The Economic Outlook 2021 – the Year of Expected Recovery

February 25, 2021

George Mokrzan, Ph.D., Director of Economics The Economic Outlook 2021 – The Year of Expected Recovery

American consumers started the year off doing what they do best – spending. After a disappointing holiday shopping season, retail sales bounced back 5.3% in January from December - five times market expectations and the highest percent gain since June. The strong start to the year signaled that the anticipated acceleration of economic growth in 2021 had begun. Real GDP is forecasted to grow at 5.7% in 2021, upwardly revised from 4.7% in the previous forecast. The distribution of vaccines to the most vulnerable parts of the population, fiscal stimulus from the $908 billion Coronavirus Response and Relief Supplemental Appropriations Act, and monetary stimulus from the ongoing massive Federal Reserve response to COVID-19 are expected to sustain the overall economic recovery that began in the third quarter of 2020. Consumer spending in service industries negatively impacted by the COVID-19 pandemic will likely accelerate broadly in 2021 after the distribution of vaccines reduces health risks, especially to the most vulnerable in the population. This spending will augment already strong consumer spending on goods and housing. Residential investment has been especially strong and is expected to continue. GDP Projected to Grow Strongly in 2021

The recovery in the U.S. economy will likely be replicated in other parts of the world as timely vaccine developments coupled with policy stimulus abroad create a synchronized international economic recovery, supporting a continued rebound in international trade. Labor markets are expected to be soft in the first quarter before resuming a strong upward trend, with the unemployment rate ending the year at 4.5%. Inflation is expected to rise 2.6% for the year, upwardly revised from the previous forecast of 2.3%. Inflation risks are expected to remain to the upside this year as large parts of the services economy reopen from COVID-19 limitations. Inflation is anticipated to remain on a rising trend in 2022 as economic stimulus continues to pour into the economy from historic levels of monetary and fiscal policy.

The Fed Funds rate target is expected to reside in the 0.0% - 0.25% range throughout this year as the Federal Reserve will likely be cautious not to forestall the recovery. Central bank bond purchases are downward forces on government bond yields, thereby posing a constraint on long-term interest rate increases this year. However, with economic growth and inflation normalizing, the depressed 10-year Treasury yield is forecasted to climb to 1.75% by year-end, returning to its range during the 3-month period prior to the COVID-19 crisis. Interest rates and inflation are likely to push higher in 2022 if highly accommodative monetary and fiscal policies become permanent – a risk that could create unintended consequences.

The forecast solely incorporates fiscal policies approved by Congress as of the time of this publication. If further fiscal stimulus measures to counter the COVID-19 crisis are enacted, then the forecasts for GDP, inflation, and market interest rates would likely be revised upwards, depending on the specifics of any new legislation.

Retail Sales Revive in January

After slowing during the COVID-19 impacted fourth quarter, retail sales rose strongly by 5.3% from December to January. Retail sales not only rose from December, but also were up significantly over January of last year, a month before COVID-19 became an impediment to spending. Vehicle sales were up 13.0% in January over last year, retail spending excluding vehicles was up 6.1% YoY, and retail spending that excluded vehicle and fuel sales was up 7.6%.

Spending increases were broad-based, but clearly reflected consumer adaptation to COVID-19 restrictions. Spending on the home was high as sales at Building Materials and Garden Supply stores were up 19.0% from January 2020. Furniture and Home Furnishings also rose +5.0% YoY. Consumers continued to spend highly on Food and Beverages (+11.8% YoY), Health & Personal Care (+6.2% YoY), and General Merchandise (+5.9% YoY). Consumers occupied themselves with Sporting Goods and Hobbies, up +22.5% from last January. They also continued to have goods delivered to their homes from Non-store Retailers, up +28.7%. Not all industries benefitted from the at-home lifestyle. Spending was down -7.8% YoY at gasoline stations, down -11.0% at Clothing and Accessories stores, and down -16.6% from January 2020 at Food Services & Drinking Places. As vaccines become more widely distributed to the population and consumers increase travel and dining outside the home, sales are expected to increase significantly in industries dependent on mobility and social contact.

The strong retail spending surge in January reflects a consumer that is able and willing to spend. Stimulus checks to consumers from the $908 billion Supplemental CARES Act was a boost to personal incomes and spending in January. A generally sound average consumer in conjunction with increased vaccines, the end of the flu season, and the release of high pent-up demand will likely lead to strong consumer spending in the coming months and in 2021 overall.

Retail Sales Start the Year Sharply Upwards

Commodity Prices Stage A Strong Rebound

Commodity Prices rose strongly in early 2021, continuing a whipsaw recovery from precipitous declines in March and April of last year. The V-like economic recovery in the United States and much of Asia, coupled with extraordinary monetary stimulus by central banks across all continents, have helped to restore prices across the commodity space. The prices of a broad range of metals, industrial materials, foods, and even beleaguered energy products have been rising strongly. In addition to global recovery and open monetary spigots, massive fiscal policy support is adding fuel to the aggregate demand increase that is driving overall commodity price increases.

Commodities Becoming Valuable Again

At its highest level since September 22, 2014, the highly followed CRB Commodity Price Index rose 18.1% between February 15, 2020 and February 15, 2021. (Please see the above chart. The period marked in grey is the official National Bureau of Economic Research recessionary period). The CRB index is comprised of a broad range of non-energy materials. The Metals sub-index includes copper, lead, steel, tin, and zinc. Foodstuffs represent 10 commodity markets such as grains, beans, pork, and steers. Industrial materials encompass materials such as burlap, other textiles, rubber, and resins. Metals have risen the most, but all commodity types have been moving upwards.

The strong recovery in commodity prices has raised the question of whether inflationary pressures are rising. To examine this question, we focus on another commodity price index produced by the Foundation for International Business and Economic Research (FIBER) – the FIBER Industrial Materials Price index. This index is comprised of many of the same Metals and Industrial Materials that are part of the CRB Commodity Price index. It also includes Crude Oil and Benzene and excludes foodstuffs. The index’s history aligns with inflationary and non-inflationary periods in the United States. Periods when the index is rising strongly tend to coincide with high inflation periods. Periods when the index is relatively stable tend to align with low inflation periods. In the chart below, the FIBER Industrial Materials Price Index rose strongly during the high inflation period of the 1970s. It also rose during the first decade of the New Millennium (2000s). While inflation in the CPI-U during the 2000s did not reach the high rates of the 1970s, high inflation did occur in housing markets – the boom that led to the housing bust and Great Recession. The years leading up to the Great Recession also experienced high growth in energy prices.

Commodity Prices as Inflation Indicators

FIBER Industrial Materials Price Index Log Scale 5.5 5.5

5.0 5.0

4.5 4.5

4.0 4.0

3.5 3.5

3.0 3.0 616365676971737577798183858789919395979901030507091113151719 Most Recent Data: January 2021

In the first half of 2020, the FIBER Industrial Materials Price index declined briefly below the low range of the index for the first time since the Great Recession. The recovery in the index has been quick and sharply upwards to a level today that approaches the highs of the index over the last decade. If the index stabilizes and remains within its upper range of recent years, then its activity would be consistent with the continuation of a stable overall inflation environment. On the other hand, if the index breaks to higher levels in the months to come, then the indicator would point to rising overall inflation. We will be watching this indicator of inflation and others in the coming months, especially given recent developments in the expansion of the money supply.

Money Supply at Historic Highs

Since the COVID-19 shutdowns in March and April, money supply has made a meteoric ascent. The Federal Reserve and other central banks around the globe commenced massive bond buying programs to bring down long-term interest rates and provide needed liquidity. These purchases swelled their balance sheets and injected correspondingly large quantities of reserves into the banking system. Please see the following chart. In turn, the banking system multiplied these high-powered reserves into record money supply growth in a process known as the Money Supply Multiplier, in which bank lending and purchases of securities lead to deposit growth throughout the banking system. M2 grew a record 25.8% in January compared to January 2020. MZM (zero maturity) grew the most since November 1983 at 29.3% in May and has come down somewhat since then. M1, comprised of demand deposits and currency, grew a historic 69.7% in the last year.

Global Central Bank Bond Buying at Historic Highs Triggers Record Expansion of Liquidity

Global CentralBank Assets on BalanceSheets (local currencies)

8,000 Bank of 8,000 England (mil. 7,000 Pound) 7,000 7901.65 6,000 Federal 6,000 Reserve 5,000 5,000 ($bil) = 4,000 $7442.23 4,000 Bank of 3,000 Japan (bil. 3,000 Yen) = 2,000 7105.64 2,000 ECB (bil. 1,000 Euro) = 1,000 0 7054.47 0 '06 '07 '08 '09 '10 '11 '12 '13 '14 '15 '16 '17 '18 '19 '20 H.4.1. Assets Of All Federal Reserve Banks, Assets, Excl. Eliminations From Consolidation, Mil USD - United States / 1000 (Consolidated Central Bank Balance Sheet of the Eurosystem, Assets/Liabilities, Mil EUR - Euro Zone) / 1000 (((Central Bank Balance Sheet, Assets,Thous YEN - Japan) / 1000) / 1000) / 100 (Central Bank Balance Sheet, Liabilities, Reserve Balance, Mil GBP - United Kingdom) / 100 Recession Periods - United States

The historic injection of reserves and subsequent money supply growth are highly supportive of economic recovery from the COVID-19 downturn. Monetary policy will continue to provide stimulus to the recovery throughout 2021 and 2022 as well. However, high money supply may have negative long-term ramifications for inflation after the recovery occurs if money supply is not reduced to long-term normal levels. Temporary reductions in money velocity should help to contain inflationary pressures in the short-term, but the eye- popping levels of money supply expansion will likely need to be contained in the years to come. In response to the outsized increases, the Federal Reserve is expected to begin to taper its current asset purchases of $120 billion per month ($80 billion in U.S. Treasury securities and $40 billion in MBS) as soon as the unemployment rate recedes to a level close to the structurally achievable unemployment rate. We expect this tapering to occur next year, with the Federal Reserve beginning to prepare financial markets for the actions by the fourth quarter of this year. Other central banks worldwide will likely follow suit as their respective economies approach sustainable growth at their respective full employment levels.

Historic Expansion of Money Promotes Economic Recovery but Creates Long-term Inflation Risks If Allowed to Persist

Business Sales Recover in Goods Sectors of the Economy

Business Sales in the goods areas of the economy were 2.6% higher in December 2020 than in December 2019, reflecting recovery from the COVID-19 downturn that froze activity in the early part of the year. The magnitude of the drop in Business Sales in April (-18.4%) was dramatic, but short. Sales bounced back broadly as soon as economic restrictions imposed to contain the spread of COVID-19 were lifted. As a result, Retail, Wholesale, and Manufacturing areas of the economy entered 2021 on sound footing as sales have returned to normal expansionary growth rates in all three sectors.

Business Sales Broadly Growing Business Sales -- Seasonally Adjusted 12-Month Percent Change 20 20

10 10

0 0

-10 -10

-20 -20

-30 -30 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Total Business Manufacturing Wholesale Trade Retail Trade Most Recent Data: December 2020

Lean Inventories

Swings in inventories have been as dramatic as the swings in sales. Business inventories had become bloated overnight with the economic shutdowns in March and April 2020, spiking Inventory-to-Sales ratios. However, Inventory-to-Sales ratios declined rapidly as sales resumed. By August, the total Business Inventory-to-Sales ratio had stabilized, albeit at a low level overall compared to the pre-COVID-19 period. The Wholesale Inventory-to-Sales ratio had returned to pre-COVID-19 levels and the Manufacturing Inventory-to-Sales ratio had returned to a level somewhat above the pre-COVID-19 period, but the Retail Inventory-to-Sales ratio had declined to record low levels. Tight inventory levels create strong incentives for production growth, and 2021 will likely become a year of inventory rebuilding. The alternative is foregone sales, which businesses will counter with herculean efforts.

Inventories Tighten with the Return of High Sales Inventory to Sales Ratios 1.70 1.70

1.60 1.60

1.50 1.50

1.40 1.40

1.30 1.30

1.20 1.20

1.10 1.10

1.00 1.00 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 Total Business Manufacturing Wholesale Trade Retail Trade Most Recent Data: December 2020

Manufacturing Outlook Remains Strong on High Orders

New orders for durable manufactured goods in January rose to the highest level since July 2014. Compared to January 2020 (pre-COVID-19 downturn), total new orders for durable goods were up 6.3%. Annual growth was broad-based, with Primary Metals up 6.3%, Fabricated Metal Products up 4.9%, Machinery up 6.3%, Computers and Electronic Products up 9.4%, Electrical Equipment & Appliances up 8.5%, and Motor Vehicles up 7.8%. Besieged by technical issues and lower travel demand, the Civilian Aircraft & Parts orders group was the only major category showing annual declines in new orders. Semiconductor and labor shortages will likely challenge manufacturers in the coming months, but the order pipeline is generally strong.

New Orders for Durable Goods Make V-like Recovery

Equipment Leads Private Sector Investment

Business equipment investment commenced a V-like recovery in the second half of the year that is projected to continue into 2021. Growth in equipment spending has been broad-based, encompassing transportation equipment, industrial equipment, information processing equipment and other categories. New orders for Non-defense Capital Goods Excluding Aircraft have continued to reach new highs. Businesses in all sectors are investing to increase productivity. In addition, Manufacturers are increasing capital investment to counter growing labor shortages.

New Orders for Business Equipment Rise to Record High in January

Investment in Non-residential Structures Lagging Equipment Investment

Business investment in equipment in Q4 2020 was 3.5% higher than in Q4 2019, representing full recovery from the COVID-19 downturn. Intellectual property products, such as software and research & development, also achieved annual growth, at 1.6% in the fourth quarter. However, not all sectors in Non-residential investment have recovered to date. Spending on private Non-residential Structures was down -14.5% from Q4 2019 to Q4 2020. COVID-19 related closures and restrictions froze non-residential building activity early in the crisis, and the recovery has been slow in this area. Uncertainty regarding future demand may be weighing on these large capital investment projects. Businesses are challenged by a host of questions created by the pandemic: brick and mortar vs. online, urban vs suburban & rural, work from home vs traditional commute, coastal states vs. interior states, and other potential long-term changes in structure demand. The answers to these and other questions will ultimately be revealed as the COVID-19 crisis ends and activity enters the new normal. The only question is exactly what that new normal will be?

Recovery Lags in Nonresidential Fixed Investment Through the Fourth Quarter

Industrial Production Continued V-Like Recovery in January

Industrial Production rose 0.9% in January, bringing total industrial production within 1.8% of full recovery from the COVID-19 downturn. Leading the industrial production gains, Consumer Goods production grew 2.8% from January 2020 on broad-based gains in both Consumer Durable Goods and Consumer Nondurable Goods. Defense and Space Equipment production was also up 4.6% in the last year. Other major areas of Industrial Production rose in January but had not fully recovered to pre-pandemic levels. In January, Business Equipment was -3.8% YoY, Materials was -3.4% YoY, and Non-industrial Supplies (business and construction) were -4.0% YoY. Full output recovery in these areas is expected in the coming months as production catches up with increases in demand and prices. However, reports of shortages in semi-conductors could provide impediments to production in areas of the economy such as vehicles, reflecting the continued need for supply diversification and onshoring of critical components used in manufacturing.

Consumer Goods Lead Industrial Production Rebound

By industry group, Mining production led with 2.3% growth between December and January but was still down -11.5% from levels in January 2020. The sharp drop-off in energy prices last year, to negative prices at one point, discouraged energy production. Recent increases in the price of crude oil into the $60 - $70 range should increase incentives for production going forward. Manufacturing rose 1.1% and was only -1.1% below January 2020 output levels. Utilities declined -1.2% from December, but activity at utilities was above a relatively warm January 2020 by 6.6%.

Industrial Production is expected to continue to improve as strong new orders, tight inventories, rising prices, and increasing overall activity in the economy lift production plans in 2021, with annual expected growth in the 4-5% range.

World Economy Is Recovering

Although the United States has led developed economies in recovery, it was clearly not alone in making a V- like recovery during the summer months of 2020 after the first outbreak of the virus shut down significant parts of the world economy. By September, Total Retail Sales in Advanced Economies were up 3.3% YoY. While the U.S. represents the largest share of the Advanced Economies index at 43.3%, the EA-19 (Eurozone) garnered 27.8% of retail share and Japan added another 10.4%. Although the virus worsened in virtually all parts of the globe during the 2020/2021 winter months, the strong and immediate recovery in retail sales last year suggests that consumers worldwide will likely spend at high levels once restrictions lift and normal social activities resume. The worldwide distribution of vaccines is not even, especially towards many emerging market economies, but the clear impact of vaccinations is positive on economic growth no matter what the location.

V-Like Recovery in Retail Sales Across Advanced Economies in 2020

The economic recovery has broadened across the globe. World trade has returned to pre-COVID-19 levels in November. (Source: CPB Netherlands Bureau for Economic Policy Analysis). Led by the United States and Asia, business, consumer, and investor expectations have risen dramatically from the depths of the crisis. According to Sentix, expectations have risen to a record high for the data, even as current conditions have remained well off the highs of recent years.

International Sentiment is Generally Rising

All countries incurred damage to labor markets during the crisis, although most advanced countries other than the United States employed direct subsidies and directives to companies to maintain employment levels in the face of temporarily weak demand, with various success. The Paycheck Protection Program is comparable to these programs in that it provided grants to small businesses that maintained certain employment levels. However, the degree of labor markets centralization in advanced economies is generally much higher abroad than in the United States. Although that degree of centralization offers protection to workers on the downside, it generally does not provide as much lift to employment on the upside. This flexibility in labor markets is an attribute when the economy is recovering and growing – as it is doing now. United States labor markets are generally more dynamic than other advanced economies, leading to wider swings in employment and unemployment during the COVID-19 downturn and recovery.

Labor Market Responses Vary Among Advanced Economies

Regardless of the form of stimulus utilized, sovereign debt rose in virtually all countries during the pandemic induced downturn. Fiscal policy has generally been successful in promoting economic growth, assisting consumers, and businesses to weather the sharp drop-off in economic activity. However, it also added to high levels of debt that had already been amassed prior to the crisis. High debt relative to GDP can ultimately hinder long-term economic growth. As the chart below indicates, the emerging market economies generally have less debt weight, especially since their GDP denominators will likely grow faster than the GDP denominators in the advanced economies. The policies that impact GDP growth in the long-term are just as important, if not more so, than the actions that directly impact debt. This is especially true of the advanced economies, given their mature state and slow population growth. High debt relative to GDP growth will likely be the biggest long-term challenge in the economy, both domestically and internationally, in the coming years.

Debt-To-GDP Rises Across the Globe to Counter COVID-19 Downturn

Top-10 Economies by GDP >>> Central Government Debt as % of GDP 240 240 Japan = 220 219.59% 220 Italy = 200 200 154.20% 180 US = 180 129.28% 160 Canada = 160 119.30% 140 140 France = 120 116.50% 120 UK = 100 100 101.00% 80 Germany = 80 70.00% 60 Brazil = 60 40 63.02% 40 China = 20 India61.70% = 20 57.49% 0 0 '91 '93 '95 '97 '99 '01 '03 '05 '07 '09 '11 '13 '15 '17 '19 '21 Government consolidated gross debt, General Government, % of GDP - United Kingdom Central Government Debt to GDP Ratio, Percent - Japan Federal Debt, Total Amount Outstanding As Percent of GDP, Percent - United States WEO Forecast, General Government Gross Debt, % of GDP, Percent - China Government Consolidated Gross Debt, General Government, Percent Of GDP - France Government Consolidated Gross Debt, General Government, Percent Of GDP - Germany Gross Government Debt, As a % of GDP - India Government Consolidated Gross Debt, General Government, Percent Of GDP - Italy Public Debt, Net Debt, Percent Of GDP, Percent - Brazil Gross Government Debt, As a % of GDP - Canada Recession Periods - United States

Source: Factset and Huntington Southern Ohio/Northern Kentucky Economic Breakfast, February 17, 2021

Summary Table Key Economic Indicators February 25, 2021 272018 20120198 20202019 202021*20* Total Real GDP Annual Growth Rates 2.9% 2.3% -3.5% 5.7% 2012 Chained Dollars

Consumption 3.0% 2.6% -3.9% 6.6% Non-Residential Fixed Investment 6.4% 2.1% -4.0% 7.7% Residential Fixed Investment -1.5% -1.5% 6.0% 20.6% Exports 3.0% 0.0% -13.0% 9.3% Imports 4.4% 1.0% -9.3% 14.2% Government Purchases 1.7% 2.3% 1.1% 1.0% Change in Private Inventories $48.1 $67.0 $-80.9 $46.3 (Billions 2012 Chained Dollars)

Trade-Weighted Dollar Index (Jan. 2006 = 100) 115.6 114.7 111.56 109.0 Year-End Source: Federal Reserve

Nominal GDP 5.4% 4.1% -2.3% 8.1% Current dollars

Consumer Price Index for Urban Consumers 2.4% 1.8% 1.2% 2.6% (CPI-U) - Annual Rate

Federal Funds Rate Target 2.25% to 1.50% to 0.00% to 0.00% to Year-end range 2.50% 1.75% 0.25% 0.25%

10-year Treasury Note 2.69% 1.92% 0.93% 1.75% Year-end interest rate yield

National Income Pre-tax Corporate Profits 6.1% 0.3% -4.1%* 12.6% Average annual growth rate

Net New Average Monthly Non-Farm Payrolls 193K 178K -778K +625K (Thousands of Workers) Unemployment Rate – Year End 3.9% 3.5% 6.7% 4.5%

 Data Sources: Haver Analytics, Federal Reserve, Factset Inc., and other sources noted in text.

* Forecasts: Huntington Investment Management of the Private Bank, Division of Huntington National Bank

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