The Best and Worst of Times

Pandemic deaths continue to mount, but vaccine deployment and massive policy support will lift growth in 2021.

March 11, 2021


This Macroeconomic Outlook report is excerpted from the First Quarter 2021 Fixed-Income Outlook.

The U.S. economic recovery continued in the fourth quarter even as new COVID-19 cases surged, with real gross domestic product (GDP) increasing at an annual rate of 4.1 percent. As of January 2021, U.S. real GDP had retraced 85 percent of the decline that occurred in March and April of 2020, while employment had retraced 67 percent of its decline through February. Nevertheless, output and employment remained 3.6 percent and 5.4 percent below their February peaks, respectively, much worse than during the first year of past downturns.

Employment Remains Considerably Below Pre-Covid Levels

U.S. Employment During Recessions, Cumulative Change From Cycle Peak

As of January 2021, U.S. real GDP had retraced 85 percent of the decline that occurred in March and April of 2020, while employment had retraced 67 percent of its decline through February. Nevertheless, output and employment remained 3.6 percent and 5.4 percent below their February peaks, respectively, much worse than during the first year of past downturns.

Employment Remains Considerably Below Pre-Covid Levels

Source: Guggenheim Investments, Haver Analytics, BLS. Data as of 2.28.2021.

The good news is that several highly effective COVID-19 vaccines have begun to be distributed in the United States and elsewhere. With herd immunity likely attainable this summer, we expect the beleaguered service sector to experience a strong recovery in 2021 as the need for social distancing gradually diminishes. In addition, consumers—already holding excess savings of roughly $1.8 trillion—are seeing a further boost to disposable income as the $900 billion stimulus bill passed in December shows up in the data. Nearly $1.9 trillion in additional stimulus is set to be passed imminently. The combination of progress in the fight against COVID-19, massive fiscal stimulus, and extremely easy financial conditions should boost real GDP growth to 6–7 percent in 2021, the strongest since 1984.

We expect the Fed to do its part to support the recovery, guided by a new and more dovish policy framework. The Fed will no longer aim to cool an overheated labor market but will instead strive to overshoot the 2 percent inflation target in order to compensate for past periods of below-target inflation. While headline inflation is certain to rise in coming months due to sizable base effects, policymakers' focus is on the much weaker underlying inflation trend in place. As core inflation lags real GDP by about 18 months, more sequential downside is ahead over the next several quarters, and the experience of the last expansion suggests the Fed will struggle to achieve its 2 percent inflation target, let alone exceed it on a sustained basis, based on globalization, demographics, and technological trends.

Fed Is Likely to Maintain Maximum Accommodation as Inflation Falls Short

Cumulative Core PCE Inflation Shortfall From 2 Percent Target Since Business Cycle Peak

As core inflation lags real GDP by about 18 months, more sequential downside is ahead over the next several quarters, and the experience of the last expansion suggests the Fed will struggle to achieve its 2 percent inflation target, let alone exceed it on a sustained basis, based on globalization, demographics, and technological trends.

Fed Is Likely to Maintain Maximum Accommodation as Inflation Falls Short

Source: Guggenheim Investments, Haver Analytics. Data as of 11.30.2020. Note: Dotted purple line shows Guggenheim forecast for cumulative core PCE shortfall at the end of 2023 rather than the precise forecast path.

These conditions virtually ensure that the Fed will keep its policy rate at zero for at least the next several years while maintaining an aggressive pace of Treasury and Agency MBS purchases well into 2022. Our expectations for the path of Fed policy in coming years translate into a fair value estimate for 10-year Treasury yields of 0.85 percent, indicating that yields have risen too far too fast, aided by bearish seasonals. We see a constructive near-term backdrop for credit markets as deeply negative real interest rates and low FX hedging costs will spur a reach for yield. A key risk to our bullish view on credit is the emergence of several new strains of COVID-19, which raises the prospect of a much longer and deadlier battle against the coronavirus.

—Brian Smedley, Head of Macroeconomic and Investment Research; Maria Giraldo, CFA, Managing Director; Matt Bush, CFA, CBE, Director

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. It contains opinions of the authors but not necessarily those of Guggenheim Partners or its subsidiaries. The authors’ opinions are subject to change without notice. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. Past performance is no guarantee of future results.

Investing involves risk. In general, the value of fixed-income securities fall when interest rates rise. High-yield securities present more liquidity and credit risk than investment grade bonds and may be subject to greater volatility. Asset-backed securities, including mortgage-backed securities, may have structures that make their reaction to interest rates and other factors difficult to predict, making their prices volatile and they are subject to liquidity risk. Investments in floating rate senior secured syndicated bank loans and other floating rate securities involve special types of risks, including credit risk, interest rate risk, liquidity risk and prepayment risk. Guggenheim Investments represents the following affiliated investment management businesses of Guggenheim Partners, LLC: Guggenheim Partners Investment Management, LLC, Security Investors, LLC, Guggenheim Funds Investment Advisors, LLC, Guggenheim Funds Distributors, LLC, GS GAMMA Advisors, LLC, Guggenheim Partners Europe Limited, and Guggenheim Partners India Management.

©2021, Guggenheim Partners, LLC. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC.


FEATURED PERSPECTIVES

Despite the Gray Mood, Skies Are Only Partly Cloudy - Featured Perspectives
May 24, 2022

Despite the Gray Mood, Skies Are Only Partly Cloudy

The outlook for credit amid rising inflation, monetary tightening, and war in Europe.

Fed Aggressiveness Following Delayed Liftoff Sets Up 2023 Collision - Featured Perspectives
May 18, 2022

Fed Aggressiveness Following Delayed Liftoff Sets Up 2023 Collision

The risks of tightening into a downturn.

For Lessons on Fighting Inflation, Skip Over Volcker to 1946 - Featured Perspectives
March 22, 2022

For Lessons on Fighting Inflation, Skip Over Volcker to 1946

Clues from history on how to successfully end the current surge in prices.


VIDEOS & PODCASTS

Market Outlook 

First Quarter 2022 Market Outlook

Maria Giraldo, CFA, Managing Director, Investment Research, and Evan Serdensky, Director, Portfolio Management, provide our macro and markets outlook.

Macro Markets Podcast 

Macro Markets Podcast Episode 15: Mid-Term Election Markets, Currencies, the Neutral Rate

Paul Dozier on how stocks have performed in midterm election years, and head of foreign exchange Cameron Crosby discusses the currency markets.