May market recap: GDP number and leading economic indicators promise significant growth
At month’s end, the U.S. Commerce Department confirmed the U.S. economic growth accelerated during the first quarter at an annualized rate of 6.4%, helped in large part by the large fiscal stimulus. In more good news, the number of Americans filing new claims for unemployment dropped to 406,000 for the week ending May 22, a pandemic low.
In the U.S., the Purchasing Managers’ Index (PMI) – a leading indicator of gross domestic product (GDP) growth or decline – rose to levels not seen since 2007. That caused the chief economist for HIS Markit to observe that the economy posted a “spectacular acceleration of growth.” The U.K. PMI saw similar record highs, while the Eurozone saw its fastest order book growth in 15 years. Among developed nations, Japan’s PMI lagged, as the country is experiencing another wave of COVID-19 infections.
In its monthly report on durable goods orders, the U.S. Census Bureau showed orders declined 1.3% in April, but hidden beneath the overall number was the fact that orders for capital goods increased 2.3% during the same period. That seems a positive sign that companies are making the investments that could increase the supply of goods and keep pace with rising demand levels. In effect, it serves as an indication that the Fed may be right (see next section) in its view that inflationary pressures are short-term and containable over the long-term.
Inflation: Fed still believes it’s not a long-term concern
After a downward shock in 2020, tailwinds from reopening the economy conspired in April to drive inflation significantly higher. However, nearly 60% of the month-over-month increase in headline inflation1 was composed of just five components -- used cars, rental cars, lodging, airfares, and food away from home. These price hikes may be very transient in nature, and simply represent the goods and services that are in high demand as the economy reopens. The U.S. Federal Reserve and Treasury Secretary Janet Yellen emphasized this point and seemed to dismiss those who believed that persistent inflation would be an issue. A very weak auction on May 20 for 10-year TIPS (Treasury Inflation Protected Securities) seemed to support the Fed’s view of inflation.
Is the Fed ready to think about tapering again? FOMC meeting minutes suggest maybe
The reported minutes of the Fed’s May Federal Open Market Committee meeting delivered a big surprise. The minutes stated:
- "Many participants highlighted the importance of the Committee clearly communicating its assessment of progress toward its longer-run goals well in advance of the time when it could be judged substantial enough to warrant a change in the pace of asset purchases.”
- “The timing of such communications would depend on the evolution of the economy and the pace of progress toward the Committee’s goals.”
- “A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”
The asset-purchase program is a major component of the Fed’s accommodative monetary policy. Any plans to reduce the scale of the program – or “taper” – would have major implications. In its announcements after previous meetings, the Fed has clearly indicated it is not yet ready to begin tapering. But these minutes created some confusion. Is the Fed really thinking about tapering? The message was akin to saying merely, “We’re thinking about thinking about tapering.”
The stock market seemed to shrug off the mixed signs, as it rallied in the aftermath of these confusing minutes being reported. Still, the month-end GDP numbers will provide a good indication of the pace of the economic recovery. The final steps taken to fully reopen the economy will play a critical role, as will the pace of the lifting of supplemental unemployment benefits that some believe have been a disincentive for workers to find new jobs.
While on the path to recovery, the U.S. still seems to be waiting for Europe to catch up. It has been difficult for U.S. bond yields to rise any higher when the yields on so many other countries’ bonds remain so much lower.
While no one expects that the Fed will just suddenly announce it will begin tapering, the latest minutes suggest the Fed has begun setting the stage for when it will.
Bitcoin sells off, raising questions about its broad applicability
Bitcoin was especially volatile during the month. China’s ban, preventing finance firms from servicing crypto transactions, certainly had an impact. While that isn’t entirely new news, the ban’s continuing impact combined with the impact of a negative Tweet from Elon Musk, who has been a key proponent of Bitcoin. He expressed concerns about its environmental impact. On the surface, it may seem odd that a digital currency can hurt the environment. But bitcoin “mining” (the process of bringing new currencies into circulation) and the work of verifying transactions and maintaining the blockchain require intense computer power and that demands considerable energy. Further complicating matters is that two-thirds of bitcoin miners are in China, which is still heavily dependent on coal as an energy source. It is perhaps not a good sign for the future of the cryptocurrency that one person’s social media post could have such an outsized impact on its value.
The fact that the hackers of the Colonial Pipeline also requested – and received – a ransom in bitcoin also heightened concerns about how often Bitcoin is used to support illegal activity.
All these medium-turn headwinds have heightened talk of the need for the U.S. government to increase regulation on cryptos and issue its own digital currency.
The Bank of America Merrill Lynch released a survey this month, indicating that bitcoin was one of the most crowded trades. It has become increasingly clear that it presents a systemic risk that will have to be examined and addressed.
Federal Reserve Chair Jerome Powell has noted that cryptocurrencies have not served as a convenient way to make payments because of how widely they swing in value. Still, the Fed has suggested it may be open to issuing a U.S. CBDC (Central Bank Digital Currency). Chair Powell has said the Fed will issue a report on the topic this summer.
Unemployment: A discussion that needs context
While new jobless claims did drop, the level of unemployment remains a broad concern. Still, when you adjust for seasonality and account for people staying out of the workforce because of a lack of childcare (from closed schools and daycare centers), the low employment levels may be a transitory rather than sustained issue.
The same observation can be made about the fact that unemployment has remained high because of pandemic-enhanced unemployment benefits. Eventually that will roll off, and some companies, like Chipotle, McDonalds and Bank of America, have already taken steps to overcome any disincentives for returning to work by raising their wages.
If wages become artificially high, then inflation could become a problem, but the markets seem to believe these issues will work themselves out as the economic reopening continues to roll out.
It remains to be seen what the infrastructure legislation will look like and what its economic impact will be.
With the amount of excess reserves in the system and the volume of worker shortages, there is definitely a need for economic growth to catch up. But for the moment, few investors seem to be panicking about what it all means.
Taxes: Watching what the Biden Administration will do
The Biden Administration announced that the new higher capital gains tax rate for high income earners will be retroactive to April. The federal budget proposed for this year sets the top capital gains rate for those with more than $1 million of annual income at 43.4%, up from 23.8%. The April effective date means it is already too late for high-income earners to sell investments and try to capture the older lower capital gain rate.
The tax enforcement plans announced by President Biden target cryptocurrencies. The Administration’s proposal includes a requirement that digital currency transfers of at least $10,000 be reported to the IRS.
The Treasury Department also estimated that wealthy taxpayers are hiding more than half their income outside of wages and salaries. It is leading the charge on the President’s push for Congress to expand funding for the IRS and implement broad, new financial-transaction-reporting requirements.
To crack down on tax havens, the Administration has also proposed a global minimum tax whereby a company would pay at least a certain percentage of its profits in taxes, regardless of where in the world those profits are being earned.
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