Thomas Garretson, CFA
Senior Portfolio Strategist
Fixed Income Strategies
Portfolio Advisory Group – U.S.

After last week’s solid GDP report, data this week quelled near-term concerns that activity may be heading for a slowdown to start the first quarter, with Purchasing Managers’ Indexes, jobless claims, construction spending, and durable goods orders all trending in the right direction.

While debate goes on in Washington over the ultimate size and structure of a third fiscal aid package, there is more likelihood it will come in at a number well north of the $750 billion–$1 trillion markets and analysts have generally been expecting.

And as RBC Capital Markets, LLC Chief U.S. Economist Tom Porcelli stated in a note this week “the size of the stimulus is less relevant to the path of economic activity and more relevant for the magnitude of the change. In other words, economic activity is going up and it is already going to be fairly strong. More stimulus just makes the already strong number stronger.”

How much stronger? As the chart shows, consensus expectations as of the January Bloomberg survey had the U.S. economy on track to recover to pre-pandemic levels of economic activity by Q3 2021. RBC Capital Markets is looking for growth of 5.3 percent this year, after what looks to be a 2.5 percent drop in activity in 2020 once the final numbers are in. A stimulus package closer to the proposed $1.9 trillion could take that growth number north of 6 percent; the difference between the U.S. economy recovering not to pre-pandemic levels this year, but to pre-pandemic trend growth—as if the pandemic had never struck. A far cry from the more than three years it took the U.S. economy to recover from the financial crisis in 2008.

Strong policy response likely to fuel faster U.S. recovery

Line graph of GDP recovery in 2008 and 2020

Chart showing that U.S. GDP is expected to recover to pre-pandemic levels of activity in less than two years, faster than the three-plus year recovery following the 2008 financial crisis.

GDP recovery from 2008 recession
GDP recovery from 2020 recession

Return to pre-COVID GDP levels could be seen by Q3 2020

Note: Dashed line shows Bloomberg consensus forecast; real GDP shown as percentage of pre-recession levels in Q4 2007 and Q4 2019.

Source - RBC Wealth Management, Bloomberg

Of course, much of this depends on the path of COVID-19 and the ongoing rollout of vaccines. But on that front, the rollout continues to gather steam with 34.9 million vaccine doses administered in the U.S. through February 3, exceeding the 26.6 million confirmed COVID-19 cases since the onset of the pandemic, while the trend in new cases is trending notably lower.

Purchasing managers remain confident

But the economic outlook isn’t just supported by prospects for fiscal aid. This week, purchasing manager surveys for both the manufacturing and service sectors continue to point to strong demand, according to the Institute for Supply Management. While the headline indexes both remain well-above the breakeven level of 50, which indicates expansion, it’s in the details that a sustained recovery appears to be firmly in place.

As one respondent stated: “Business is very good. Customer inventories are low, with a significant order backlog through April. Supply base is struggling to keep up with demand, disrupting our production here and there. Raw material lead times have been extended. COVID-19 continues to cause challenges throughout the supply chain. Huge logistics challenges, especially in getting product through ports and in getting containers. We are seeing significant cost increases in logistics and raw materials.”

The chart shows that this kind of sentiment is widespread across U.S. manufacturing. The index on customer inventory levels is near the lowest on record—another factor supportive of the growth outlook as companies will need to bring inventories back to more-normal levels to meet projected demand later in the year. At the same time, manufacturers have lofty levels of order backlogs to work through in the coming months and quarters which should, at a minimum, maintain activity. The pricing story is where things get interesting, as rising input costs across the board, from apparel to paper, and plastics to primary metals, have pushed the ISM Manufacturing Report on Business Prices Index near the highest levels on record.

U.S. manufacturing: Demand remains robust

Low inventories, rising backlogs support growth outlook, but cost pressures building

Column chart comparing manufacturing inventory levels, order backlogs and input prices

Chart showing the views of managers at U.S. manufacturing firms, who see inventory levels as historically too low, order backlogs as historically high, and that the costs of manufacturing inputs are rising sharply.

10-year survey range
Current index level

Note: Levels above 50 indicate expansion, below 50 contraction.

Source - RBC Wealth Management, Bloomberg, Institute for Supply Management

That should boost inflationary impulses through the producer side, but how much of that is passed along to the consumer remains to be seen. But with still-high unemployment, we think it’s minimal over the near term. However, as the economy reopens further, and with supply chain constraints likely to continue, we think this dynamic will be one to watch.

Market signals abound

Just more than a year removed from inverted Treasury yield curves, where short-term rates are higher than long-term rates, which signals heightened recession risks, markets are now focused on steepening yield curves, yet another sign of an improving growth and inflation outlook.

This week, one of the benchmark indicators, the yield spread between two year Treasury notes and 10-year Treasury notes, crossed above one percent for the first time since late 2016, when growth optimism was improving ahead of tax reform expectations. Despite recent market volatility, markets continue to trade on the growth and reflation theme that has prevailed for some time.

Fed impact

Of course, downside risks remain, and uncertainty remains abnormally elevated, particularly around the Fed as stronger growth and higher inflation are already fueling fears the Fed could dial back asset purchases. But as Fed Chair Jerome Powell noted last week, the Fed already largely expects these types of inflationary pressures to play out over the course of the year, but essentially characterized them as “transitory” phenomena. We expect Fed policy to remain as is for the balance of 2021.

The data continues to show the value of a robust policy response from both the fiscal and monetary front, and of not pulling back prematurely, and while much of the outlook remains dependent on the path of COVID-19, with plenty still to be done, the tailwinds suggest to us plenty of reason for optimism.

This article was originally published in the Global Insight Weekly with the title “A low bar for high growth?”

This publication has been issued by Royal Bank of Canada on behalf of certain RBC ® companies that form part of the international network of RBC Wealth Management. You should carefully read any risk warnings or regulatory disclosures in this publication or in any other literature accompanying this publication or transmitted to you by Royal Bank of Canada, its affiliates or subsidiaries.

The information contained in this report has been compiled by Royal Bank of Canada and/or its affiliates from sources believed to be reliable, but no representation or warranty, express or implied is made to its accuracy, completeness or correctness. All opinions and estimates contained in this report are judgments as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. This report is not an offer to sell or a solicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. Every province in Canada, state in the U.S. and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents, as well as the process for doing so. As a result, any securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should be construed as, a solicitation to act as a securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealer in that jurisdiction. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice.

This material is prepared for general circulation to clients, including clients who are affiliates of Royal Bank of Canada, and does not have regard to the particular circumstances or needs of any specific person who may read it. The investments or services contained in this report may not be suitable for you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. To the full extent permitted by law neither Royal Bank of Canada nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of Royal Bank of Canada.

Clients of United Kingdom companies may be entitled to compensation from the UK Financial Services Compensation Scheme if any of these entities cannot meet its obligations. This depends on the type of business and the circumstances of the claim. Most types of investment business are covered for up to a total of £85,000. The Channel Island subsidiaries are not covered by the UK Financial Services Compensation Scheme; the offices of Royal Bank of Canada (Channel Islands) Limited in Guernsey and Jersey are covered by the respective compensation schemes in these jurisdictions for deposit taking business only.

Thomas Garretson, CFA

Senior Portfolio Strategist
Fixed Income Strategies
Portfolio Advisory Group – U.S.
We want to talk about your financial future.