The Economic Outlook Broadening Economic Growth, High Inflation and Supply Challenges Continue

July 10, 2021

George Mokrzan, Ph.D., Director of Economics The Economic Outlook Broadening Economic Growth, High Inflation and Supply Challenges Continue

After a strong overall start to the year at 6.4% annualized growth in the first quarter, the economic recovery accelerated in the second quarter and is expected to continue in the second half of the year, although at a more moderate pace than in the first half of the year. Un-replicated in other large nations, the highly successful vaccine program in the United States is expected to bring domestic economic activity closer to pre- COVID-19 levels in the coming months, especially in the areas of the service economy most negatively impacted by the pandemic. Consumer spending on services is likely to increase significantly, with travel, tourism, and school-related shopping expected to provide a significant boost to consumer spending growth in the third quarter. However, supply constraints and high inflation will likely slow purchases of consumer goods relative to services overall, thereby slowing growth in the goods sector of the economy, which previously recovered the quickest from the COVID-19 related shutdowns. Vehicle sales will likely slow in the third quarter as the semi-conductor shortage has resulted in a significant reduction in retail vehicle inventory.

Monetary and fiscal stimulus will likely continue to maintain high levels of aggregate demand in the economy, but the peak in Federal aid has likely passed. Business spending on capital equipment is at record levels and is expected to be an added driver of economic growth in the second half of the year. Inventory rebuilding will also spur growth in manufacturing, although supply constraints will likely remain a challenge. International trade is recovering as the world economy experiences a largely synchronous recovery. However, COVID-19 remains a risk to many foreign economies as the flu season approaches in the fall. Vaccination success abroad has fallen short of the American standard in most foreign nations. Spending by state and local governments has been supported by the American Relief Plan and will likely exhibit strong growth in the next year. Housing investment is expected to grow strongly overall in 2021, although housing will likely encounter inflationary headwinds. The overall forecast for growth in real GDP in the United States is 7.2% in 2021, sufficiently high to offset the -3.5% decline in 2020. Coinciding with strong GDP growth, employment growth improved in June and is expected to grow solidly for much of 2021, bringing the unemployment rate down to 4.5% by year-end from 5.9% in June.

While the year will be one characterized primarily by economic recovery, inflation is also expected to rise at rates unfamiliar in recent years. Broad-based inflationary pressures have emerged that will likely result in annual inflation growth of 3.5% in 2021, well above 1.25% in 2020, and the highest since 2008. Inflation will likely rise 4.1% or more when measured on a 12-month basis in December. Numerous supply challenges and bottlenecks have emerged in restarting the economy including shortages of labor and material inputs. The worldwide shortage of semi-conductors is especially constraining to the production of vehicles and other modern products that require computer technology. Many of these challenges will be met by private sector adjustments in production and demand in the coming months, although uncertainty regarding the end of supply constraints is high. Overall inflation is expected to decline next year, making much of the current inflation temporary or “transitory” in the parlance of Federal Reserve policy makers. However, the current

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expansion of aggregate demand relative to constrained aggregate supply is historically high in magnitude, raising long-term inflation risks. The Federal Reserve will likely be cautious to not raise the Fed Funds rate target in 2021 so as not to forestall labor market recovery. However, the Federal Reserve is expected to begin to taper their asset purchases from the current $120 billion per month pace beginning in the fourth quarter of 2021. The Federal Reserve is also forecasted to begin to raise the Fed Funds rate target in 2022, ahead of many current market and policy maker projections.

Central bank bond purchases are downward forces on government bond yields, thereby posing a significant constraint on long-term interest rate increases this year. Challenges in reigniting economies abroad and concerns that the upcoming flu season would continue to restrain foreign economies with weak COVID-19 vaccine programs raised foreign demand for U.S. Treasuries, thereby suppressing long-term interest rates. International growth unevenness could exert continued downward pressure on long-term interest rates in the second half of the year. This potential demand for United States Treasury bonds from international sources was compounded by market realization that the Federal Reserve’s extraordinary monetary policy will end somewhat sooner than previously anticipated. This was communicated by Federal Reserve officials after the most recent meeting of the Federal Open Market Committee on June 22-23, 2021. Direct Federal relief to households is also past its peak, which will likely slow growth of consumer expenditures and economic activity from historically high rates in the first half of the year.

Volatility in long-term interest rates will likely continue in the second half of 2021. However, the current period of high uncertainty should diminish as the global expansion increasingly gains solid ground in 2022. Sustained national and worldwide economic growth, massive increases in money supply, an increase in long-term inflation over the previous 10-year period, and high deficit financing are forecasted to return long-term Treasury yields to levels last experienced prior to the COVID-19 crisis, with rates rising in the mid 2-3% range by mid-2022. Interest rates and inflation could rise even higher in 2022 if aggregate demand remains above aggregate supply for an extended period. In such a scenario, the dollar would also encounter downward pressure concurrent with a widening trade deficit and higher inflation.

Forecast risks remain elevated. High volatility is likely to continue in financial markets given the historic changes to economic activity and policy in the COVID-19 downturn and recovery. Enacted government policies are incorporated into the forecast, but newly authorized policies in the coming year(s) could also have significant impacts on the ultimate course of economic growth, inflation, job creation, and financial markets. The American Jobs Plan (AJP), American Families Plan (AFP), proposed federal budgets, and other proposed programs are not incorporated into the forecast as they have not yet been approved into law.

For the full forecast, please see the Summary Forecast Table at the end of this report.

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Real GDP Forecasted to Grow Strongly in 2021 Real GDP (Chained 2012 Dollars) 40 40

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-40 -40 I II III IV I II III IV I II III IV 19 20 21 1-Quarter Annualized Growth Rate 4-Quarter Percent Change Most Recent Historical Data: Q1 2021

Employment Picks Up in June

After a slow start to the quarter, total employment in the nation rose by 850,000 jobs in June bringing total job growth during the second quarter to 1,702,000. With social mobility returning with growing vaccination rates, the Leisure and Hospitality sector added 977,000 jobs. Supported by the American Relief Plan (ARP), Government jobs grew by 298,000. Gains during the quarter were broad-based, although Construction employment declined by 38,000. Employment grew a relatively modest 19,000 in Manufacturing and 17,000 in Mining over the quarter as many firms in goods related industries encountered challenges in hiring qualified workers. The national unemployment rate declined marginally from 6.0% in March to 5.9% in June.

Labor markets improved in June, but employment levels sadly remained well below pre-COVID-19 levels. At 145,759,000 in June, payroll employment was comparable to employment levels in January/February of 2017. Payrolls remained 6,764,000 shy of record high employment of 152,523,000 in February 2020 – the month preceding the extensive COVID-19 related shutdowns. However, on a relative basis, employment recovery of 15,598,000 or 69.75% has been substantial. This percentage should continue to rise in the second half of the year.

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Employment Recovering, but well below pre-COVID-19 Peak

Labor force participation changed little during the second quarter at 61.6%, remaining in a tight range of 61.4% - 61.7% since May 2020. Retirements and extended unemployment benefits are likely hampering labor force participation. The Federal unemployment assistance program ends in September, and many states have been opting out of the program before that time to incentivize workers to return to employment. However, a bright sign in June was a rise in the Labor Force Participation rate for the 25 – 54 age group, an age range when labor market participation is typically high. The Labor Force Participation rate for Prime working age individuals rose from 81.3% in May to 81.7% in June. Participation rates rose by 0.4% for women and by 0.3% for men.

Prime Age Labor Force Participation Improving, but well below pre-COVID-19 Peak

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Rising labor force participation was especially welcomed by small businesses, who have struggled to find qualified workers even as unemployment in the economy was high. Challenges in finding qualified workers reached pre-COVID-19 highs in the second quarter according to the NFIB survey of its member small businesses.

Small Businesses Struggling to Find Qualified Workers Again Small Businesses with Few of No Qualified Candidates for Job Openings Source: NFIB, Haver Analytics 63 63 60 60 57 57 54 54 51 51 48 48 45 45 42 42 39 39 36 36 33 33 30 30 27 27 24 24 21 21 18 18 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 Latest month plotted: June 2021

Total Employee Compensation rose at a 3.7% annualized rate in the first quarter for the largest quarterly increase since the third quarter of 2006. The strong increase in total compensation (including benefits) coincides with the highest Job Openings on record in the second quarter. Accelerating compensation growth is not typical in the early stages of the economic cycle when unemployment levels are usually elevated. In a major upward revision, employee compensation is forecasted to rise 3.6% annually, up from 2.6% in 2020. Total Employee Compensation averaged 2.3% in the ten years spanning 2011- 2020. Please see the following chart. The forecast of 3.6% applies for each of the next two years, and potentially for a longer period depending on the longevity of the current business cycle.

Employee Compensation Rising Strongly

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Inflation Rising Broadly

Inflation has been highest for products and services most impacted by the COVID-19 downturn and restart, but virtually all areas of the economy have encountered high inflation headwinds in the first half of 2021. Between May 2020 and May 2021, the Consumer Price Index for urban consumers rose 5.0%, the biggest 12- month increase since August 2008. When food and energy are excluded, the core Consumer Price Index rose 3.8% for the largest 12-month increase since May 1992.

The greatest increases in inflation have been in areas of the economy severely impacted by supply challenges in restarting the economy after the COVID-19 shutdowns. The price of used cars and trucks has risen 29.7% since May 2020 as the semi-conductor shortage significantly reduced the supply of vehicles produced during a period when demand was very high. Eventually, producers will overcome the semiconductor and other supply bottlenecks through increased production. High prices will also reduce demand. High prices and inventory shortages reduced new vehicle sales to a 15.4 million annualized rate in June after 3 consecutive months averaging 17.8 million.

While the highest inflation to date has been in goods, inflation will also rise for services as demand rises again for travel, leisure activities, and hospitality. Many of price disturbances will also stabilize as the economy and economic activity gradually return to normal levels comparable to the pre-COVID-19 period. In general, a high degree of the current inflation is likely to be temporary or “transitory.” However, the magnitude of inflation has been significant and broad-based across the economy as reflected in the following charts. Businesses are paying higher prices regardless of the goods and services they produce, an indication of rising cost pressures in the pipeline. With levels of demand running high, many of these rising costs will likely continue to feed price increases for all goods and services in the second half of the year.

Consumers Encountering Significantly Higher Inflation

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Prices Paid by Producers Have Risen Sharply in the first half of 2021

Regardless of sector, inflation is rising strongly. During the first quarter, GDP inflation was running at a 4.3% annualized rate, the highest since the second quarter of 1990. Import prices rose at a 12.6% annualized rate in the first quarter, a potential source of ongoing cost pressures and inflation in the economy. Inflation was running at annualized rates of 20% for exports, 3.7% for personal consumption expenditures, 12.3% for residential investment, and 6.1% for government expenditures. Non-residential fixed capital investment was the only major area of the GDP accounts that did not experience significant inflation during the first quarter.

Most of the supply bottlenecks and temporary surges in inflation due to reopening will stabilize in the next year, and the overall level of inflation is expected to decline from 3.5% annualized growth to a rate somewhat below 3%. Commodity markets are already anticipating lower inflation next year based on forward rates in futures markets. Futures prices have declined from current prices for many essential commodities, in so-called ‘backwardation.’ However, inflation is not expected to return entirely to the benign levels of the last decade.

Supported by extraordinarily high monetary and fiscal policies during the COVID-19 recovery, historically high aggregate demand in the economy is likely to exceed constrained aggregate supply for the foreseeable future, thereby raising long-term inflation risks. Federal Reserve policy makers have begun to respond to these risks by bringing projected policy interest rate increases forward somewhat from 2024 to 2023, but the magnitude of the current surge in inflation is large and levels of liquidity injected into the economy are unprecedented, creating significant uncertainties in the inflation outlook.

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Inflation High Across Sectors of the Economy

Housing Markets in Focus

Housing Markets have been booming amid the COVID-19 outbreak and economic recovery. According to the FHFA Purchase-Only Housing Price index, housing prices in the nation rose 12.6% from the first quarter of 2020 to the first quarter of 2021 for the strongest annual gain since the fourth quarter of 2006. Utilizing monthly data, markets accelerated further in April, as the price of homes purchased rose 16.0% for the largest 12-month gain on record. Strong housing markets have increased consumer wealth and have been an important contributor to the overall economic recovery in the last year. However, meteoric gains in home prices raise the question of whether housing markets are becoming frothy – a danger that ultimately led to one of the worst recessions since the Great Depression in 2007 - 2009.

Since all housing markets are local, the following charts focus not only on national trends but also on localities where Huntington has deposit-taking branches – the Huntington Footprint. All the Huntington Footprint States have strong home purchase price gains that are comparable to the national average. The average 4-quarter home purchase price gain in the 11 Huntington Footprint States was 12.2% in the first quarter of 2021, just slightly below the national increase of 12.6%. The five states that had gains at or above the national average were Colorado at 13.0%, Indiana at 13.1%, Michigan at 12.6%, Ohio at 13.7% and South Dakota at 14.7%. The states with gains somewhat below the national average were Pennsylvania at 11.9%, West Virginia at 11.9%, Kentucky at 11.5%, Minnesota at 11.3%, Wisconsin at 10.9% and Illinois at 9.6%. Hence, the range of variability between states was unusually tight – a distinction from the dispersed housing price gains during the housing boom in the early part of the decade. In the housing boom of the 2000s, strong home price growth was highly concentrated in certain hot-market states such as California. This is evident in the Home Price Charts below as most of the current Huntington Footprint states had lower housing price growth than the national average in the boom years of the first decade of the millennium.

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Strong Home Price Growth in the Eastern Huntington Footprint States

Strong Home Price Growth in the Western Huntington Footprint States

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The stellar home price trends of the Huntington Footprint states were broad-based, and large gains also occurred in the large Metropolitan Statistical Areas (MSAs). In the following chart, a composite index of home prices for the 20 largest MSAs in the nation is compared to the five MSAs in the Huntington Footprint that are part of the index. In the 12 months through April, the S&P Corelogic Case Shiller Home Price Index for the 20 largest metropolitan areas in the nation grew 14.9%. According to this highly quoted Home Price Index, home prices grew 15.4% in Denver, 13.3% in Detroit, 13.2% in Cleveland, 11.3% in Minneapolis and 9.9% in Chicago. The tight range around national home price growth contrasts significantly to the home price growth during the housing boom years of the 2000s, when home price growth was below national home price growth in all five of the aforementioned MSAs.

Strong Home Price Growth Across Metropolitan Statistical Areas (MSAs)

Home sales activity has been unusually brisk in the last year, while inventories for sale have not kept up with demand. The Months’ Supply of Existing Homes on the market has dropped to 2 months for high price homes and to 1 month for Low and Medium Price Homes according to the American Enterprise Institute. Regardless of initial home value, all homeowners are in a sellers’ market.

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Inventory of Homes for Sale is Extremely Low

Demand has been high for all types of residential structures regardless of type according to Redfin. Days on the market have dropped substantially in the last year not only for Single-Family Residences, but also for condominiums and coops (Single Units Only), and townhouses.

Days on the Market are Low Regardless of Residence Type

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Are large and broad-based home price gains of the last year indictive of a bubble in housing markets? Housing is typically viewed as a conservative real asset that also protects against inflation. Home prices levels and appreciation should be broadly consistent with overall incomes that are generated in the economy. To illustrate this point, the following chart compares the percentage growth in per capita disposable income to the percentage growth in the price of housing since January 2000. Over time, home prices should move in line with individual incomes. During the early years of the decade, home prices as reflected by the S&P Corelogic Case Shiller Composite Index for the 20 largest MSAs grew significantly faster during the boom years than per capita disposable personal income. When home prices reached levels that were significantly above what incomes in the economy could support, home prices fell until a new equilibrium was reached. Of course, this deflationary process caused significant disturbance to the economy, and was a major contributor to the Great Recession of 2007-2009. Between 2012 and 2019, average home prices began rising at a pace somewhat faster than incomes growth, but the differential between home prices and incomes remained relatively stable. That stable period ended with the onset of the COVID-19 downturn in 2020, when the pace of home price growth accelerated significantly. Income growth will soon return to its natural growth rate in line with the pre- COVID-19 trend as determined by fundamentals in the economy.

While the differential between home price growth and sustainable disposable personal income growth has widened, the spread between the two indicators is below the wide percentage spread during the housing boom of the 2000s. However, if home price growth trends continue at a double-digit pace in the next year, the spread between home price and incomes growth will widen further. A resultant drop in home prices that creates damage to households and economic growth could occur. In sum, strong housing market growth is not a risk yet, but would likely become one if double-digit annualized home price growth continues.

Housing Price Growth Could Lead to Unsupportable Price Levels if Differential to Per Capita Personal Income Widens Further Housing Prices Compared with Per Capita Disposable Personal Income Percent Change Since January 2000

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-40 -40 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18 19 20 21 Per Capita Disposable Personal Income S&P CoreLogic Case-Shiller Home Price Index: Composite 20 (SA, Jan-00=100) Latest month plotted: April 2021 (Home Prices)

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In addition to home prices and personal incomes, the National Association of Realtors’ (NAR) Housing Affordability index incorporates the level of mortgage rates, which started in July at an extremely low rate of 2.98% for a 30-year fixed rate. The NAR Housing Affordability Index also incorporates regional differences in home prices, incomes, and other factors. The result is shown in the chart below. Recent increases in the price of housing is moving the index down in all major regions of the nation, but affordability remains at higher levels than during the housing boom in the first decade of the new millennium. Lower mortgage rates allow for somewhat lower mortgage payments, thereby making mortgages affordable for more individuals. The highest affordability in the nation remains in the Midwest.

Housing Affordability likely to Decrease as Home Prices Rise NAR Housing Affordability Index 300 300

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50 50 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17 19 Nation Northeast Midwest South Median family income qualifies for 80% mortgage West on median priced home. Most Recent Data: April 2021

High market liquidity and supportive fiscal policies during the pandemic and economic recovery have provided strong impetus to housing purchase prices. They also are boosting rents in many areas. The following charts track annual rent growth for selected MSAs in the Huntington Footprint States. The Zillow Observed Rent Index calculates rent differences for the same rental units over time, thereby controlling for quality. Overall, the MSAs with the strongest rent increases were in states with the strongest overall home price increases, as state specific economic fundamentals factor into rent levels. States that have lagged in employment recoveries, such as Illinois and Minnesota, have MSAs with the lowest rent appreciation to date. As economic recovery widens and strengthens in the coming months, rents will likely pick up in all areas.

One of the risks of a continuing housing boom is its potential negative impact on renters. As home prices rise and affordability declines, many new potential home buyers will likely choose to rent rather than to buy a home. This in turn raises demand for rents, thereby spreading inflationary gains in housing onto rents. Given that the current surge in home prices is broad-based across home price levels, this negative inflationary impact could also fall significantly on those with the least capacity to pay higher rents. Rent inflation generally poses the greatest risks to low-income and moderate-income households. 13 Public

Rents Rising in many MSAs in States with the Strongest Housing Markets

Rents Rising but Depend on Strength of Local Jobs Recovery

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Forecast Summary Table Key Economic Indicators July 10, 2021 272018 20120198 20202019 202021† Total Real GDP Annual Growth Rates 2.9% 2.3% -3.5% 7.2% 2012 Chained Dollars

Consumption 3.0% 2.6% -3.9% 8.1% Non-Residential Fixed Investment 6.4% 2.1% -4.0% 7.9% Residential Fixed Investment -1.5% -1.5% 6.1% 15.5% Exports 3.0% 0.0% -13.0% 5.1% Imports 4.4% 1.0% -9.3% 12.3% Government Purchases 1.7% 2.3% 1.1% 5.8% Change in Private Inventories $48.1 $67.0 $-77.4 $13.6 (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% 10.8% Current dollars

Consumer Price Index for Urban Consumers 2.4% 1.8% 1.25% 3.5% (CPI-U) – Average 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% 1.8% Year-end interest rate yield

National Income Pre-tax Corporate Profits 6.1% 0.3% -1.2% 12.0% Average annual growth rate

Net New Average Monthly Non-Farm Payrolls 193K 178K -785K +621K (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 15 Public

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