William D. Johnston

Chairman

Economic Commentary

It is now clear that at the current daily average of vaccinations against COVID-19 in the United States, the country will not meet the 70% threshold until early August. The July goal was ambitious and assumed that the early two million per day vaccination rate would hold. The evidence is clear that it did not, and neither did the percent of initially vaccinated who returned for their second dose to become fully vaccinated. Our current seven-day average is holding steady at one million new doses, and when aggregated with the slightly over two hundred million fully vaccinated, it should push us to two hundred thirty five million, or seventy percent, by the first week in August. The silver lining in the demographic data is that those in our country most likely to have aggressive health issues when infected are more likely to have been vaccinated. This is good news for our healthcare system as well as for the future fatality rate of those contracting the disease. While the Delta variant is being widely talked about, the other silver lining is that both of the primary vaccines in use have shown great efficacy against the latest and apparently more infectious variant.

For the past sixteen months, we have argued that the economy could not get to recovery without COVID-19 being in remission. Data reveals that both of those important things are happening, which is really great news. Michigan remains in the top decile of states whose populations are fully vaccinated (56.3%), and particularly effective in those communities who are typically underserved in the health care system.

The New York Federal Reserve’s Weekly Economic Indicator (WEI) which measures production, consumption and labor data, retreated from its third week in May high of +11.43 and now measures +9.96. Recall that this measure is comparing economic activity (GDP) in real time vs. activity one year ago. Comparing the third week of June 2021 WEI data with the same period in 2020 suggests that our current run rate of GDP growth is +6.5%, further signaling that the recovery is not only well under way but is organically sustainable, which may put further pressure on the Federal Reserve and Treasury Department to adjust their paths in the forward cycles. Unlike other global central banks, the United States Federal Reserve has a dual mandate focused on stimulating employment while also containing inflation. If we look through that dual mandate lens, we can see the challenge for the Fed. U-3 Unemployment is currently at 5.8%, with growing participation rates and decreasing continuing as well as initial claims. Though this is solid progress it is a full two percent from where we were prior to the pandemic, and the Fed has signaled its continued policy of accommodation (maintaining very low interest rates) to further stimulate consumption, production and employment. They are doing so, though, in the face of increasing inflationary headwinds. The Federal Reserve’s tool kit is limited to a variety of interest rate levers. Some are subtle and others more robust, but their current statements and meeting notes affirm that their eye is more focused on the economy rather than inflation. My sense is that this administration and Federal Reserve leadership are more in sync than not. More about inflation in a bit.

The Treasury Department has everything to do with banking, which is the pathway of stimulus lending. They can, with congressional authorization, expand lending programs and define rules surrounding access and repayment as well as forgiveness of debt. The SBA payroll protection plans were examples of stimulus that aided employment and got money to consumers. Combined with the IRS, who the Treasury Department directed to send payments to taxpayers (with authorization from Congress), our economy began traveling the road of sustainability and then growth in the depths of the pandemic-created recession. Of course, overlaying all of these programmatic opportunities to assist the economy in times of great stress is the political dogma and will of the elected practitioners, mainly Congress and the administration.

Economic history illustrates that elected representatives increase their concern about inflation if their party is not in power, and conversely demonstrate less concern if they hold the keys to the kingdom. The Treasury Department and IRS can offer assistance to economic growth, but only with the authorization from Congress. The Federal Reserve on the other hand is mandated to serve its mission theoretically free from political will or dogma. Thus far, the Fed Chairman has signaled that there needs to be a duration of time to smooth the current data with respect to commodities and prices. His reasoning, augmented by the meeting notes and comments of other Fed Board Governors, is that the deep recession created by the pandemic and augmented by supply chain disruption has created false price/demand signals. Further, Chairman Powell has reiterated the desire to keep rates low for the next six to eight quarters, allowing pricing equilibrium of commodities to reflect actual supply and demand dynamics. Tightening rates now would endanger economic output, business capital investment, and continued employment growth according to Fed meeting note summaries. Actions always speak louder than words, but in this case we have Federal Reserve leadership laser focused on economic and employment growth backed up by both their words and deeds.

Both political parties know that Americans place economic prosperity at the top of their preferences. The common question in most election cycles is “are you better off than you were two or four years ago?” Economic recovery from the pandemic-created recession is on the Democrats watch, as is COVID-19 remission. The two are inextricably linked, and both parties know it. Infrastructure spending is again a top voter concern and each party needs and wants to control the narrative. The problem, as both parties are discovering, is of whom and what is their political base comprised. The administration has rolled out their proposed multi-trillion dollar infrastructure plan, and as expected it was met with significant Republican opposition. The Democrats have 476 days remaining of guaranteed legislative majority power. Republicans look at the same time period as an opportunity to regain legislative strength in either the House or Senate or perhaps both, and thus there is a stalemate with respect to a bi-partisan infrastructure bill. Continued economic recovery and COVID-19 remission diminishes Republican legislature’s opportunities to gain seats in the House; however, Democrats know that the redistricting that occurred due to the last census hugely benefits Republicans.

President Biden introduced a proposed infrastructure plan that included the platform specifics that he ran and was elected upon, which included elements that he knew were championed by a portion of his political base. He also knew that the breadth and specific focus of the proposal would never be endorsed or approved by the Republican leadership. The rollout was important because it provided the platform for bi-partisan discussions, which have now led to a deal that many in both parties don’t like. When the president was a young senator he could tell a legislative opportunity was near when neither party liked the deal. A part of the president’s political soul is bi-partisanship, and he views infrastructure as the best possible opportunity to achieve a significant bi-partisan political victory. His messaging isn’t subtle and the Republican leadership is not going to give him this victory without witnessing him abandon a part of his political base focused on the “Green New Deal.” Republican leadership assumes the following:

The president doesn’t have enough political capital to force a single party passage of his initially proposed infrastructure deal even though he has technical majorities in both the House and Senate.

Midterm elections will be close and are only 476 days away. The president’s approval and therefore his party’s approval will hinge on economic recovery, employment and COVID-19 remission.

A bi-partisan smaller infrastructure plan proposed by the president and passed by Congress doesn’t hurt Republicans, but may cause some erosion of the president’s base within his own party.

Deals like this take a long time and each day that passes also erodes political capital. My sense is that the infrastructure plan currently endorsed by the administration and leadership in Congress will pass, but that not much political capital will be won or lost by either side.