Delta Variant Cutting Into 3Q Economic Growth
As we had mentioned in previous commentaries, it was our judgment the recent rise in COVID-19 cases stemming from the Delta variant could detract from but not derail economic growth in 2H 2021. We are now seeing some of that detraction surfacing in data likely to impact third-quarter results.
The Delta variant has led to escalating numbers of COVID-19 cases at a frightening rate over the past three months. Previously as low as 12,000 new cases per day in the U.S. during the latter weeks of June, the rolling seven-day average of new cases has now ballooned to north of 180,000 (Worldometer.info). This dramatic resurgence is now having effects on economic activity despite continuing evidence the vaccines are providing strong protection against the new variant strain.
This has been most recently seen in the August nonfarm payrolls report displaying net new jobs added to the economy of only 235,000. This jobs report was the weakest since January and well below consensus expectations of more than three times that amount. The lack of employment growth was most readily apparent in the travel and hospitality sector, which added no net new jobs in August after monthly gains averaging 350,000 during May through July.
While there are potential silver linings in the August jobs report, it was still a major disappointment. Optimists might fairly point to more than 100,000 in upward revisions for June and July and a favorable setup for September, as job gains stand to benefit from school reopenings and the expiration of unemployment benefits originally granted by the CARES Act in March 2020. However, with total job gains a half million below consensus forecasts, this report can only be categorized as a big disappointment.
Third quarter gross domestic product (GDP) growth forecasts will need to be revised lower than initial estimates. It is now clear 3Q 2021 GDP growth is more likely to come in lower than initial expectations of better than 6% before the precipitous rise in the Delta variant began. In addition to the slowing jobs growth, recent declines in retail sales, consumer sentiment, and the impacts of higher monthly inflation now seem to be affecting this quarter’s growth more than was previously forecast. The Federal Reserve Bank of Atlanta is now tracking 3Q GDP growth at 3.7%.
Inflation continues to loom as a concern for consumers and investors. Following inflation reports for July reflecting year-over-year price trends slightly moderating for core consumer price index (+4.3%) and the Fed’s preferred measure of core personal consumption expenditures price index (+3.6%), consumers and investors are anxiously awaiting August data to be released in the weeks ahead to help decipher how long these elevated trends might continue. While expectations of continuing inflation could have a psychological impact on consumer activity, we continue to believe inflation is likely to revert toward 2% by the end of 1Q 2022.
We continue to believe the Federal Reserve will begin tapering its open market asset purchases in 4Q 2021. Despite what is likely to be slower 3Q growth than the Fed may have expected, we still believe the committee will begin reducing its monthly pace of $120 billion in Treasury bond and mortgage-backed securities purchases sometime in the final three months of the year. Given recent data, we believe the timing now perhaps favors an announcement at the early November Fed meeting with implementation in December. We still believe an actual rate hike is unlikely before CY 2023.
We now see CY 2021 GDP growth in the 5.5%–6% range and believe the Delta variant remains the biggest variable between now and year end. As new COVID-19 cases unfortunately continue to mount, investors should watch for virus trends to potentially moderate in 4Q as booster vaccine doses begin to be administered, and look for the economy to adjust to rising case numbers once again as it has done a few times since the pandemic began.
We continue to see the overall economic environment as a favorable one for the equity markets. This is largely based on what appears to be continuing rising corporate earnings trends for the remainder of CY 2021 and into CY 2022 driven by stronger revenues and higher profit margins combined with still historically low long-term interest rates. As we await what looks to be another strong round of earnings reports for 3Q 2021, we maintain our mid-year 2022 price target on the S&P 500® of 4,800.
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