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In the debate about fiscal policy that is currently taking place in the United States, one would expect that support for President Biden’s proposed massive fiscal expansion would come from the left and that opposition would come from the right. While mostly true, this is not entirely the case. Interestingly, the latest debate has created some strange bedfellows. For example, support for the Biden policy has come from Harvard Professor Ken Rogoff. He famously wrote the book This Time is Different about the dangers of excessive government accumulation of debt. For Rogoff, however, this time is truly different in that he thinks the US government ought to borrow heavily in order to address the current crisis. According to him, “we are in a different world today.” In addition, he said, “Yes, there is some risk we have economic instability down the road, but we have political instability now.” In contrast, opposition to Biden’s policy has come from Larry Summers, also of Harvard and formerly top advisor to the last two Democratic presidents (Clinton and Obama). In fact, Summers had written extensively about “secular stagnation” and the need to use fiscal policy expansion in order to address economic weakness. Now, however, he is concerned that Biden intends to undertake too much fiscal expansion, thereby creating the risk of much higher inflation.
It is interesting to note that both Rogoff and Summers think there ought to be additional government spending. Their difference is about the scale. What are the arguments? If you assume that, prior to the pandemic the economy was running at roughly full capacity and that, in the interim, it would have grown about 2.0% based on growth of the labor force and productivity, then we’re now running about 4.5% below capacity. Yet the Biden plan is to boost spending by about 9.0% of GDP. Summers argues that, by boosting demand above the capacity of the economy will create bottlenecks and the result will be higher inflation. Moreover, it can be argued that, until the vaccine is fully distributed, stimulus won’t help disrupted industries like restaurants and airlines. Thus, the additional spending will likely boost demand in industries that are already running strong. That, in turn, would be inflationary.
What is the counter argument? It is that the economy was not really at full capacity just prior to the pandemic and that, consequently, there is room for more stimulus. Specifically, although unemployment was 3.5% before the pandemic, this was after a decade of declining labor-force participation. Technological change and globalization had disrupted such industries as manufacturing, leading to job losses for relatively unskilled people. Many simply dropped out of the labor force. Plus, the rising cost of childcare led many lesser skilled women to exit the labor force. If disrupted workers could return to the labor force, then the economy is likely operating far more than 4.5% below capacity. Many supporters of the Biden plan argue that a big boost to aggregate demand, followed by more investment in infrastructure and retraining, could go a long way toward creating an economy that is able to absorb a far larger share of the working age population without generating inflation. Moreover, supporters of the plan argue that the Federal Reserve has adequate tools to quickly fight inflation should it arise.
Regardless of the debate, it is increasingly clear that something akin to what Biden has proposed will pass the Congress and become law, most likely in March. Thus, we are on the verge of a very interesting experiment.
Meanwhile, the European economy is set for good growth later this year, once the virus recedes, governments lift restrictions, and the vaccine is fully distributed. Moreover, it is expected that governments will continue to provide fiscal support to households and businesses for much of this year, thereby helping to stabilize the economy against disruption in key industries. However, the European Union forecast indicates that the region’s economy will not return to prepandemic levels by the end of this year. Yet, at the same time, it expects that governments will remove stimulus by the end of the year.
This raises an important question: is Europe facing a slowdown next year because of premature withdrawal of stimulus? This is the opposite of the debate in the United States where some observers are warning that the stimulus proposed is excessive and that it will overstimulate the economy by 2022, leading to higher inflation. In the Eurozone, if the stimulus programs offered by member states are deemed inadequate, then the burden of economic management will continue to fall on the European Central Bank. Yet ECB President Lagarde has warned that monetary policy might not be enough and that members states need to engage in strong fiscal policy. However, member states are likely to be averse to more accumulation of debt, especially Germany which, according to the International Monetary Fund, is set to have a substantial fiscal contraction.
This raises another important question: Will the EU provide another round of support to member states following the EUR750 billion that it agreed to undertake? The answer is that it is highly unlikely, given the current political environment. Another important question is: After the vaccine is introduced, will strong pent-up demand sufficiently boost economic activity so as to offset the negative impact of withdrawing fiscal stimulus? If so, then the withdrawal of stimulus might not lead to a sharp slowdown in growth. For this scenario to take place will require success in fully distributing the vaccine quickly.
Under former US President Donald Trump, US policy toward cross-border investment between the United States and China involved casting a wide net to stop or discourage investments that were considered a threat to US national security. This entailed halting inbound investment by Chinese technology companies and restricting exports of certain technologies to China. This was part of what has been called “decoupling,” in which the symbiotic relationship between technology companies of the two countries was disrupted, potentially leading to separate development of technology standards. Meanwhile, the new Biden administration has signaled an intent to prevent technology transfers that might damage US national security. However, supporters of Biden have talked about moving from decoupling to a policy that has been called “small yard, high fence.” That is, the policy will be to define the areas of contention more narrowly and then build a high virtual fence around key sectors of the US economy. But, at the same time, the administration hopes to avoid throwing the baby out with the bathwater. Rather, it wants to restore trade and capital flows that are beneficial to both sides. Of course, the devil is in the details and the parameters of policy have still to be determined.
Meanwhile, there continue to be strains in the relationship. For example, it was reported recently that China is considering restrictions on exports of rare earth metals that are used by the US military. China accounts for 80% of the production of these metals that are critically important in both military (fighter jets) and civilian (mobile telephones) Technologies. The United States is attempting to develop capacity for rare earth metals at home and in other key countries, such as Australia. In fact, such efforts are cited in China as a reason to avoid export controls. Another example: In the United States, apparel companies are rapidly shifting away from sourcing product in China, in part because they want to avoid association with alleged policies of forced labor. Moreover, the Biden administration says it will be tough on China on human rights issues. The Chinese share of the US apparel market fell in 2020 to a decade low of 23%. The share collectively held by Vietnam, Bangladesh, India, Indonesia, and Cambodia rose 7 percentage points to 42% in 2020.
The Eurozone is a significantly bifurcated economy, with considerable strength in manufacturing and continued virus-related weakness in services. This is evidenced by the latest flash purchasing managers’ indices (PMIs) published by IHS Markit. PMIs are forward-looking indicators meant to signal the direction of activity in the manufacturing and services sectors. They are based on sub-indices, such as output, new orders, export orders, employment, pricing, pipelines, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth, and vice versa. The manufacturing PMI for the Eurozone increased to 57.7 in February, a 36-month high and an indication of very rapid growth of activity. The manufacturing PMI was 60.6 in Germany and 55.0 in France, both a three-year high. The stellar level for Germany reflects strong demand for exports, especially from China. At the same time, Europe’s manufacturing sector is experiencing supply chain disruption, delivery delays, and rising input prices. Markit commented that “there is the potential for some near-term disruption should the situation worsen, and firms find themselves short of raw materials and components.”
The strength of manufacturing is helping to partially offset the weakness of services. Still, the overall composite PMI remains in negative territory. The services PMI for the Eurozone fell to 44.7 in February, a three-month low and a level indicating a rapid decline in activity. The services PMIs were 45.9 in Germany and 43.6 in France. Markit commented that “ongoing COVID-19 lockdown measures dealt a further blow to the Eurozone’s service sector in February, adding to the likelihood of GDP falling again in the first quarter.” However, Markit offered a more positive assessment of the future, saying that “vaccine developments have meanwhile helped business confidence to revive, with firms across the Eurozone becoming increasingly upbeat about recovery prospects. Assuming vaccine rollouts can boost service sector growth alongside a sustained strong manufacturing sector, the second half of the year should see a robust recovery take hold.” This viewpoint is consistent with our own Deloitte forecast. For example, we expect the German economy to contract at an annualized rate of 2.0% in the first quarter. Yet we also expect Germany to grow at annualized rates of 7.4%, 10.4%, and 6.1% in the following three quarters, respectively. We see similar patterns for France, Italy, and Spain.
Outside of the European union but within Europe, the United Kingdom is following a slightly different pattern from that of the Eurozone. The UK PMIs indicate that the services sector is starting to stabilize after having contracted. Meanwhile, although the manufacturing sector is growing, disruption of supply chains is holding back growth. Such disruption is related both to the pandemic and as to the transition to Brexit. Specifically, Britain’s services PMI increased from 39.5 in January to 49.7 in February, a level indicating almost no change after a sharp decline in January. This was a four-month high. Markit noted that “although the hospitality sector, including hotels and restaurants, reported a further steep decline, as did the transport and travel sector, rates of contraction eased considerably. Business and financial services companies meanwhile recovered to register modest expansions, helping the hard-hit service sector to come close to stabilizing.” At the same time, the manufacturing sector grew at a healthy pace, with a PMI of 54.9 in February. While output grew only modestly, new orders were up strongly, but not export orders. In fact, more than half of companies reporting worsened exports attributed it to Brexit. British manufacturers reported severe supply chain problems due to “international shipping delays, strong worldwide demand for raw materials, and Brexit-related trade frictions.” That said, businesses “remained resolute that things can only get better.” The sub-index for future expectations was up strongly, fueled by confidence in the vaccine.
Meanwhile, the British government reports that, in January, retail sales fell 5.9% from a year earlier and were down 8.2% from the previous month. This was largely due to the economic restrictions. On the positive side, the further vaccination of the population will likely lead to a resurgence in retail sales in the months ahead.
The PMIs for the United States are astoundingly high, indicating that the economy was likely growing rapidly in February. The PMI for services rose to 58.9, a 71-month high indicating very rapid growth of activity. Output rose rapidly, especially as economic restrictions started to be lifted. Exports of services, however, declined due to restrictions on international travel, which affected the tourism industry. Employment by service providers increased. At the same time, the manufacturing PMI was 58.5, also a level indicating rapid growth. Growth in both sectors was fueled by government stimulus, declining infections, increasing vaccinations, and optimism about vaccines and further stimulus.
The strength of the PMIs raises a question about whether the economy really needs more stimulus. In an interview on CNBC, US Treasury Secretary Janet Yellen was asked whether a big package was needed given good economic news. She said, “We think it’s very important to have a big package [that] addresses the pain this has caused 15 million Americans behind on their rent, 24 million adults and 12 million children who don’t have enough to eat, small businesses failing. I think the price of doing too little is much higher than the price of doing something big. We think that the benefits will far outweigh the costs in the longer run.” Some critics have suggested that the planned stimulus is so big that it is expected to generate much higher inflation. On the issue of inflation, Yellen said, “Inflation has been very low for over a decade, and you know it’s a risk, but it’s a risk that the Federal Reserve and others have tools to address. The greater risk is of scarring the people, having this pandemic take a permanent lifelong toll on their lives and livelihoods.”
In recent weeks, high-frequency credit and debit card data indicated a sudden surge in consumer spending. Last week, we learned from the government that this was accurate and that retail sales increased dramatically from December to January. The best explanation is that the passage of a US$900 billion stimulus program in December, which included direct US$600 payments to most individuals and enhanced unemployment insurance to the unemployed, largely contributed to the surge. Unlike the stimulus funds distributed early in 2020, which were largely saved or used to pay down debts, this time consumers evidently used a significant share of the money to fill in their pent-up needs. Moreover, January saw a sharp decline in the number of new infections, thereby signaling to consumers that it could be safe to go out again.
Here are the details for the January numbers. Total retail sales were up 5.3% from November to December after having declined 1.0% in the previous month. Sales were up 7.4% from a year earlier. The monthly increase was strong across multiple categories. For example, sales were up from December to January by 12.0% at furniture stores, 14.7% at electronics stores, 23.5% at department stores, 5.0% at clothing stores, 6.9% at restaurants, and 11.0% at nonstore retailers. Although overall sales were far above the year earlier level, this was not the case for clothing stores (down 11.1% versus a year earlier) or restaurants (down 16.6% from a year earlier).
At the same time, sales at nonstore retailers were up 28.7% over a year earlier. Thus, the retailing sector has undergone a radical transformation in just a year. From a year earlier, store-based retail sales increased only 3.3%. More than half the increase in total retail sales over the past year was attributable to online sales. If the elevated level of online shopping persists after the pandemic ends, this could create substantial disruption for the store-based retailing industry, and especially for the property companies that develop and manage physical stores and shopping centers. It could have a permanent impact on the distribution of employment between stores and online businesses. Traditionally, store retailers have been one of the largest employers in the US.
Two additional factors are likely to boost spending in the coming months. One is the expected large number of people being vaccinated. Distribution of the vaccine will likely make people feel comfortable with social interaction. President Biden has said that everyone will have access to the vaccine by the end of the summer. The other factor is the expected passage of an additional stimulus package, which will likely include direct payments of US$1,400 to most individuals. It is reasonable to expect that a substantial share of that money will be spent in the first few months following distribution. However, the recent severe weather in much of the United States could have a negative impact on retail sales numbers in February.
It now appears highly likely that, by March, the US Congress will pass a spending package roughly in line with the US$1.9 trillion plan proposed by President Biden. Alluding to the weak employment report for January issued recently, Treasury secretary Janet Yellen said that the fiscal plan will result in full employment by next year. She noted that the non-partisan Congressional Budget Office states that, without further stimulus, unemployment will remain high for the next several years. In response to critics who say the package is too big, Yellen said, “We have people suffering, particularly low-wage workers and minorities, and through absolutely no fault of their own. We have to get them to the other side and make sure this doesn’t take a permanent toll on their lives. So, we need a package that's big enough to address this full range of needs.”
Meanwhile, the US$1.9 trillion plan is meant to protect the economy until vaccines are fully distributed. It is not meant to boost long-term growth or assist the economy in making the transition to a new normal. Instead, Biden intends to propose a second round of spending increases later in 2021 that will involve direct investment in infrastructure as well as measures to address climate change, education, digital transformation, and health care. When combined with the first package, this would entail a very large increase in spending, although it is likely that the second package will be spread over several years. In any event, the second package might be paid for, in part, by higher taxes on corporations and upper-income households. The so-called reconciliation process, by which the first package will be passed in Congress, can be used one more time this year and it is likely that this process will be used for the second package. Already members of Congress and business lobbies are girding for the debate to come. Any debate about taxes will take into account the fact that some aspects of the 2017 tax cut are set to expire in a few years.
The massive increase in spending that is planned has raised concerns about inflation risk. Former Treasury secretary Summers warned that the US$1.9 trillion package could lead to “inflationary pressures of a kind we have not seen in a generation with consequences for the value of the dollar and financial stability.” Yellen acknowledged that “inflation is a risk that we have to consider.” Still, she said, “I’ve spent many years studying inflation and worrying about inflation. And I can tell you we have the tools to deal with that risk if it materializes.” This raises the question as to how investors view this debate. Although the so-called breakeven rate—that measures investor expectations of inflation—has risen, it remains historically low. Moreover, the real (inflation-adjusted) yield on Treasury bonds remains negative, suggesting that investors are not concerned that massive government borrowing will crowd out the private sector’s access to credit. Still, the headline yield on 10-year Treasury bonds is at the highest level in about a year, mainly due to somewhat higher expectations for inflation. Thus, investors expect higher—but not ruinous—inflation.
Meanwhile, equity prices are up sharply. Investors now believe there will indeed be a US$1.9 trillion package (having previously expected a watered-down package), and likely another package later in the year. Consequently, Wall Street economists are upwardly revising their forecast for 2021 economic growth.
As for inflation, consumer price inflation remains relatively muted, although it appears to be accelerating slightly. The government reported that, in January, consumer prices were up 0.3% from the previous month, the fastest rate of increase since August. Prices were up 1.4% from a year earlier, the same rate as in the previous month. When volatile food and energy prices are excluded, however, core prices were unchanged from the previous month and were up 1.4% from a year earlier, the slowest rate of increase since June of last year. As for food and energy, food prices were up strongly, but the effect was offset by a sharp decline in energy prices. In any event, underlying inflation remains below the 2.0% target set by the Federal Reserve. Although the latest commentary surrounding the purchasing managers’ indices (PMIs) suggested that input shortages and supply-chain disruption are likely causing a rise in the wholesale prices of some goods, it appears that this has not yet had a general impact on consumer prices. Still, this could change. Meanwhile, Treasury bond yields fell on the news about inflation as investors digested the fact that inflation remains lower than they anticipated.
Meanwhile, Federal Reserve chairman Jay Powell said that “fully realizing the benefits of a strong labor market will take continued support from both near-term policy and longer-run investments so that all those seeking jobs have the skills and opportunities that will enable them to contribute to, and share in, the benefits of prosperity.” He noted that, although the unemployment rate has declined, a large number of people has dropped out of the labor force, rendering employment well below the level from before the pandemic. He said that the headline unemployment rate of 6.3% “dramatically understates” the true nature of the problem and that the true rate is probably closer to 10%. Moreover, job growth has lately decelerated sharply, meaning that the economy is not moving in the right direction. In addition, Powell noted that, for those workers in the bottom income quartile, employment has fallen by 17% in the past year. Thus, the burden of economic weakness is falling on the weakest elements in society. What does the state of the job market mean for inflation? Powell said that he wants to avoid the mistakes of the past when, during recoveries, if inflation accelerated, the Fed would tighten monetary policy, thereby stifling growth. He said that, this time, the Fed will be averse to a quick tightening and will be amenable to allowing inflation to exceed the target for a prolonged period. The overriding goal appears to be restoring employment.
What if we do get a bit more inflation? If, for example, inflation exceeds 2.0% a year from now, should we worry? The answer, as usual, is yes and no. The Federal Reserve has said that its 2.0% target is not a maximum but an average. Thus, 2.5% inflation wouldn’t necessarily cause the Fed to lose sleep. The good thing about higher inflation is that it would grease the wheels of commerce and provide a bit more pricing flexibility for businesses. It would likely result in lower real (inflation-adjusted) borrowing costs. Then again, higher inflation would likely lead to higher bond yields, thus raising the nominal cost of servicing government debt. Higher inflation could also lead to expectations of persistent inflation, thereby causing businesses to be less cautious about costs and efficiency. Once expectations of higher inflation are embedded in the economy, they are difficult to remove. Thus, the Fed will have to play a careful balancing act. For now, the Fed has made clear that it is more concerned with the health of the job market than it is about inflation.
Meanwhile, the main risk remains the virus. An important part of the fiscal package is funding for virus suppression and vaccine distribution. The hope is that, if successfully implemented, these programs could render the virus largely defeated by the last quarter of this year, thereby setting the stage for a strong continuation of the recovery in 2022. Yet multiple risks remain. First, new variants of the virus are now spreading in the United States, even as the number of new infections is declining. The UK variant is doubling every 10 days. Second, existing virus suppression efforts might not be sufficient in face of a rapid spread of new variants. It is not clear whether Americans will be amenable to the kinds of restrictions that might be needed to suppress yet another wave. Third, at current distribution rates of the vaccine will not be sufficient to achieve herd immunity this year. Failure to accelerate distribution will delay recovery and could provide an opening for new variants. Thus, one could argue that investors are only looking at the bright side.
One aspect of the proposed fiscal package is support for working women through subsidized childcare and paid parental leave. The goal is to restore labor force participation among women, which has fallen lately. Moreover, female participation fell not only during the pandemic, but over the past two decades. The United States is the only major industrial nation to have seen female participation decline in the last two decades. It is also the only one without mandatory paid leave and subsidies for childcare. Participation declined for less educated women but remained relatively steady for highly educated women. Also, participation declined for women under the age of 55 but increased for women who are aged 55 and above. There is considerable empirical evidence to suggest that the challenges and high cost of parenting have discouraged some women from participating in the labor market, especially during the pandemic. The administration argues that, by providing support to discouraged women, it will likely boost participation, thereby expanding the economy and generating more tax revenue. Many critics argue that such a program is too costly and that it imposes burdensome costs on private-sector employers.
In 2020, the British economy contracted at the fastest pace in more than 300 years. Real GDP fell 9.9% from 2019 to 2020. Among major European economies, only Spain’s fell more quickly, largely due to the collapse of its critical tourism industry, which accounts for 12% of Spanish GDP. Business investment in the United Kingdom also fell more than 11% in 2020. Meanwhile, Britain remains in trouble owing to the continued outbreak of new strains of the virus and the measures implemented by the government meant to stifle the virus. Our own Deloitte forecast is that, in the first quarter of 2021, real GDP will contract at an annualized rate of 15.4%.
Despite the bad news, there are some green shoots. In the fourth quarter of 2020, the economy performed considerably better than many observers had expected. Real GDP grew at an annualized rate of 4.1%, the best performance of any major European economy. Still, that left real GDP 7.8% below the level from a year earlier. Moreover, assuming that the current economic restrictions are successful in suppressing the outbreak and are ultimately lifted, and assuming that the rapid pace of vaccination continues, it is reasonable to expect strong growth for the remainder of the year. Indeed, our Deloitte forecast is that real GDP will grow at double-digit rates in the second and third quarters and that, for all of 2021, the economy will grow 4.4% from the previous year. We also expect that real GDP will return to the precrisis level by the third quarter of 2022. The biggest risk to the British economy, however, is that new strains of the virus could interfere with virus suppression and with the success of the vaccination program.
After intensive negotiations, Mario Draghi has formed a government and will take the role of Prime Minister of Italy. Improbably, he has managed to persuade all of Italy’s major political parties to support the formation of a new government. This meant persuading the leaders of the left of center Five Star Movement and the right of center League, both of which have been highly Euro-skeptical. Yet these skeptics have agreed to a government that will be led by the man who saved the euro. Draghi has chosen a cabinet of politicians and technocrats. He will have two opportunities to boost Italy’s fortunes. First, he will be able to spend the 200 billion euros that will be allocated by the European Union (EU) from the 750 billion euros it will borrow. Italy will obtain the largest share of that bounty of any country in the EU. The money is meant to be spent on long-term economic recovery and transformation. Draghi has been explicit that this provides Italy with a cushion and a way to fund reform. Second, Draghi will likely seek legislation meant to liberalize the otherwise sclerotic economic system.
Although previous governments improved government finances in the last two decades, the country still suffers from excessive regulation, poorly designed tax rules, corruption, and inefficiency. It ranks low on the World Bank’s ranking of countries based on ease of doing business. In Italy, it is harder to start a business than in any other Western European country, thereby limiting entrepreneurship, innovation, and productivity growth. Draghi hopes to address this problem and use the EU money to grease the wheels of reform. How will he get reform legislation through the Parliament? First, he is very popular at the moment, with an approval rating of 60% in the latest polls. This should serve him well. Second, the hope is that the various political parties will agree to reform legislation rather than being seen as responsible for undermining the last best hope for turning Italy around. If Italy succeeds, each party can claim responsibility. If Italy fails, they can each blame Draghi. As President Kennedy once said, “victory has a thousand fathers, but defeat is an orphan.”
The European Commission has upwardly revised its forecasts for economic growth in 2021 and 2022. The EU said that “there is light at the end of the tunnel” and that the Eurozone economy will grow 3.8% this year as well as next year, after having contracted by 6.8% in 2020. It expects that real GDP will return to the prepandemic level by the middle of 2022, a bit earlier than previously anticipated. Its relatively optimistic view comes at a time when the economy is moribund because of economic restrictions related to the latest outbreak. In addition, the EU is struggling with a worsethan-planned rollout of the vaccine. Still, the EU says that its forecast is based on an expectation that economic restrictions will be eased as the outbreak diminishes and that the rollout of the vaccine will accelerate. In fact, the EU forecast is based on the assumption that at least 70% of the population will be vaccinated by the end of the summer of 2021. The EU’s Economics Commissioner said that this goal is “quite challenging.” Presumably failure to meet that goal will result in slower economic growth. Meanwhile, our own Deloitte forecast is for a decline in real GDP in the Eurozone during the current first quarter but a moderate increase for the full year. The EU predicts that, for 2022, real GDP will be above the 2019 level in Germany and France but below it in Spain and Italy. Spain and Italy have seen their large and critically important tourism industries massively disrupted.
In 1929, Joe Kennedy (father of President Kennedy), who was a savvy investor, sold all his shares just before the market crashed. He later said that he knew to get out when the man who shined his shoes was offering stock tips. The collapse of asset price bubbles is often preceded by strange happenings. Indeed, recently, something unusual has been happening in financial markets, and it has been driven by retail investors communicating with one another on social media. First, there was the stunning increase in the share prices of two major companies. Then, there was a huge increase in the price and trading volume of silver. In each case, prices were driven far above economic fundamentals, ultimately leading to massive losses once frothy prices collapsed. This strange activity involved large numbers of retail investors who were intent on punishing short sellers. These investors used options to leverage their ability to drive the market. Evidently, there were a substantial number of short positions, something that infuriated day traders who were communicating through various channels on social media. So, they improbably banded together and drove prices to the stratosphere, causing big paper losses for short-selling hedge funds. In the process, they temporarily gave themselves big paper profits, especially for those who quickly sold their positions. Later, many lost plenty of money when prices returned to reality. What can we make of this?
First, among amateur traders there is a sense that short selling is a morally bad thing and ought to be punished. Yet is it bad? Short selling simply involves taking a position that enables a trader to profit if the price of a share declines. It can be beneficial not only to the short seller but to the market in general. It provides liquidity to the market, enables better price discovery, helps to prevent bubbles, and enables investors to hedge exposure. The latter is especially important for commodity buyers. Yet for every company that wants to hedge their exposure to a commodity, there must be a counterparty who is essentially a speculator. Also, all this activity helps to assure better allocation of capital. So short selling is mostly a good thing, but somehow it seems wrong to many observers because it involves betting on failure.
Second, when investors work together to drive prices, it is often seen as a form of price manipulation, which is illegal. It is not clear if there will be prosecutions. However, there are likely to be calls to revisit the regulatory environment. This new nexus of social media and financial markets provides new opportunities to generate market turmoil, mislead investors, and generate unrealistic prices.
Finally, the problem with recent activity is that it led some asset prices to become unhinged from fundamentals—something that cannot be sustained indefinitely. If speculators, working together, push an asset’s price to an unreasonable level, ultimately someone gets hurt. For now, it seems that more unusual activity is on the horizon. Having proven the efficacy of their actions, day traders will likely look for other opportunities to make a quick and massive profit.
Weakness in the global economy remains centered around the services sector. The manufacturing sector continues to expand at a healthy pace due to strong demand for goods that do not involve or require social distancing. However, the services sector, especially retailing, hospitality, and transportation services, has been badly disrupted by the need for social distancing.
In January, the global services sector was a mixed bag, with a rapid decline in activity in Europe, a sharp deceleration in China, and a strong acceleration in the United States. We know this based on the latest purchasing managers’ indices (PMIs) for services released by IHS Markit. PMIs are forward-looking indicators meant to signal the direction of activity in the broad services sector, which encompasses retail and wholesale trade, transportation, telecoms, hospitality, finance, professional services, education, and health care. PMIs are based on such sub-indices as output, new orders, export orders, employment, pricing, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth—and vice versa. Recent movements in services PMIs have been heavily driven by changes in rates of infection and the degree to which governments have imposed restrictions on activity.
The global manufacturing industry continues to expand at a robust pace, driven by moderately strong consumer demand, recovering global supply chains, and rebounding business investment. The health of manufacturing is well due to the fact that people can still purchase goods and stay away from other people. Indeed, global trade in goods has recovered to precrisis levels, driven by the rebound in demand for manufacturing goods. The global PMI dropped modestly from 53.8 in December to 53.5 in January, a level indicating moderately strong growth in activity. But, although the PMI was barely changed, it masked the fact that the PMI shifted significantly in the world’s two largest economies. The US PMI went up to a record high and the Chinese PMI went down to a seven-month low.
Among the common themes across multiple countries and regions were a shortage of raw materials, supply chain constraints, and shipping difficulties. Thus, many industries are struggling to return to normal after a period of substantial disruption. As for shipping, many container ships were mothballed early in the crisis and have not yet been put back into operation. Thus, shipping costs have risen. Ultimately, supply and demand will match one another, and shipping costs will likely decline.
The Eurozone services PMI fell from 46.4 in December to 45.4 in January, a level indicating a sharp decline in activity. The PMIs for Germany and France (46.7 and 47.3, respectively) fell modestly. The decline in France partly reflected more intense economic restrictions meant to fight the virus. Likewise, virus-related restrictions in Germany continued to take a toll on services activity. The PMI for Spain fell sharply from 48.0 in December to 41.7 in January, a level indicating a rapid decline in activity. The worsening economic situation in Spain mirrored the sharp increase in infections. However, the PMI for Italy improved from 39.7 in December to 44.7 in January, a level consistent with a sharp decline in activity. In part, the improvement reflected growing business confidence that the corner will soon be turned.
Outside of the Eurozone, the UK services PMI fell sharply from 49.4 in December to 39.5 in January, indicating a severe decline in activity. This was driven, in part, by new restrictions meant to deal with the outbreak of the new strain of the virus. New orders fell at the fastest pace since May 2020. There was an especially pronounced decline in activity in travel, leisure, and hospitality as consumers increasingly stayed home. Also, survey respondents indicated that Brexit played a role in reducing orders from the EU in January. The full impact of Brexit is hard to discern because the virus situation complicates things.
Europe’s manufacturing sector is performing well. The Eurozone manufacturing PMI fell from 55.2 in December to 54.8 in January. This left it at a level indicating strong growth of activity. The January PMIs varied by country, with Germany at a high 57.1, the Netherlands at 58.8 (a 28-month high), and Italy at 55.1 (a 34-month high).In contrast, the PMIs were only 51.6 in France and 49.3 in Spain. The stronger countries are benefitting from their exporting prowess while the weaker ones are hurt by the impact of the pandemic on domestic demand. Overall, the deceleration in the Eurozone reflected the impact of economic restrictions related to the pandemic. Also, Markit noted that, like other regions, Europe is facing shortages of raw materials and supply-chain constraints. Still, the robust growth of manufacturing is helping to offset a very weak services sector.
Meanwhile, the manufacturing PMI for the United Kingdom fell sharply from 57.5 in December to 54.1 in January. Although this left activity growing at a healthy pace, the sharp drop in the PMI reflected challenging recent events. Markit noted that “a mixture of harsher COVID-19 restrictions and Brexit led to near-record supply-chain disruptions, lower exports and increased costs. The impact was felt most at consumer goods producers, who reported steep falls in output and new orders. There were also early signs that smaller companies were being hit harder by the tougher operating environment than medium- and larger-scale producers.” The outlook for UK manufacturing will depend on suppression of the virus and the speed of vaccine distribution.
Europe faces many problems, going forward. These include risk from new strains of the virus, dormant services activity due to restrictions, and severe problems in distributing the vaccine. Despite these headwinds, the PMI surveys indicated a relatively positive outlook on the part of businesses. They are evidently confident that, by later this year, the situation will have improved.
China’s manufacturing PMI fell from 53.0 in December to 51.5 in January. Notably, the sub-index for output remained strong. Rather, the sub-index for new orders indicated a sharp weakening and the sub-index for export orders fell to negative territory as global demand weakened. In addition, employment in the industry declined. Markit commented that “the manufacturing sector continued to recover in January, but the momentum of both supply and demand weakened, dragged by subdued overseas demand. The gauge for future output expectations was the lowest since May last year though it remained in positive territory, showing manufacturing entrepreneurs were still worried about the sustainability of the economic recovery.” Markit also noted that inventory shortages and shipping delays had a negative impact on the activity in the sector. Higher prices of raw materials ate into profitability. Finally, Markit said that concerns about the resurgence of the virus in China led companies to worry about overall domestic demand as well as supply chains.
In China, the services PMI fell sharply from 56.3 in December to 52.0 in January, a level indicating modest growth in activity. It was the lowest services PMI in nine months. Given that the manufacturing PMI also fell in January, it appears that China’s economy is decelerating as the new year begins. What happened to services? First, new orders from overseas weakened substantially, likely due to the weakening economic situation in Europe and North America. Second, new domestic orders also weakened, possibly due to geographically isolated outbreaks of the virus within China that required varying degrees of new economic restrictions. Third, employment in services decelerated as businesses became more cautious. In addition, the survey indicated greater concern about the potential for further outbreaks of new strains.
Japan suffered weakness in January, with the manufacturing PMI falling from 50.0 in December to 49.8 in January, meaning that activity fell marginally. Markit noted that “a rise in COVID-19 infections and issuance of a state of emergency dampened operating conditions. Despite broad stabilization in December, the decline in January meant that the sector has not registered growth since April 2019.”
Meanwhile, Japan’s services PMI fell from 47.7 in December to 46.1 in January, a level indicating a significant decline in activity. The worsening was likely due to the implementation of a state of emergency meant to fight the virus. Both output and new orders contracted sharply. Businesses expressed hope that the vaccine will improve the situation. However, they expressed concern about whether the summer Olympic games in Tokyo will be able to take place.
The manufacturing PMI increased from 57.1 in December to a record high 59.2 in January. This means that the sector grew very rapidly. Output grew at the fastest pace in more than five years and new orders increased at the fastest pace in more than six years. The only thing holding back the sector were supply chain disruptions and shortages of raw materials. As a result, input costs accelerated, thereby leading to a surge in output prices. Thus, the sector is set to experience more inflation, at least temporarily. Markit noted that consumer and business demand is strong, which is helping to offset the weakness of consumer-facing services that are holding back overall economic growth.
The country bucked the global trend and experienced a sharp rise in its services PMI, which increased from 54.8 in December to 58.3 in January. This was the second-fastest increase in activity in six years. Most sub-indices improved, with strong growth in output, new orders, and export orders. Bottlenecks led to increased input prices and, consequently, prices of final output. The easing of some economic restrictions may have played a role in this improvement. The decline in the number of new infections might have convinced some consumers to become more comfortable with social interaction. The distribution of stimulus payments and enhanced unemployment insurance to households might have played a role as well. The improvement in the PMI is consistent with some other data pointing to a rebound in the US economy. For example, high-frequency credit and debit card data on consumer spending indicates a sharp upswing in spending in early January. Plus, it now seems very likely that the US Congress will pass a stimulus package similar in size to what President Biden has proposed. If so, this will likely have some positive impact on virus suppression, vaccine distribution, and consumer spending in the months ahead.
The US job market remains very weak. Last week, the government released the employment reports for January and the situation appears to be worse than many people had expected. Although there was growth in payroll employment, it was entirely due to rehiring of public-school teachers. Without that, there was no job growth. Moreover, the government reports that a large number of people dropped out of the labor force. As a result, the unemployment rate fell sharply. The report surprised on the downside, given some recent data that hinted at a better job market. The reality is that the job market is moribund, with employment remaining well below the level from just prior to the pandemic. The question now is whether the fiscal measures that are likely to soon pass the Congress will have a positive impact on hiring. And even any positive impact could be offset if the outbreak of the virus is not soon suppressed. The best hope, of course, is that the vaccine will be quickly distributed, thereby helping to suppress the outbreak and create confidence that it is safe to go out again.
Meanwhile, the government publishes two reports on the job market; one based on a survey of establishments, the other based on a survey of households. Let’s first consider the establishment numbers. In January, payroll employment increased by a very modest 49,000, after having fallen by 227,000 in December. Yet employment at local public-schools increased by 49,400. This means that there was no net improvement in other areas of the job market. Here are some details:
Overall, the establishment report paints a bleak picture of a stalled job market, with severe weakness in sectors that have been disrupted by the pandemic (such as restaurants and hotels), but also modest weakness in other sectors (such as manufacturing). The level of payroll employment in January remained more than 10 million below a year earlier, or down 6.3% from a year earlier. Moreover, average hourly earnings of payroll workers were up 5.4% from a year earlier. This is not because existing workers experienced big wage gains. Rather, it mostly reflects a shift in the composition of the workforce, with a substantial loss of low-paying jobs in consumer-facing service enterprises. Note, for example, that the number of jobs in restaurants is down 18.8% from a year earlier. In addition, the number of jobs in hotels is down 33.4%.
Meanwhile, the household survey revealed a decline in labor-force participation and a decline in the unemployment rate from 6.7% in December to 6.3% in January. The household survey includes self-employment. It found that the number of people participating in the labor force (either working or actively seeking employment) fell by 406,000 from last month and by 4.3 million from a year earlier. However, among college graduates, the number of people participating in the labor force increased over the past year. A disproportionate share of the decline in labor-force participation is attributable to women, nonwhite workers, and those with lower levels of education. As such, the trend from the past year exacerbated existing problems of inequality. Finally, the number of people reporting being unemployed for longer than 27 weeks increased from 1.2 million a year ago to 4.0 million in January 2021. These long-term unemployed remain participants in the labor force and are actively seeking work.
The report suggests that the labor market remains weak and disrupted. It reinforces the argument that the economy needs a boost from the government, a viewpoint shared by both political parties, but with disagreements about the size and composition of a package. In the Congress, the Democrats have begun to activate the process known as reconciliation in order to pass the proposed US$1.9 trillion package with a simple majority in the Senate. The details of the package have still to be worked out. It will likely include direct payments of US$1,400 to a large number of people who fall below a certain income threshold that has yet to be determined. The hope is that, because the money will likely go to those most in need, it is less likely to be saved. Some critics, such as former Democratic Treasury Secretary Larry Summers, say that the proposed expenditure is far more than is needed to push the economy back toward full capacity and that, consequently, it could ultimately cause a significant increase in inflation. The Biden administration, as well as Fed Chairman Powell, says that a large package is required to avert scarring of the economy and that there is greater risk of doing too little than of doing too much. They say that the economy is currently operating well below capacity and that government support can help to alleviate that situation as well as boost the earning power of those at the lower end of the income spectrum. The big unknown is how fast the vaccine will be distributed. The fiscal package includes money meant to accelerate distribution.
Investors evidently view the impending fiscal stimulus as likely to boost inflation, at least modestly. The so-called breakeven rate on 10-year bonds, which is an excellent proxy for investor expectations of inflation, increased to the highest level since 2018 at 2.17%. This means investors expect the average rate of consumer price inflation in the next decade to be 2.17%—slightly above the Federal Reserve’s target. The yield on the 10-year Treasury bond increased to the highest level since March 2020 at 1.16%. Although expectations of inflation have risen in conjunction with the change in fiscal policy, investors are evidently not concerned that there will be ruinous inflation. This implies that they expect the Federal Reserve to be willing to reverse policy should inflationary pressures become acute.
Global equity prices fell sharply last week when investors focused on the continued outbreak of the virus, the slow distribution of the vaccine, and the risks faced by economies, especially emerging economies, that fail to suppress the virus quickly. The number of new infections continues to be quite high in the United States, United Kingdom, and Spain, and has even risen sharply in Israel, which has vaccinated the largest number of people on a per capita basis. In the United Kingdom, the number of deaths per capita is the highest in the world and Britain is in the midst of a severe lockdown that could last a long time. Lockdowns are in place in other parts of Europe, with negative economic consequences. Meanwhile, despite worries about the potential impact of new strains of the virus, several large US states are easing economic restrictions, thereby raising fears of yet another surge in infections.
In this environment, there is a general consensus that, at least in the short run, economic activity is likely to be suppressed in the United States and Europe. Already retail sales and employment have declined in the United States. Indeed, Federal Reserve Chairman Powell said as much when the Fed announced a continuation of its existing monetary policy of low interest rates and asset purchases. The Fed stated that “the path of the economy will depend significantly on the course of the virus, including progress on vaccinations. The ongoing public health crisis continues to weigh on economic activity, employment, and inflation, and poses considerable risks to the economic outlook.” Some investors are concerned that, should a surge in inflation emerge, the Fed will likely choose to tighten monetary policy by raising interest rates or scaling back asset purchases. Yet Chairman Powell dismissed that idea. He said that, should there be an increase in inflation later this year or next, it will likely be “transient.” Specifically, he said, “We’re going to be patient. Expect us to wait and see and not react if we see small, and what we would view as very likely to be transient, effects on inflation.” Moreover, when asked about the possible inflationary impact of excessive fiscal stimulus, he said, “I’m much more worried about falling short of a complete recovery, and losing people’s careers and lives that they built, because they don’t get back to work in time. I’m more concerned about that than about the possibility which exists of higher inflation. Frankly, we welcome slightly higher inflation.” From Powell’s comments, one can infer that Fed policy is likely to remain accommodative for a long time.
While financial markets have recently exhibited euphoria about the potential impact of mass vaccination, there is now concern that the speed of vaccination will not be adequate—which partly explains the recent decline in equity prices. Moreover, there is some concern that new strains of the virus could be tougher to fight for the existing vaccines. Indeed, some pharma companies are looking at providing boosters to fight against the new and more contagious strains. So far, several worrisome strains have been identified, including those originating in the United Kingdom, Brazil, and South Africa. These have already found their way to other countries.
The virus strain that originated in South Africa is especially concerning. It is reported that, in January, the per capita number of deaths in Africa surpassed the global average for the first time, with the death rate in Zimbabwe rapidly rising to a very high level. And, even though 40 million vaccine doses have been administered worldwide, none of them have been administered on the African mainland with its more than one billion population. This alarming failure raises the possibility of a catastrophic surge in infections in Africa that could rapidly spill over into other parts of the world despite the best efforts to control travel. Moreover, the International Monetary Fund says that “inequitable distribution of vaccines risks exacerbating financial vulnerabilities, especially for frontier market economies.” Despite fears about the potential problems in emerging markets, equity markets in emerging countries performed well in January, driven by an inflow of foreign money. Yet this could quickly be reversed if it becomes apparent that the outbreak is likely to worsen economic prospects. Meanwhile, emerging countries are especially vulnerable to what happens in the rest of the world, given their dependence on remittances, tourism, commodity prices, and global manufacturing supply chains. And, advanced economies are vulnerable to what happens in the emerging world, given financial links, dependence on migrant workers, and dependence on stable supply chains.
Despite negative sentiment expressed by equity investors recently, there are reasons why some investors might have a positive disposition. In the United States, the Biden administration announced that it will order a quantity of vaccines that will be enough to inoculate most of the US population by the end of the summer. If the US government is successful in quickly distributing the large order, it could be a game changer for the US economy. In Europe, however, there continues to be concern about the ability to get the vaccine to the population. The European Union has warned vaccine producers that they must deliver to the countries that have placed orders or there will be restrictions on exports of vaccines made in Europe. The United Kingdom, however, warned about “the dead end of vaccine nationalism.”
The scale of disruption of the global labor market that took place in 2020 is now coming into focus, according to the International Labor Organization (ILO). Specifically, the ILO says that 8.8% of global working hours were lost in 2020 relative to the fourth quarter of 2019. That translates into about 255 million full-time jobs. This is about four times more than what took place during the global financial crisis in 2008-09. Moreover, the ILO’s baseline forecast is that there will be job growth in 2021, but not enough to offset the loss since the crisis began. As such, the ILO predicts that, for all of 2021, the loss of employment relative to the precrisis level will be the equivalent of 90 million full time jobs.
The ILO also noted the vast disparity in labor market disruption between different industries. Not unexpectedly, it said that a disproportionate share of job losses took place in accommodation, food service, arts and culture, and retail. At the same time, there was positive job growth in higher skilled service sectors, such as information and communication as well as financial services. Also, the ILO noted that government support programs helped to offset income losses in affluent countries, but not in many other countries. The biggest loss of working hours took place in countries classified as lower-middle income. By region, the biggest loss took place in the Americas region (in both Latin America, and the United States and Canada). The smallest loss of working hours took place in Asia Pacific and in Africa. Finally, more women than men suffered a loss of working hours.
The data provided by the ILO indicates the massive scale of the problem and suggests that the road to recovery could be difficult. With many jobs permanently gone, it will take time for many industries to recover and to reemploy disrupted workers. Some jobs may never come back as consumer and business behavior shifts in response to the pandemic. The skills mix will shift, leaving some workers behind and likely contributing to an increase in income inequality. From a public-policy perspective, an important imperative will be investment in human capital so that the skills mix of the workforce can better match the needs of employers.
The US economy grew at a decent pace in the fourth quarter, but not enough to bring real GDP back to the level from a year earlier. It appears that the outbreak of the virus in the fourth quarter took a toll, suppressing consumer spending growth, although consumer spending did grow even as consumer income declined. That said, business investment in equipment soared while investment in residential projects continued to grow rapidly. Thus, the economy offered a mixed picture in which some sectors suffered due to the outbreak while others recovered strongly. Still, the bottom line is that economic activity remains suppressed relative to where we were a year ago. Getting over that hump will require a full suppression of the virus, something that could happen this year if vaccine distribution is rapid.
Let’s consider the numbers. In the fourth quarter, real (inflation-adjusted) GDP increased at an annualized rate of 4.0% from the previous quarter. This came after we saw spectacular growth of 33.4% in the third quarter (which helped to partially offset the 31.4% collapse of GDP in the second quarter). Clearly, the economy decelerated in the fourth quarter. Indeed, fourth quarter GDP was 2.5% below a year earlier, indicating that we have not yet returned to the precrisis level. For all of 2020, real GDP was down 3.5% from 2019, the worst performance since 1946.
Going into the details, the weakness of GDP growth in the fourth quarter was largely due to consumer behavior. Overall consumer spending only grew at a rate of 2.5%, with spending on durable goods remaining unchanged and spending on nondurable goods dropping 0.7%. As for durables, there was an increase in spending on automobiles but a decrease in spending on furnishings and recreational goods. The only major category of consumer spending that grew was in the services category (up 4.0%), but this was almost entirely due to a sharp increase in spending on health care. Other service categories, such as food service and transport services (airlines), declined. The weakness of consumer spending was consistent with weak employment growth. In addition, real disposable personal income declined at a rate of 9.5% in the fourth quarter, largely due to the expiration of some forms of government support. The fact that spending grew at all signals that households saved less and dipped into their savings. The stimulus package that the Congress passed in late December will boost income in the first quarter of 2021. Also, if the Congress passes additional stimulus as requested by President Biden, there will be a further increase in income. It is not clear, however, if this will mostly be saved (which is what happened in early 2020).
Business investment did surprisingly well in the fourth quarter. Nonresidential fixed investment increased at a rate of 13.8% in the fourth quarter, including a 24.9% increase in investment in equipment. This included big increases in spending on transportation equipment as well as information technology. This makes sense—the huge increase in online shopping has likely boosted the demand for motor vehicles for delivery services. The increase in information technology likely reflects the fact that businesses are doing more things remotely. Notably, investment in equipment was up 3.4% from a year earlier, the first year over year increase since the third quarter of 2019. On a quarterly basis, investment in structures was up a modest 3.0% and investment in intellectual property was up a more robust 7.5%. The latter meant that businesses continued to spend on software and on research and development. Meanwhile, residential investment was up at a spectacular rate of 33.5%, reflecting the continued decision by numerous households to switch residences. Finally, inventory investment was strong in the fourth quarter, accounting for roughly a quarter of GDP growth.
Trade made a net negative contribution to GDP because imports grew more strongly than exports. Still, exports were up rapidly, with goods exports rising at an annual rate of 31.1% in the fourth quarter. Imports of goods were up at an annual rate of 30.8%. Finally, government purchases fell modestly in the fourth quarter, entirely due to a decline in purchases by state and local governments that have been financially distressed due to the pandemic.
Going forward, our Deloitte forecast is for negative GDP growth in the first quarter as the negative consequences of the current outbreak continue to take a toll on consumer behavior and employment. Naturally, the expectation is that the negative consequences will be concentrated in key industries that are most vulnerable to the outbreak. Nonetheless, if the Congress quickly passes another stimulus and distributes money to households, small businesses, and state and local governments, it could have a positive impact on the first quarter numbers. It would certainly have a positive impact on the second quarter numbers. Moreover, if the money going to households is focused on those most in need, then the result could be more impactful as it is less likely such money would be saved. Alternatively, the acceleration in the current spread of new strains of the virus could create further trouble, in terms of both public health and the economic outcome. The newer strains are reported to be more contagious and possibly deadlier. The degree to which current vaccines are successful in treating these strains is uncertain. Further uncertainty could hurt business investment. Added threats of the virus will certainly hurt consumer spending.
In December, personal income increased modestly from the previous month due, in part, to a rise in unemployment insurance benefits. Meanwhile, consumer spending declined in December for the second consecutive month. Moreover, that decline was across the board, encompassing durable and nondurable goods as well as services. Also, it is notable that, in December, real personal income was higher than a year earlier. Yet real consumer spending remained lower than a year earlier. However, that decline from a year earlier was entirely due to a sharp decline in spending on services. Spending on goods was up from a year earlier. The bottom line is that the consumer sector was worsening as the year ended, thereby setting the stage for a likely decline in real GDP in the first quarter.
Unless consumer spending suddenly increases significantly this month, it is likely that it will be a drag on GDP growth in the first quarter. The unknown factors that will determine the path of the consumer include the degree to which the virus is quickly suppressed (as of now, the number of new infections, while high, is declining); the speed at which the vaccine is administered; and the size and timing of new government stimulus. The last item will be a function of the current negotiations between President Biden and Congressional leaders.
In the fourth quarter of 2020, the Eurozone experienced a sharp increase in infections, leading many governments to impose varying degrees of economic restrictions. This led to expectations of weakened economic growth. We’ve now learned that economic growth did, indeed, decelerate in three major Eurozone countries, but not to the degree that had been expected. Specifically, GDP grew modestly in Germany and Spain in the fourth quarter but declined in France. In Germany, real GDP increased 0.1% from the third to the fourth quarter but was down 3.9% from a year earlier. This was the fourth consecutive annual decline in real GDP. In Spain, real GDP was up 0.4% from the previous quarter but down 9.1% from a year earlier. For both Germany and Spain, the fourth-quarter annual decline was worse than the third-quarter annual decline. This means that, after starting to recover in the summer of 2020, both countries experienced a setback in the fourth quarter due to the outbreak of the virus. In France, real GDP fell 1.3% from the third to the fourth quarter, a serious decline but not as bad as some analysts had anticipated.
The weakness of these economies was largely due to weak consumer spending. For example, French consumer spending fell 5.4% in the fourth quarter while business investment and exports expanded. In Germany, household spending fell but investment and exports grew. Overall, these three important economies performed better than our own expectations, but there was evident weakness. Moreover, the current situation does not bode well for the coming months. The outbreak of the virus has continued, especially owing to the rampant spread of new strains. Many governments continue to pursue lockdowns in order to stifle the spread of the virus. This, in turn, suppresses consumer activity. Meanwhile, there continue to be difficulties in accelerating distribution of the vaccine. This raises questions about the timing of an ultimate strong recovery.