Growth rates have peaked, but the economic expansion continues

by Badgley Phelps | Oct 13, 2021

Outlook: Fourth quarter 2021


The pace of growth moderated in the third quarter, but the economy continues to expand. The spread of COVID-19’s Delta variant and issues in the supply chain, including shipping delays and shortages of both product components and labor, acted as a drag. However, the pace of growth remains solid, and the U.S. economy is expected to grow by approximately 5.0 percent in the fourth quarter.

Given the recovery, the Federal Reserve is expected to begin reducing the level of stimulus they are employing. No increase in interest rates is expected until late in 2022, at the earliest, but the central bank has indicated it is likely to reduce the magnitude of monthly bond purchases in the coming months. Notably, this represents a reduction in the level of stimulus, rather than a tightening of financial conditions, and suggests monetary policy will remain accommodative for the foreseeable future.


Inflation has advanced in a sustained manner since bottoming in the spring of last year. In August, the Consumer Price Index reached a level of 5.3 percent, marking its fourth consecutive month at or above the 5 percent threshold. Prices for energy, raw materials, autos, and dining out have increased significantly in the last twelve months.

The Federal Reserve continues to emphasize its view that much of the inflationary pressure is transitory. While some aspects of inflation are likely to be temporary, such as base effects that compare today’s price levels to the muted numbers of a year ago, other factors are more controversial. For example, it is not clear that conditions in the global supply chain will improve quickly. Strong demand, coupled with delays at shipping ports and shortages of materials and labor, have combined to create bottlenecks that could persist well into next year. In that instance, inflationary pressure may be more persistent than expected resulting in a sustained increase in price levels as we progress into 2022.

U.S. dollar

The spread of the Delta variant, concerns about the strength of the global economic expansion, and the expectation of a less accommodative monetary policy in the U.S., have driven the U.S. dollar higher in recent months. We expect the dollar to remain elevated in the near-term as the global economic expansion is likely to remain uneven across countries and regions. On a longer-term basis, the high level of government debt in the U.S. and improving conditions in foreign economies may weaken our currency.

Asset class

Cash/Money Market Instruments

Last summer, the Federal Reserve consistently indicated that a tapering of monthly bond purchases appeared appropriate, and the central bank did not alter guidance after its September 22 meeting. Federal Reserve Chair Jerome Powell’s press conference and the central bank’s updated economic projections indicated that the Fed is set to begin scaling back bond purchases as soon as November and complete the process by the middle of next year.

While tapering the amount of the purchases isn’t tightening monetary policy, a gradual reduction in bond purchases is the first step toward eventually hiking the Federal Funds Rate. The updated economic projections, known as the dot plot, also hinted at a more hawkish tone. The new projections indicate a 50 percent chance for a rate hike in 2022, compared to the prior median projection of no rate increases until 2023.

Intermediate Government/Credit Bonds

As the market assimilated the guidance after the Federal Reserve’s September meeting, the yield on the 10-Year U.S. Treasury increased approximately 20 basis points to end the third quarter at a yield of 1.49 percent. Although interest rates are expected to remain low by historical standards, the latest announcement indicates an upward bias.

Credit spreads, the difference in yield between corporate and U.S. treasury bonds, remain extremely tight despite the recent increase in rates. Both investment grade and high yield spreads are within ten basis points of their all-time lows. Notably, headline news that generated volatility in equity prices in September did not significantly impact the outlook for corporate bonds. As we progress into next year, credit spreads are expected to remain tight, barring an unforeseen interruption in the global economic expansion.

Tax-Exempt Municipal Bonds

The municipal bond market has remained insulated from the volatility affecting some other areas of the capital markets. Inflows into tax-exempt bond funds in the third quarter have persisted at a pace of about 1.5 times the 12-month average reflecting strong demand for this asset class. The proposed increase in the top personal income tax bracket to 39.6 percent, and a 3 percent surcharge for those earning over $5 million, kept demand for municipal bonds strong. However, the demand may be balanced in the future by legislation that would reinstitute tax exemption for advance refunded bonds. If that legislation is enacted, supply could increase by as much as $100 billion.

U.S. Equity

The U.S. equity market generated mixed results last quarter. Stocks of large, growth-oriented companies provided modest gains, while other segments of the markets generated small losses. Sentiment around strong earnings growth and a continuation of the economic expansion was somewhat offset by concerns about COVID-19, the Federal Reserve’s plan to taper bond purchases, the potential for a significant increase in tax rates, as well as slowing growth rates for both the economy and earnings.

Looking forward, we expect the market to continue its upward trajectory, but with a more normal level of volatility. Earnings growth is expected to remain solid, and the economic expansion is poised to continue. In addition, monetary policy is exceptionally easy and is likely to remain accommodative for the foreseeable future. However, valuations are elevated, growth rates are falling from peak levels, the global supply chain is suffering from bottlenecks, and the market has increased significantly in a relatively short time. Given these disparate factors, we expect the market to experience some bouts of volatility, even though the outlook remains positive.

International Equity

International equities experienced a dichotomy last quarter. Markets in the developed economies generated returns that were positive in local currency terms. However, the U.S. dollar increased and when the performance is converted into our currency, the developed markets generated a small loss. Stocks in the emerging markets generated more significant losses, in both U.S. dollars and in their local currencies, given concerns about COVID-19, short-term lockdowns in some economies, and expectations for slowing growth in China.

The stage is set for a strong recovery in earnings and valuations remain attractive. These factors should provide a nice tailwind to equity markets. However, we expect the international markets to continue to be volatile with disparate returns across the group. Vaccine distribution is occurring at an uneven pace across countries worldwide. In addition, some governments are pursuing short-term lock-down strategies to contain COVID-19. Those two factors serve as a near-term headwind to growth. China has also implemented stronger oversight amongst a number of industries and their economy is poised to slow in the coming year. In short, the economic expansion provides a positive backdrop for the group, but we expect disparities in performance across the member countries.


Commodity prices were mixed last quarter. Oil and agriculture prices increased while gold, copper and other metals declined. In aggregate, commodity prices have increased significantly in the last eighteen months and looking forward, we expect them to remain elevated. Consumer net worth is at record levels and the ongoing economic expansion should sustain high levels of demand for finished goods. At the same time, supply constraints and bottlenecks in the supply chain are leading to rising input prices, long delays in production, and shortages of some products. The combination of these factors is making consumers and producers less sensitive to rising prices for source inputs while increasing the focus on fulfilling demand.

Potential opportunities & risks


New opportunities/new markets—The outbreak of COVID-19 has presented a unique set of challenges. It also provides businesses with a unique opportunity to differentiate and develop new markets. By some estimates, technology has been pulled forward two to three years and new products and services are in high demand. Prevalent themes include the increased use of technology, home improvement, home ownership, products and services that facilitate working from home, and a significant increase in the use of online retail relative to shopping in stores. 

The emergence of new technologies—The convergence of cloud computing, significant increases in computing power and the advent of the smartphone have created a connected world in which new technologies change the way we live. This convergence has created investment opportunities centered around long-term themes in which disruptive companies can capture high levels of market share in a relatively short period of time.

The evolution of finance—Technological advancements are disrupting traditional methods of banking, finance, and transfers of cash. For example, we are experiencing a global shift from paper currency to electronic payments fueled by the popularity of credit and debit cards. Online payment systems facilitating money transfers, e-commerce, buy-now-pay-later arrangements, and electronic bill paying services are also experiencing strong demand. This shift is still in its early stages and is expected to have a long runway as it is occurring across both the developed and the developing economies.


Setbacks in the re-opening of the economy—The rate at which vaccines have been developed is unprecedented. However, variants of the virus and the uneven distribution of vaccines globally could be problematic and may slow the rate at which we can return to more normal lifestyles.

Debt related issues—Sovereign debt levels were rising prior to the outbreak of COVID-19. However, in the wake of the virus, debt has increased significantly. In the U.S., government debt increased 24 percent last year and stimulus measures adopted earlier this year sustain that trend.

Inflation—Given the unprecedented amount of fiscal and monetary stimulus, supply chain bottlenecks, a shortage of labor, as well as the Federal Reserve’s policy of allowing higher rates of inflation, there is a risk that the recent increase in price levels may persist and be harder to contain than policy makers anticipate.

Increasing government regulation of technology companies—Several of the leading technology companies have established dominant market positions and have few competitors. As the power of these companies continues to increase, government regulators are placing them under greater scrutiny by assessing their privacy policies, acquisition plans, and competitive practices.

Geopolitical risks—Conflicts in many parts of the world have escalated or have near-term catalysts that may result in a change in dynamics. We continue to monitor events across the Middle East, Russia, and the Asia Pacific region. In particular, tensions between the U.S. and China remain elevated and we are closely watching relations between the two countries.

Cybersecurity—Cybersecurity remains a significant issue as evidenced by persistent attacks on governments, businesses, and individuals worldwide.


Originally posted on October 13, 2021


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