By at least one popular measure, the US economy will fully recover and exceed its pre-pandemic strength in the second quarter.
US gross domestic product is expected to grow at an annualized rate of 10.4% through the quarter that ends in June, according to the Federal Reserve Bank of Atlanta’s GDPNow model. Growth at that pace would place economic output at a new record high, surpassing the peak seen during the fourth quarter of 2019. It would also be the second-strongest rate of growth since 1978, exceeded only by the record-breaking expansion seen through the third quarter of 2020.
The central bank’s nowcast is a type of projection that is updated as new economic data is published. GDPNow isn’t an official forecast from the Atlanta Fed, and is instead used to narrow down where quarterly growth is likely to land. The model also ignores the pandemic’s impact beyond its influence on source data such as retail sales and global trade, according to the Fed.
The first GDPNow reading for the second quarter was published on Friday, just one day after the Commerce Department published its initial estimate of first-quarter growth. US GDP expanded at an annualized rate of 6.4% in the first three months of the year, missing the median estimate of 6.7% but still showing a sharp acceleration from the prior period. The jump was primarily fueled by widespread vaccination, gradual reopening, and stimulus passed by former President Donald Trump and President Joe Biden.
Though some individual indicators have already surpassed their pre-pandemic levels and signal a strong recovery, GDP remains just below its previous peak. Following the first-quarter reading, GDP has retraced about 96% of its pandemic-era decline. With data tracking consumer spending and hiring trending higher as the economy reopens further, the US is largely expected to complete its GDP recovery in the next two months.
Economists outside the Fed also see growth accelerating through the current quarter. The consensus estimate from a survey of forecasters calls for annualized growth of just under 9% in the second quarter. The most bullish estimates see GDP expanding at a rate of more than 11%, while the least optimistic expect growth to land at about 6%.
The estimates underscore the fact that, should vaccination continue and case counts decline further, the US is on track for its strongest rate of annual growth in decades. The International Monetary Fund estimates GDP will grow 6.4% through all of 2021, exceeding global growth of about 6% and marking the fastest rate of expansion since the early 1980s. Separately, Federal Reserve officials hold a median estimate of 6.5% growth this year.
The consensus economic forecasting community – from academics to Wall Street economists – have since last April gotten one thing consistently wrong: they’ve been too cautious on US GDP growth.
In addition to underselling the resiliency of the overall economy, high-frequency economic data has also been consistently beating these forecasters’ expectations since early 2020. These misses point to one conclusion, the initial drop in the economy following the COVID outbreak was not as large as anticipated and the subsequent rebound has been stronger.
As the continued recovery keeps surprising to the upside forecasters are now, belatedly pushing estimates up. But even with these revisions, economists are still undershooting the strength of the US economy, and, there is room for growth estimates to continue climbing in the months ahead.
We’re doing better than expected
Recall that a month or two ago, some economists were warning about the possibility of a small GDP contraction in the first quarter of 2021. But since then current quarter tracking estimates have surged on the incoming economic data. Following strong reports on retail sales and industrial production, nowcast estimates from the Federal Reserve Banks of Atlanta and New York are projecting first quarter GDP growth of 9.5% and 8.3%, respectively.
According to the latest estimate from BlueChip, the consensus sees first quarter GDP growth at just 2.9%. Given how strong January is likely to be, the economy would have to soften quite a bit in February and March for that number to come in so low. And softening growth seems unlikely given developments on vaccine distribution, plummeting COVID case growth, and the possibility of more fiscal stimulus.
And the rest of the year could be just as strong
How about the rest of the year? Thus far, I’d argue that confidence has increased in the growth outlook for 2021, but that the consensus has yet to really come to terms with the stronger growth the US will likely get for the year.
As it stands, even if consensus catches up to the stronger first quarter nowcasts, they would only be projecting 6.5% annual GDP growth for the year. To get there all one needs to do is take the Atlanta Fed tracking estimate for the first quarter while keeping the rest of the quarters unchanged. That’s not a stronger forecast, merely an acknowledgement that conditions have held up better than you thought going into the year.
In the nearby figure, we plot the distribution and evolution of consensus 2021 forecasts. Since December, the mean of the distribution has shifted right, indicating that, on net, forecasters are a bit more upbeat. While there is a bit more variation in the forecasts in the latest month, nearly half the respondents are in the 5% to 6% annual growth range, reminding us of the famous Keynes quip that “it is better for reputation to fail conventionally than to succeed unconventionally.” Few are really sticking their necks out.
The consensus is failing to give enough attention to the “right-tail” scenario, the risk that growth drastically outperforms expectations, beyond the most bullish forecast on The Street. I suspect that few would be willing to pencil in an 8% to 10% forecast for 2021 real GDP, too much reputation risk.
Yet, it hardly feels like much of a leap when one considers the following:
The US economy has been holding up reasonably well despite widespread COVID cases. There is plenty of growth in the pipeline as it is. As an example, building permits have surged, signaling strong gains in residential construction and inventories remain low, implying room for gains in factory production.
If the “path of the economy depends significantly on the course of the virus” as the Fed and others repeatedly claim, it is important to recognize that the virus is fading away quite fast. Cases have plunged and vaccinations have picked up with the likelihood of a pick-up in the pace over the coming weeks and months.
Uncle Sam is about to push through another massive stimulus with the economy already beating expectations. $1 trillion? $1.9 trillion? It does not matter. We are in unprecedented territory. The only question now is how fast the pool of excess household savings will be drawn down.
In short, If the economy has been holding up relative to estimates in the face of COVID, it stands to reason that it will leap further still once the pandemic passes.
More broadly, we all know that the second half of this year will be better, but no one really knows how strong the back-half of 2021 can be; the distribution of risks largely skew one way, upward. Who wants to be the one to pencil in growth numbers no one has seen in their careers? Not many are willing to make that leap. The last time we saw the consensus even contemplating numbers like I’m talking about, I was in diapers. The mid-1980s does not feel like a useful comparison but that was the last time we saw growth in the 7% range. It takes a lot of risk (cajones?) to pencil in an outlier forecast.
For investors, I think there are a few implications. First, do not expect growth estimates to surge higher. As the data come in, economists will mark estimates higher on the news. But, we ought not to expect the consensus to get out in front of the economic data. Better to wait and see.
Second, if I’m right about this, then there is continued scope for the consensus to be surprised to the upside, helping continue the recent momentum behind stock prices. One reason why equities have climbed is because the economy has been beating expectations in the first place. The way the consensus is acting makes this more likely to continue.