If the last two years have taught us anything, surely it’s that forecasting the future is a fool’s errand. Who, at the beginning of 2020, could have predicted the onset of a global pandemic and the subsequent economic shock that followed, prompting unprecedented fiscal and monetary intervention, resulting in a new peak in economic output and a doubling of the stock market, all in 22 months? At many points over the past few years, time seemed to have slowed to a crawl, while more recently – at least as it relates to the economy and markets – time seems to have sped up. And the story is still unfolding. Although daily life has returned to some semblance of normality in most parts of the country, Covid-19 continues to mutate and spread, business as usual is anything but, and mask manufacturers are in no danger of closing shop anytime soon.
Chastened by the savage unpredictability of the recent past, we approach the outlook for next year with more than the usual degree of trepidation. Suffice it to say that 2022 is likely to be a year of even more change (how’s that for an easy prediction?), as economic leadership shifts from the emergency supports of government spending and low interest rates back towards more fundamental drivers. Transitions are tricky, and therein lies the risk as the new year dawns. Will a continued recovery in the labor market support household income and spending? Will companies be able to find enough workers to fill open positions? Will supply chains heal, or is higher inflation the new normal? Might inflation force the Federal Reserve to raise interest rates more quickly than markets anticipate? Can corporate earnings and profit margins continue to expand? And lest we forget the obvious, can the economy really return to normal with a backdrop of a lingering global pandemic?
We start the new year at the crossroads on many of these issues, with implications for the economy, business, and financial markets. Which way now?
What’s Past is Prologue
Let us start with a quick glance back at 2021 for context. As the new year dawned, the Pfizer and Moderna vaccines for Covid-19 had just been given emergency use authorization by the FDA. Although this was undeniably good news, delivering the vaccine efficiently to at-risk populations proved to be a challenge. An article on page A1 of the New York Times on January 1 explained in great detail why the distribution of vaccines was taking longer than expected, thereby putting “the campaign to vaccinate the United States against Covid-19 far behind schedule in its third week.” States rationed limited doses by imposed differing eligibility requirements based on age and the presence of underlying conditions, leading to long lines, “vaccine tourism,” and occasionally wasted doses.
Economic news was similarly unsettling. Although things had clearly improved from the earliest and darkest days of the pandemic, 2021 dawned with more economic questions than answers, particularly in the labor market. Unemployment stood at 6.7%. Over 800,000 people were filing initial claims for unemployment insurance every week, and more than 5 million people were filing continuing claims week after week. At the risk of mixing metaphors, there was light at the end of the tunnel, but the economy wasn’t out of the woods quite yet.
Because of this fragility, and on the very afternoon of his inauguration, President Joe Biden unveiled his proposed $1.9 trillion American Rescue Plan. Once debated and amended by the Senate and House, and enacted in March, the plan included, among other things, an extension of enhanced unemployment benefits of $300 per week, $1,400 direct payments to individuals, an expanded child tax credit, and a continuation of the Paycheck Protection Program. This legislation built on the $2.2 trillion Cares Act passed in March 2020, and the $900 billion in economic support included in the Consolidated Appropriations Act passed in December 2020, both under the Trump administration. These three plans together added up to $5 trillion of economic stimulus, equivalent to about 25% of GDP. To put this into context, the American Recovery and Reinvestment Act of 2009, passed in response to the global financial crisis, was only $831 billion, or about 5% of GDP at the time.
The ultimate driver of the U.S. economy is personal consumption, which is precisely why so much of this fiscal stimulus was designed to put dollars into people’s pockets, in the hopes that they would then be spent. And it worked. The nearby graph illustrates trends in household income and spending. The gap between the two lines represents unspent income, or savings. The three notable spikes in disposable income in 2020 and early 2021 correlate to the three major pieces of legislation mentioned in the previous paragraph. This is not a new phenomenon: Previous government spending programs, usually enacted in periods of economic stress, were also designed to boost household income, but never to the degree of the past two years.