Economic update – May 2021

There is little doubt that the US economy is doing much better than previously thought but the US Federal Reserve (the “Fed”) is not inclined to slow it down. It is important that the Fed is gentle with its policy communications. The markets like what they are hearing and they are showing that with very large gains on Wall Street and the ASX 200.

At the start of April, President Biden announced his $US 2 trn infrastructure package that would further stimulate the economy. He also announced an increase in the corporate tax rate from 21% to 28% after Trump cut it from 35% to 21% four years ago. A month later, Biden is still struggling to work the bill through Congress. Most want the ‘hard’ infrastructure investment such as roads and bridges but some argue there is too much ‘other’ expenditure in the bill.

Of course, there is kick back against the corporate tax rate hike. US Treasury Secretary Yellen has called for a global floor for corporate tax rates. Trump attracted a lot of business back to the US from lower tax rate locations. Biden and Yellen are worried about reversing that flow with a tax hike. Given that the EU cannot co-ordinate its member-countries’ fiscal policies we see little chance of the US orchestrating global minimum tax rates. The solution seems to be a more modest tax rate hike and a commensurate cut in recommended expenditures.

Biden gave a speech to a joint sitting of Congress marking his first 100 days in office. He rightly claimed success in vaccinating the population to date. 220 million have been vaccinated against his previously-thought ambitious target of 100 million made in January.

Biden also launched another multi-trillion-dollar expenditure package for families on paid leave, childcare and the usual social payments. To pay for this package, he is proposing to increase the capital gains tax (CGT) rate from 20% to 39.6% for those earning more than one million dollars per year. This tax hike too is likely to meet a lot of resistance. And as one guest on CNBC noted, ‘there are a lot of millionaires on both sides of the aisle in Congress.”

On hard data, US economic growth for the first quarter came in at 6.4% compared to an expected 6.1% (annualised growth rates). Retail sales were up 9.8% against an expected 6.2% and 916,000 new jobs were created against an expected 675,000. The unemployment rate is down to 6.0%. House prices were up 12% on the year which is the best result in 15 years.

These data points were strong enough to make long bond yields react at first in fear of rate hikes but they have since settled down again. As Fed chairman Powell noted, there are still 8.4 million jobs that were lost at the start of the pandemic which are yet to be re-filled. There is a lot of slack to catch up, but the pace of growth is very welcome.

Companies, too, have been playing their part. Quarter one US reporting season is well under way and many of the results have been spectacular. Big banks, IBM, Amazon and Facebook amongst many others massively beat earnings expectations. Importantly, revising these past earnings estimates upwards has reduced the seemingly over-pricing (in P/E ratios) that some thought were looking a bit high. It’s not surprising that Wall Street reached several new highs throughout April!

At home, it appears that consumers and businesses are unusually happy. The Westpac consumer sentiment index was the highest since April 2010 and the NAB business confidence index was at its highest level ever. Our unemployment rate fell to 5.6% which is not that much above the pre-COVID rate of 5.2%. 70,700 new jobs were created but they were nearly all part-time.

Our CPI inflation rate came in at 1.1% for the year against an expected 1.4% and the Reserve Bank (RBA) target range of 2% to 3%. There is no appetite at the RBA to hike rates any time soon.

China’s economic data was more mixed in the latest postings. Economic growth was a spectacular 18.3% but 19% had been expected because of the shut-down a year ago. Retail sales growth was a proper beat at 34.2% compared to an expected 28%. Industrial production was a slight miss.

The UK is recovering from a blip down in January’s exports owing to the initial impact of Brexit. February’s exports were strong enough to just about wipe out the January loss. On the other hand, Europe is really struggling largely because of the pandemic effect. Europe just entered a double dip recession.

The UK took a firm approach to tackling COVID after an initial failure by imposing strict lock-downs and a massive vaccination program. Serious disease and death rates plummeted as result of the government action. People are now allowed to go to pubs and cafes etc, providing they drink outside! Boris Johnson still expects to open the economy by mid-June. We have not yet heard of any adverse effects of having relaxed the lock-down policy.

In Australia, our vaccination policy is still in a state of flux – to put it mildly. Our infection rates are very low by international standards but our vaccination rate is also very low. With vaccination hubs now Government policy, it is possible that our vaccination rate will start to climb.

Sadly, some countries are really suffering from COVID – particularly India where infection rates went above 300,000 new cases a day. At the other extreme, just about every adult in Israel is now fully vaccinated.

Naturally, we still think our, and the US economies and markets may experience some bumps along the way but the overall direction is still up. Our January 1 forecasts for the ASX 200 and the S&P 500 are still very much on track. US monetary and fiscal policy generally provide strong underpinning of stock market activity.