US economy grew 6.9% in Q4 but headwinds are gathering

The United States economy grew at a stronger-than-expected pace in the final three months of 2021, but clouds ranging from Omicron to higher interest rates are gathering over the US recovery.

Gross domestic product (GDP), which measures the total output of goods and services in an economy, increased at a rate of 6.9 percent in the fourth quarter compared with a year earlier, the US Bureau of Economic Analysis said on Thursday.

That was stronger than what most analysts had forecast, but disruptions from Omicron, which has led to a wave of workers calling in sick, likely weighed on growth during the closing days of December, and the opening weeks of this year.

“The Omicron wave means the economy is starting 2022 on a much weaker footing and we expect growth to disappoint over the rest of this year, too,” said Andrew Hunter, senior US economist at Capital Economics.

A  build-up of inventories by retailers and wholesalers led the growth charge in the fourth quarter. Consumer spending – which drives some two-thirds of US economic growth – was also healthy, although not nearly as robust as it was in the first half of 2021.

For all of 2021, the economy grew 5.7 percent – the strongest performance since 1984. But that 80s vibe also comes with a downside – namely inflation.

Personal Consumption Expenditures stripped of food and energy – the Federal Reserve’s preferred inflation gauge increased 4.9 percent in the fourth quarter compared with a year earlier.

Myriad factors drove economic growth in 2021. Government largesse in the form of massive COVID stimulus payments left consumers flush with savings. Vaccination rollouts led to the rollback of business-sapping COVID restrictions. And as the economy reopened, consumers unleashed a lot of pent-up demand that few saw coming.

Before COVID struck, US consumers splashed out more heavily on services than goods. But virus-weary consumers turned their voracious spending appetites to goods when the economy reopened.

The result: businesses did not have enough supplies to meet that massive uptick in demand – an imbalance that triggered supply chain snarls and shortages of raw materials, increasing costs for businesses.

Meanwhile, the combination of government aid and cheap money policies by the Federal Reserve also fomented a major disruption to the US jobs market.

The Fed slashed interest rates to near zero and unleashed a host of other extraordinary measures in the opening weeks of the pandemic in 2020 to help keep the US economy afloat during lockdowns that threw 22 million Americans out of a job. And the Fed kept those cheap money policies in place as COVID restrictions were repealed to help get Americans back to work.

The labour market has been recovering nicely, but it also changed in some major ways.

Those job-boosting low-interest rates also swelled asset prices.  As a result, many older workers who saw the value of their homes and stock portfolios boom decided to take earlier retirement. Government aid also allowed workers to be choosier about how they earn a living – birthing the phenomenon that has come to be known as The Great Resignation.

Far from a deficit of jobs, the US economy currently has a near-record number of job openings. And workers feel so confident about their employment prospects that they are quitting in record numbers.

Some workers unleashed their entrepreneurial animal spirits to start their own businesses while many others decided it was time to demand a better deal from their employers.

To lure scarce job seekers, businesses have been sweetening compensation packages with signing bonuses, fatter paycheques and better benefits.

Workers have not had this much power in decades. And they are getting a well-deserved raise. But those higher labour costs, combined with higher raw material costs are feeding inflation.

Consumer price inflation is running at its highest level since 1982.

With price pressures running so hot, the Fed has refocused its priorities away from boosting the jobs market and towards getting inflation under control.

The most powerful tool at its disposal is interest rates. On Wednesday, Federal Reserve Chairman Jerome Powell confirmed that the Fed will likely start raising interest rates in March.

But higher interest rates, while inflation-cooling, also suppress economic growth, underscoring the balancing act the Fed is trying to pull off.

If inflation starts to spiral too far too fast, expectations of higher prices on the horizon can become unhinged and force the Fed to raise rates abruptly and possibly derail the recovery.

What the Fed is aiming to do is to raise interest rates just enough to tamp down inflation while keeping the economy on a growth trajectory.

Powell told reporters on Wednesday that the Fed has some leeway when it comes to increasing rates. “I think there’s quite a bit of room to raise interest rates without threatening the labour market,” he said during his post-policy setting meeting news conference.

That hawkish stance on inflation was not well received by US stock markets, which turned negative following Powell’s comments.

Still, despite the headwinds from higher interest rates, Omicron, and diminished government spending, many economists think the economy will continue to grow this year. They just do not see it growing as strongly as last year.