The FOMC meets on Wednesday and Thursday of this week and will issue its post-meeting statement at 2:00 PM ET on Wednesday. Further monetary accommodation is unlikely given the most recent round of fiscal stimulus beyond the winter package, though there may be talk of yield curve control in the face of rising bond yields. Average inflation targeting, which implies zero-rates beyond the return of inflation to 2%, supports a ZIRP position for the foreseeable future, though the markets are braced for the median Fed funds rate projections in the March SEP to show a 2023 rate hike.
The updated SEP at the March meeting will need to incorporate the introduction of vaccines and two rounds of fiscal stimulus since the December 15-16 FOMC meeting, as well as an array of upside surprises since December for most U.S. economic and inflation reports. Boosts in growth prospects at the March meeting will extend the hikes evident in both the December and September SEP reports from the bleak official forecasts in July.
We expect a boost for the median 2021 GDP estimate to the 4.8% area from 4.2% in December, 4.0% in September, and a higher 5.0% in June when they assumed a much bigger 2020 drop with an ensuing bigger 2021 bounce. The median jobless rate estimate for 2021 will be lowered to the 4.6% area from 5.0% in December, 5.5% in September, and 6.5% in June.
The PCE chain price medians for 2021 should cautiously sit at around 2.2% for the headline and 2.0% for the core, after 1.8% December medians for both, September medians of 1.7%, and respective June medians of 1.6% and 1.5%. The Fed will likely low-ball the inflation estimates relative to the hefty price gains evident thus far in 2021. See our policy outlook page for a table of assumptions for the Fed’s revised forecasts.
In the following, we summarize economic developments that have occurred since the last FOMC meeting in January regarding the labor market, inflation and consumption.
The Labor Market
Payroll gains started 2021 on a stronger footing after the -306k December drop that reflected the resurgence and subsequent lockdowns, and seasonal factors that expected a normal holiday period. We saw an average payroll gain of 273k in the first two months of 2021, after a 2020 average payroll drop of -786k. The unemployment rate sat at a 3.5% cycle-low in February of 2020, before surging to 4.4% last March and peaking at 14.7% last April. The rate has since eased to 6.2% in February, down a tick from 6.3% in January, and 6.7% in both November and December. The participation rate tumbled from a 5-year high of 63.3% in January and February of 2020 to 62.7 last March and a 48-year low of 60.2% last April, before climbing to 61.4% through February of this year.
The y/y average hourly earnings gauge was lifted sharply in April of 2020 by the shift in the compositional mix of jobs with the shutdowns, as layoffs were heavily concentrated among low-wage employees. This measure rose from what was a cycle-high of 3.4% in March of 2020 to 8.0% last April, before falling back to 4.4% by November. The y/y gauge bounced again to 5.5% in December with further layoffs and held at 5.3% in both January and February.
Employment in the goods sector has shed jobs in both January and February of this year, after improving steadily in the second half of 2020. Monthly goods-based employment changes are averaging -61k in 2021, from -69k in 2020, versus averages of 8k in 2019 and 52k in 2018.
Service sector employment rose in both February and January, after a -356k December drop that capped a string of big gains. Service sector changes are averaging 308k in 2021 from -609k in 2020, versus 141k in 2019 and 131k in 2018.
The two-digit unemployment rate (U-3) fell to 6.22% in February, down from 6.32% in January and well under the 14.77% peak in April of 2020. The rate remains well above the prior cycle’s low of 3.48% in February of 2020. The Fed’s median projection still shows the 4.1% long-run jobless rate that was maintained throughout 2020. We expect the reported jobless rate to decline steadily toward this rate as businesses reopen and vaccines are rolled out.
The broader U-6 rate continued to improve through February, holding at 11.1% for a second month from January, and down from 11.7% in December and 12.0% in November. We saw an April 2020 spike to 22.9% from 8.8% last March, versus December ’19’s all-time low of 6.8%. The rate was just above 17% in late-2009 and early-2010, before the cyclical downtrend.
Other measures of labor under-utilization include those marginally attached to the labor force, discouraged workers, and part-time workers for economic reasons. In February, the number of people marginally attached to the labor force declined to 1.9 mln from 2.0 mln in January, and 2.2 mln in December, matching the 2.2 mln figure from April of 2020. This is well above the 1.3 mln reading at the start of the 2008-09 recession, but still below the 2.8 mln peak recorded in January of 2012.
In February, there were 529k discouraged workers, down from 638k in January, and 661k in December. This compares to 421k from February of 2020. The total is still significantly lower than the 1.3 mln such workers in December of 2010.
In February, the number of people working part-time for economic reasons was 6.1 mln, up from 5.9 mln in January. The figure is up 1.7 mln from February of 2020, and 1.2 mln from the March 2008 reading. As a comparison, this number swelled to 9.2 mln in September 2010, at the height of the last recession. That high was exceeded by the 10.9 mln figure in April of 2020.
Wage growth settled into a sustained rate near 3% between 2018 and early-2019, before the spike starting in March of 2020 from the mass layoffs of low-paid workers that changed the mix of employment. A 3.0% y/y rise for wages in February of 2020 was followed by gains of 3.5% last March and 8.2% last April, before the drop-back to 5.3% as of this February.
The latest data on unit labor costs (ULC) and the employment cost index (ECI) revealed quarterly gains of 6.0% SAAR for Q4 the ULC and an unannualized 0.7% for Q4 ECI.
We saw a y/y Q4 rate of 4.2% for ULC, following y/y gains of 3.1% in Q3 and 5.6% in Q2. The y/y gain for ECI total compensation ticked up to 2.5% in Q4 from 2.4% in Q3 and 2.7% y/y Q2.
We’ve seen a powerful updraft in energy and construction material prices into 2021 that is lifting inflation prospects for the year. We saw y/y CPI gains of 1.4% in January and 1.7% in February, after a 1.2% recent-trough in November. The Fed’s favored inflation gauge, the PCE chain price measure, posted January y/y gains of 1.5% for both the headline and core, after respective December increases of 1.3% and 1.4%. Last April marked a trough for the inflation measures. The FOMC will need to incorporate the hefty early-2021 price gains into their inflation forecasts, though they will likely low-ball estimates for the second half of the year, and will highlight the temporary base-effects driving a likely y/y inflation spike into Q2.
Real PCE is poised for a solid Q1 gain, thanks to hefty January retail sales gains, and stimulus boosts from direct deposits to individuals in both January and March. Real consumption growth should sit near 4.0% in Q1, following a 2.4% clip in Q4, and last year’s big zigzag that left a Q3 growth clip of 41.0% after a -33.2% contraction rate in Q2. GDP looks poised for growth near 4.6% in Q1, after reported rates of 4.1% in Q4, 33.4% in Q3, and -31.4% in Q2.
There is little room for further policy action at the March FOMC. Yet, the markets will be focused on the dot plot, with possible new projections of rate hikes in 2023, and the Fed’s verbiage in the press conference about the big bond yield spike in Q1 that the Fed may wish to combat with adjustments to its portfolio. We think it’s unlikely that the Fed will want to signal any changes in policy, but the markets will look for signals about how willing some policymakers may really be to accommodate inflation above the 2% objective or to meddle in the debt market with changes in the Fed’s portfolio management.