As Recovery Gains Momentum, Questions Linger About Inflation and Taxes

All signs continue to point to a U.S. economy that is on increasingly strong footing and seeing a broad recovery as we emerge from the COVID-19 pandemic. Whether it was the PMI reports, housing data, jobless claims or the LEI, the data pointed upward last week. Corporate profits are coming in ahead of high expectations for the first quarter, and we will likely receive a robust GDP report later this week.

At the same time, the events of the past week served as a reminder that as the economic recovery progresses in this country, questions will begin to emerge about how the government will pay for trillions of dollars worth of economic stimulus.

We’ve already seen some signs of rising inflationary pressures, particularly at the producer level. It is possible these could still prove temporary, particularly if the U.S. experiences productivity gains.

Then there’s the issue of taxes. It was widely reported last week that President Biden would soon unveil a proposal to increase the capital gains tax for wealthy individuals. If it comes to fruition, Americans making over $1 million a year could possibly see base capital gains nearly double, to 39.6 percent.  

The mere mention of this plan was enough to temporarily spook financial markets last week. So, as the post-pandemic recovery likely continues over the coming months and even possibly spreads to other areas of the globe, investors should remember that there may still be hurdles along the way, even if the net results remain positive. 

WALL STREET WRAP

PMIs Expand Across the Board: On Friday, IHS Markit reported a preliminary Composite U.S. purchasing managers’ index (PMI) reading of 62.2 for April, a record high since the index began in 2009. Growth was driven by the Services sector, where the index jumped to a record 63.1 — a far cry from the 26.7 a year ago. The Manufacturing PMI also topped the 60 level and set its own record, providing another sign that the economic recovery in this country continues to broaden. While business activity is increasing in the U.S., so are prices. Input costs for manufacturers increased by the most since 2008, although it remains to be seen how long these inflationary pressures will persist.

Elsewhere, IHS Markit said that business activity is improving in the eurozone, where the Services PMI moved back above 50 for the first time since last September. The vaccine rollout had been slower in Europe than in the U.S. but is now beginning to ramp up. As we’ve seen in this country, wider vaccine distribution should allow for the services sector to keep expanding in the eurozone and catch up with higher manufacturing activity.

Housing Data Remain Strong: The Census Bureau reported on Friday that U.S. new home sales increased 20.7 percent in March to an annualized pace of 1.02 million. Growth was particularly strong in the South, which was hit hard by winter storms in February. The number of homes awaiting construction rose to the highest level in nearly 15 years.

Earlier in the week, the National Association of Realtors posted March existing home sales that fell short of expectations yet still exhibited the highest year-over-year price growth on record since 1999. Mortgage rates have increased since the beginning of the year, but constrained supply has helped to support a rising price environment.

Leading Economic Index Posts Rare Feat: The Conference Board said on Thursday that the leading economic index (LEI) increased 1.3 percent in March, to 111.6. Even more noteworthy is that all 10 components of the index moved higher last month, which is something that hasn’t happened since 2006 — yet another signal of broad economic strength.

THE WEEK AHEAD

Initial GDP Reading: The key report out this week will likely be the preliminary reading of first-quarter U.S. GDP, to be announced by the Bureau of Economic Analysis on Thursday. The consensus estimate is for 6.5 percent growth, although the Atlanta Fed’s GDPNow estimate calls for 8.3 percent improvement.

FOMC Meeting on Deck: Chair Jerome Powell will hold a press conference after the Federal Reserve comes out with its next interest rate decision on Wednesday. The Fed is expected to stand pat on rates, as it is focused on a post-pandemic recovery of the U.S. labor market and has said that inflationary pressures should prove temporary. Remember, these days policy decisions are based more on outcome than on outlook.

One of the FOMC’s key inflation gauges will be reported on Friday by the Bureau of Economic Analysis. The market will be looking to see if the core personal consumption expenditure (PCE) index remained below the key 2 percent level in March.

Consumer Confidence Expected to Grow: The Conference Board will announce April U.S. consumer confidence, with economists looking for an increase from the previous month. Millions of Americans received a third stimulus payment this spring, and jobless claims have been consistently improving in recent weeks.

Flood of Corporate Earnings: One-hundred eighty companies in the S&P 500 are expected to announce quarterly results next week; 24 percent of the index members have reported numbers to date, and the average profit report has come in more than 34 percent ahead of expectations. 

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