BMO Harris Bank "US Economy: Déjà vu in ’22?"

Heading into a new year, a key question for the U.S. economy is: will it mirror the 2021 performance by rolling with the COVID punches and continue growing strongly, or will it struggle to fend off Omicron, inflation, and higher interest rates? We foresee the former scenario but have become more worried about the latter.

By most measures, 2021 was a bang-up year with estimated growth of 5.6% more than offsetting the previous year’s downturn. In fact, despite recurring supply-chain disruptions and virus waves, the economy looks to have grown a full percentage point faster than we expected a year ago (and 1½ ppts more than the consensus view). Stoked by stimulus cheques and pent-up demand for travel and in-person services, real GDP jumped over 6% annualized in the first half of the year, quickly recouping the output lost during the shutdowns. Although growth slowed in the third quarter as the emergency UI programs ended, it looks to have rebounded more than 5% in the fourth quarter. Meantime, the unemployment rate tumbled 2.5 ppts in eleven months to 4.2%, much faster than expected and within whispering distance of the half-century low plumbed before the pandemic. Homebuilders had their best year since the 2006 bubble, while resale prices spiraled 20% higher on strong demand.

Despite some near-term slowing due to travel restrictions, delayed back-to-office plans, and consumer anxiety about the new variant, the U.S. economy is expected to grow a hearty 3.5% in 2022, nearly double long-run potential. This forecast assumes no major new restrictions are needed to control Omicron, and reflects low interest rates, massive household savings, easing supply-chain disruptions, and some further fiscal support. So long as real policy rates are the lowest in four decades and deeply negative, the demand side of the economy should be ripping. The Fed’s rate hikes, perhaps starting in June, won’t sting until the following year. Households have amassed a stockpile of savings (partly from stimulus cheques), estimated at around $2½ trillion or 13% of disposable income, much of which is still parked in bank accounts. While supply glitches are hounding producers, it’s notable that American factories are operating above pre-pandemic levels, auto production is firming, and freight costs have fallen sharply from 13-year highs. Fiscal policy won’t provide nearly as much lift as in the past two years, but it could still provide a half-percentage-point boost to growth in 2022. This reflects new spending on infrastructure and, once passed into law, nearly $2 trillion of initiatives in the Build Back Better plan. The plan is focused on education, child and health care, and climate control, though the thrust of the measures will be spread over several years and mostly offset by higher taxes. Congressional Democrats are wrestling (with one member in particular) to push the plan over the finish line before the holidays. At stake is a possible suspension of the expanded Child Tax Credit in the new year, which has been fanning personal income by 1%.

Though expecting another strong year, we are less enthusiastic than the consensus view for 2022 (4%) due to Omicron, inflation, and worker shortages. While U.S. companies should have an easier time finding materials and parts, finding workers to fill the 11 million job vacancies will remain a challenge, barring a material upturn in the participation rate. Chair Powell said the jobs market is “hotter” today than in the last expansion, and our in-house measure of tightness backs him up. Should the worker shortage feed a wage-price spiral, it could keep inflation high for longer than the Fed expects, requiring aggressive tightening. For now, we expect the CPI rate to peak just above 7% early in the new year amid heated food and shelter costs, before moderating to around 3% by year-end as supply shortages ease and base effects wane. Besides inflation and Omicron, other potential risks to the economy include rising trade tensions with China (as well as with Canada and Mexico owing to proposed electric vehicle subsidies for U.S.-made vehicles) and a possible Russia-Ukraine conflict.

Given these potential landmines, 2022 will be anything but boring. But, with some luck, it should be a pretty good year for the U.S. economy.

Read important disclosures .

Sal Guatieri

Senior Economist and Director

 800-613-0205

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with two decades experience as a macro economist. With BMO Financial Group since 1994, his...(..)

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