Outlook on the United States JUL 2021 Summary • As growth accelerates, worry over US inflation has moved to the forefront. Lazard’s equity and fixed income teams alike believe that recent higher inflation levels will not last. • Our equity teams expect inflation on average to be marginally above the Federal Reserve’s 2% target for the next two to three years but do not expect it to rise more or last longer. With the US economy still in recession, our analysts are closely watching job The focus on inflation comes as the tide has turned decisively against growth. COVID-19 in the United States, and it is accompanied by a particular • In its economic impact, the COVID-19 pandemic has been akin to focus on the potential for a full reopening to drive growth. Yet, we a natural disaster, and our fixed income team expects volatility in believe it is worth sounding a note of caution. The United States is inflation, other economic data, and the path to recovery. still in a recession. Some 7.5 million people who had jobs in February • After many credit rating downgrades in the past 16 months, 2020 are no longer working, about the same number as during our bond analysts continue to believe in a bifurcated recovery, which favors an investing approach built on bottom-up security the depths of the global financial crisis. So, while it is important to selection and focused on lending to viable borrowers. consider the various risks to the economy, including inflation, the biggest risk of all is an anemic recovery that could lead to years of disappointing growth akin to the 2010s. In the United States, massive fiscal stimulus combined with a largely US Equity successful vaccination campaign has raised questions for investors Inflation was the talk of the town in the second quarter. Most in three areas. First, at what rate will jobs return and when will the economists expected inflation to rise, but few foresaw a Consumer labor market tighten? Second, how will excess savings and changing Price Inflation (CPI) reading of 5.0% in May, the highest rate in consumption patterns drive the economic recovery? And third, what almost 15 years. Two months of higher-than-expected inflation added path will inflation and interest rates take in the short-to-medium term, fuel to concerns that the United States is on the precipice of a secular and how will this change asset allocations? shift in the inflation paradigm. Almost all economists agree that some proportion of inflation is COVID-19 Update transient; the disagreement among them is how much. Our base In the second quarter, 26% of all US adults received at least one shot case view is that inflation is likely to exceed 2% for the next two to of the COVID-19 vaccine, bringing the total proportion of Americans three years, at least. However, we think this marginally above-target who have received one dose or more to 53.3% and the fully vaccinated inflation is unlikely to accelerate or to last. Even if our base case view is to 45.1%. Along with acquired immunity from those who were correct, however, we believe investors should be concerned about the already infected, this means the US population already has significant potential for higher long-term interest rates and how rising bond yields immunity to COVID-19. Yet, the pace of daily vaccinations has in general could change the environment for savings and investment. declined from over 4 million doses per day in April 2021 to just over 1 million in June 2021, and lingering vaccine hesitancy meant that RD12134 2 the United States missed President Joseph Biden’s target of having (Exhibit 2). A major portion of the jobs lost were low income. Before 70% of adults vaccinated by 4 July. At the current pace, the country the pandemic, median pay for a US worker was $60,000 and the will only vaccinate 70% of adults by the middle of the third quarter. 25th percentile of earnings was $27,000 per year. Since the pandemic By comparison, the European Union (EU) has rapidly accelerated began, jobs that pay more than $60,000 per year have increased vaccinations and likely will surpass the United States in the proportion 2.4%, while jobs that pay less than $27,000 have declined 23.6%. of the population that has been vaccinated as soon as the third quarter Jobs with salaries between $27,000 and $60,000 are down 2.4%. (Exhibit 1). While some of these low wage jobs might be gone for good, the vast majority should return as the service sector fully reopens. Exhibit 1 EU Vaccinations Will Soon Surpass US Efforts Exhibit 2 Population Vaccinated with at Least One Dose “True” US Unemployment Stands at About 8.6%, for Now (% of Total Population) (%) 80 25 Unemployment Rate Adjusted Unemployment Rate 20 60 Absentee Worker Adjustment UK 15 40 US 10 20 EU 5 0 Dec Feb Apr Jun 0 2020 2021 2021 2021 2007 2009 2011 2013 2015 2017 2019 2021 As of 20 June 2021 As of May 2021 Source: Our World in Data Official unemployment rate accounts for people who are out of work and looking for a job. In April and May 2020, US Bureau of Labor Statistics classified workers that reported being employed, but not at work as “employed.” Had they been classified as unemployed, the unemployment rate would have been 4.8 ppts higher in April and 3 ppts higher in May; this decreased to <0.5 ppt for August–October; the adjusted Still, the benefits of the US vaccination program have been staggering. unemployment rate treats the fall in labor market participation as unemployed as a proportion of total working age people. Daily cases have decreased from more than 200,000 in January to Source: Department of Labor, Haver Analytics fewer than 15,000 in June; over the same time period, the most important metric, deaths, has decreased from more than 4,000 per day to fewer than 300. Most states have rescinded mask mandates and lifted coronavirus-related regulations, spurring a rapid increase in Despite the overall weakness of the labor market, there are good reasons demand for services such as restaurants, cinemas, and domestic travel. to think the recovery will accelerate sharply in the coming months. First, labor supply should surge in September as children return to Changing patterns of consumption are fueling recoveries across in-person school and unemployment insurance benefits expire. Second, sectors. However, the economic recovery from the pandemic it is easier to lay off workers in a downturn than to hire in a recovery. entails many unknown unknowns. Investors and businesses are Employers incur search costs to find workers, as they have to take time understandably worried about the risks they can see. But, as evidenced to sift through applications while also trying to keep up with surging by jobs data so far, the recovery will not be smooth, and it will not post-COVID demand. The idea that employers could, from the depths have easily predictable effects on the economy or on financial markets. of a recession, hire everyone back who had lost jobs in the space of a few months was always a fantasy that did not account for hiring friction. Reopening: Jobs Indeed, the number of job openings outstripped hiring by almost 400,000 positions in May. While some are keen to chalk this up to The beginning of the second quarter was marked by widespread generous unemployment insurance, which is most likely a factor on the anticipation of gaining 1 million or more new jobs per month. Yet, margins, we believe that the dislocation created by the pandemic, lack job creation fell far short of expectations throughout the quarter even of child care and in-person schooling, and the closing of hundreds of while data was encouraging. With more than 7 million people still thousands of small businesses across the country are more important out of work relative to February 2020 and 3.5 million more people factors in the gap between vacancies and hiring. Finally, it’s reasonable to who dropped out of the labor market altogether, it is premature believe that the recovery will accelerate because jobs are already returning to think about tightening labor markets, in our view. If job gains as vaccinations continue and American consumers flock back to the continue at the pace of May 2021, it would take almost 15 months service sector (Exhibits 3 and 4). for employment in the United States to return to pre-pandemic levels. While headline unemployment has dropped to 5.8%, The United States is in a strange place, then: Consumption has when adding in people that have dropped out of the labor force rebounded to pre-COVID-19 levels, the median American household for economic reasons, the unemployment rate is more like 8.6% has more savings now than at any point in decades, job growth is 3 continuing at a rapid pace, and still, millions of people are looking Exhibit 3 for jobs, and many of those people are the ones who arguably need Labor Distortions Are Another Transitory Inflation Force them the most—low-income workers. What it all adds up to is Non-Farm People Unemployed, Job Openings, and Hires (Thousands) that consumers’ balance sheets are well-positioned to fuel higher 25,000 consumption for the rest of the year (Exhibit 5) even as US fiscal stimulus diminishes, thanks to child tax credits and household savings 20,000 that exceed pre-pandemic run rates by over $2.1 trillion.