🔒Despite labor constraints and inflation, cautious optimism expressed for 2022

I think we’re all ready for some hope. At least, that’s how I interpreted the results of this year’s economic forecast survey conducted by the Hartford Business Journal and New Haven Biz.

The term “cautiously optimistic” comes to mind with the seemingly collective reservations regarding supply chains and labor — and I have to say I agree with the sentiment. I think you’re on to something, Connecticut.

The 2021 economy fought through significant challenges but has still improved materially. The U.S. GDP is estimated to have grown by 5.6% in 2021 and the consensus forecast for 2022 calls for 4.1% growth.

Both numbers are considerably better than the pre-COVID pace of 2% to 3%. So, it is more than just a positive attitude — there is good reason to be optimistic.

As a result of our collective COVID experience, consumers and companies were forced to adjust their behavior. That adjustment resulted in a great deleveraging of consumer and corporate balance sheets.

The personal savings rate skyrocketed to 35% during the initial COVID lockdown and still hovers around 10%. Many consumers took the COVID lockdown as an opportunity to pay down their debt; credit card, home equity and mortgage balances all declined significantly.

On the corporate front, a similar deleveraging has occurred. The original CARES Act provided a material safety net for companies of all sizes. Most significantly, the act created the Paycheck Protection Program that provided loans ($350 billion, mostly forgiven) to small businesses. The PPP loans allowed companies to remain solvent while adjusting to the new COVID world.

While the PPP loans provided support for revenue shortfalls and supported employment levels, non-labor expenses dropped materially. Expenses such as marketing, travel, training and development, fleet expenses and entertainment all plummeted.

Today, companies are flush with cash, expenses continue to run below “normal,” and debt has been paid down. Why is this great deleveraging important? It provides plenty of ammunition for economic growth when the uncertainties surrounding COVID diminish.

The combination of strong balance sheets, a continuing reopening of the economy and historically low interest rates provide fuel for growth and reason for cautious optimism as the economy works through a host of challenges.

Managing COVID

The COVID pandemic is a new experience for just about everyone alive today. The initial social and economic reaction was swift and devastating.

Tragically, COVID has caused about 800,000 deaths in the U.S. The economic impact was dramatic as well. But the economy quickly recovered as we all adjusted to this new world.

The COVID crisis is far from over, as the delta and omicron variants demonstrate. COVID is likely to remain endemic for the foreseeable future.

However, speaking from an economic perspective, COVID is likely to be less of an economic challenge in 2022. The world’s ability to “manage” the virus has increased significantly.

Historically, pandemics eventually run their course as herd immunity is achieved through a combination of vaccination, exposure and weakening mutations. We may not be there yet, but we are getting close.

While it is unlikely that there will ever be an “all clear” COVID siren, our ability to manage the pandemic should lead to a better economic environment in 2022.

Some choppy waters

Supply chain disruptions have plagued the economy in 2021 and will persist into 2022. COVID caused a dramatic shift in spending habits toward goods and away from services. This surprised and stressed supply chains.

However, these issues are likely to dissipate as the year goes on. The economic risk is that the resolution of these constraints may take longer than many hope, and the result will be inflation.

Labor shortages will also remain problematic. The Bureau of Labor Statistics’ JOLTS report shows there are over 11 million job openings in our economy and roughly 8 million people out of the workforce. This should be a simple problem to solve.

However, a breakdown of that 8 million figure suggests it may not be as easy as it appears.

First, there are roughly 2.7 million people who are or were receiving unemployment benefits that exceeded their pre-COVID income.

Second, “excess retirees over trend” are reducing the size of the workforce by an estimated 1.5 million.

Third, visas granted to immigrants and non-immigrant temporary workers declined meaningfully by roughly 1 million during the pandemic.

Lastly, self-employment impacts the labor force as roughly 800,000 people chose to become self-employed (think rideshare and food delivery services) during COVID. Add it all up, and roughly 6 million people have left the workforce.

Will some reenter? Of course, but it, too, will take time. Meanwhile, “Help Wanted” signs will continue to proliferate.

In short, COVID, supply and labor constraints will be with us for some time. The main weapon to combat these shortages is higher prices and higher wages, i.e., inflation. Demand for goods and services seems to be robust, fueled in part by the excess liquidity.

We do not have a demand problem and therefore the risk of a recession is small. But we do have an inflation problem, and it will persist in 2022. If inflation remains at high levels, it may force policymakers in Washington to change course.

In particular, the Federal Reserve Bank may be forced to change monetary policy, i.e., raise interest rates, sooner than expected. The economy can handle modest increases in interest rates, but the stock market may not like it.

The combination of strong balance sheets, a continuing reopening of the economy and historically low interest rates provide fuel for growth.

Hopefully, COVID and the supply and labor challenges will diminish as challenges throughout the year. Overall, this is cause for cautious optimism for the 2022 economy.

Kenneth J. Entenmann is chief economist and chief investment officer at NBT Wealth Management.