US economic outlook: Strengthening growth despite a worsening supply problem

We are forecasting full-year GDP growth to come in at 7.0%, which would mark the second-fastest year for growth since 1955 (full-year growth in 1984 was 7.2%). It is increasingly evident that the fastest pace of expansion in decades comes with some significant growing pains.

Longer lead times, lack of available labor, and supply chain constraints present challenges that are as disruptive to multinational manufacturing operations as they are to independent tradespeople and even the most basic service providers with shortages ranging from microchips to two-by-fours to chicken wings.

The semiconductor shortage, in particular, is one of the most visible disruptions and has significant implications for the manufacturing of motor vehicles. We have taken down our industrial production forecasts for the next few quarters. If the chip problem gets fixed, the output should snap back swiftly, given the scarcity of inventory on dealer lots.

In recognition of the worsening supply problems against a backdrop of strengthening demand in recent weeks, we have upwardly revised our already above-consensus indication forecast. Core PCE inaction is now expected to run 2.4%-2.7% on a year-ago basis over the next five quarters.

The Federal Reserve is also looking for inaction to overshoot its 2% target for some time, and with the labor market still, far from its inclusive goal of maximum employment, we believe rates will remain on hold and that it will still be months before the FOMC is ready to broach the topic of tapering.

Strengthening growth despite a worsening supply problem

The U.S. economy is of to a faster start in 2021 than most forecasters anticipated, and while the biggest surge in activity is still on the horizon, it is increasingly evident the fastest growth in decades comes with some significant growing pains. Longer lead times, lack of available labor, and supply chain constraints present maddening speed bumps for economic growth. These challenges are as disruptive to multinational manufacturing operations as they are too independent tradespeople and even the most basic service providers with shortages ranging from microchips to two-by-fours to chicken wings.

Predictably, the scarcities have led to a big run-up in various prices particularly for raw materials with reports of fresh all-time highs on an almost daily basis for one commodity or another and various indications of increased labor costs. Even beyond commodities, where trading is famously volatile, financial markets, in general, have taken note of the quickening growth and rising price environment. The upward trend for rates that characterized activity in the bond market earlier this year may have plateaued for now with the benchmark 10-year yield largely range-bound between 1.50% and 1.75%since mid-March. However, forward-looking inflation measures like the five-year breakeven TIPSspread (the difference in yield between an infraction-protected Treasury and a regular one) recently climbed north of 2.76%, the highest in about 15 years.

To the extent that there is a theme for our May monthly forecast update, it is that economic activity could be even faster were it not for these logjams in supply chains and structural mismatches that leave many employers unable to and retain labor. In short, the economy has a supply problem rather a demand problem.

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