without resorting to increasing product prices dramatically. If workers can produce more per hour, an employer is able to absorb rising labor costs more easily and won’t need to increase prices to retain profitability.
We expect wage growth to approach 5%+ in 2022, rising faster than many company’s sales growth rates. I suspect labor productivity will show a decent increase at a 2% annual rate in 2022. If that occurs, it will be enough to absorb about 3% to 4% higher across-the-board cost increases, which should moderate some of the negative economic impact of higher-than-desired inflation.
We think 2022 will prove to be a profitable year for our nation’s businesses as we continue to dig our way out of the imbalances our economy has experienced. It should be a year when economic capital allocation continues to move away from profits toward labor. Likewise, it should be a year when the jobs market continues to perform reasonably well.
2022 should prove to be a year of less economic volatility, both for growth and inflation, than we have witnessed for some time. Yes, the economy should grow but at a slower pace than was the case in 2021. I continue to believe the days of ever-present deflation and disinflation pressures are largely behind us.
Overall historical data from St. Louis Federal Reserve, Yardeni Associates and Yahoo Finance.
1US Bureau of Labor Statistics
2 Yardeni and Associates
4Trading Economics US Housing Starts 2022 forecast
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