U.S. Economic Outlook

Higher inflation might persist for a while longer

The employment report for May was certainly not a blockbuster, nor even a small positive surprise. But it was another solid step toward normality. With 559,000 new jobs added, headline non-farm payrolls fell slightly short of what had been a very wide range of expectations: anything between 300,000 and one million new jobs, yielding a 675,000-median estimate. This range of estimates tells a story of its own: there is a high amount of uncertainty among market participants on how the dynamics play out as the 22 trillion U.S. dollar economy reopens for business – to paraphrase the U.S. Federal Reserve's (Fed's) Vice Chair, Richard Clarida.[1] Vice Chair Clarida is also the one Fed official to have actually given some guidance on how the Fed might assess whether the labor market has healed: "…at the current pace of the last three months of half a million jobs per month, it would take until August 2022," he said, for employment to return to pre-pandemic levels.[2]

Other measures of labor-market slack, such as the labor-force participation rate, or the unemployment rate, also remain far from compatible with the Fed's goal of maximum employment (Chart 1). Those measures again provide grounds for Fed officials to remain committed to their highly expansionary monetary policy even as other elements of the report have the potential to heat up the discussion regarding wages and inflation – the other key elements guiding Fed policy.

Chart 1: Measures of labor-market slack remain far from the Fed’s goal

202106_U.S. Economic Outlook_Charts_1.png

Sources: Bureau of Labor Statistics, Haver Analytics and DWS Investment GmbH as of 6/8/21

For quite some time now, anecdotal evidence has been pointing to a shortage of available skilled labor; here and there this has been interpreted as "tighter than visible" labor-market conditions.[3] Indeed the May establishment report does indicate a certain degree of tightness, reflected in moderately increasing average hourly earnings. This is especially visible in industries associated with economic reopening. The question that arises is whether there is a sustainable shift in wage dynamics, or just a temporary mismatch between the potential number of employees unwilling to go back to work (for one reason or another) and the increasing hiring needs of companies. And while certainly there is no straightforward answer to this puzzle, generous fiscal support during the pandemic, ongoing extended unemployment benefits and some pandemic-related distortions to everyday life may be playing a role.

A recent survey, for instance, indicates that many people are still hesitant to return to work because of fears of the virus – 48% want to be vaccinated and 35% want all their co-workers to be vaccinated too.[4] Even those that are fully vaccinated are demanding additional measures by their employers to feel safe. It is quite striking to learn that despite the fast progress in vaccinations (42% of the total U.S. population has been fully vaccinated at the time of writing) and the wide availability of the jab, people are still fearful. It is also possible that people have used the time off during lockdowns or spent working at home, to question their previous career path, eventually leading to the decision to take a new direction in their lives. Some may now be seeking other opportunities.

Another survey, indeed, finds that around 29% of respondents indicate that they are looking for something new while 35% would take back the same type of work and 25% whatever they can get.[5] These findings are supported by the latest release of the Job Openings and Labor Turnover (JOLTs) report for the month of April. While the headline job openings figure increased to a record high, the figure on people leaving their jobs was also revealing. The quits rate – the rate at which people leave jobs of their own volition – has risen above pre-pandemic levels and surpassed its long-term average, especially in industries associated with lower wages and/or high levels of contact with customers (Chart 2).

Chart 2: JOLTs quit rate (z-scores, e.g. deviation from long-term average)

202106_U.S. Economic Outlook_Charts_2.png

Sources: Bureau of Labor Statistics, Haver Analytics and DWS Investment GmbH as of 6/8/21
The z-score tells you how many standard deviations from the mean your score is.

Despite the resulting lower supply of labor in some industries, the good news is that for about a third of the population the pandemic has turned out to be an opportunity to improve their lives. That figure shows high levels of personal savings means people may have more scope to make life changes. And for the other two-thirds the findings highlight still more need for the vaccination campaign to get the job done and guarantee a safe return to work.

Another piece of the puzzle could be that we are experiencing an adjustment in wages that has been lacking for some time. The current situation is enabling people to obtain higher wages – another implication of a high quits rate. The overall mixture of motivations is likely to imply further wage pressures in coming months. We expect this pressure to be front-loaded and to fade as more and more people feel comfortable returning to work, whether it be to their former job, perhaps with improved wages, or something new.

Inflation should follow a similar path to wages. It is most certainly true that the current friction in labor markets will increase prices, as will disruptions to global supply chains and high prices for raw materials. But all these factors have one thing in common: they should be temporary. What we are witnessing now is fiscal intervention on a scale not seen before in peacetime – a wartime level of intervention – supported by highly accommodative monetary policy. Maybe that was what Ben Bernanke had in mind when talking about helicopter money.[6] Compared to what we have seen so far during the pandemic in terms of fiscal spending, even the recent huge infrastructure plans proposed by President Biden look relatively small. Once those massive fiscal impulses fade, inflation should return to its “normal” dynamics.

The view that inflation will be transitory does have its risks, however. It is far from impossible that there will be another escalation of the trade war with China, for example; or potential radical changes to economic policy targeting ecological sustainability. These changes might not be rooted in domestic policy-setting. A first move toward a global minimum corporation tax of 15% – as just recently agreed upon by the Group of Seven (G7) – demonstrates that powerful global forces are driving change these days.

While acknowledging these risks we continue to forecast that inflation will eventually recede over the next 12-18 months. But we also expect that the new equilibrium for inflation might be somewhat above the levels experienced before the pandemic. Transitory effects from pent-up demand, the return to work and the reallocation of labor might last longer than initially thought. Some production of critical infrastructure like microchips might be repatriated and now well-established forms of telecommunications have the potential to increase productivity, warranting somewhat higher wages and therefore prices. Eventually, however, those effects should generate a healthy level of inflation, consistent with labor markets at maximum employment.

Chart 3: Survey of professional forecasters 10-year ahead inflation expectations

202106_U.S. Economic Outlook_Charts_3.png

Sources: Federal Reserve Bank of Philadelphia, Haver Analytics and DWS Investment GmbH as of 6/8/21

Our view that transitory inflation won't disappear quickly, however, does not change our expectation that the Fed will remain quite complacent about loose money. One of the Fed’s favorite measures of inflation, inflation expectations (Chart 3), remains well within the Fed’s comfort zone and therefore can be described as "well anchored."[7] Still we believe that the Fed is progressing further toward a discussion of tapering in late summer. Most likely it will hint that the economy is making “sufficient progress" toward their goals during the Jackson Hole Symposium in late August. Actual tapering, however, is unlikely to start before late 2021 or early 2022, followed by a first-rate hike in 2023.

In line with our view of temporally higher inflation, there is good progress to report, too. We have significantly raised our gross-domestic-product (GDP) growth projections for 2021 to 7.2% year-over-year (Q4/Q4). The economy has proven more resilient to Covid-19 than was generally expected, helped by the extraordinary level of stimulus and fast progressing vaccinations.

What remains in question is the longer term, when monetary stimulus is tapered, and the government starts to address a fiscal deficit expected to exceed 15% of GDP this year.

The pandemic bills will eventually have to be paid.

Overview: key economic indicators

















GDP (% qoq, annualized)









Core inflation (% yoy)*










Headline inflation (% yoy)*









Unemployment rate (%) (EOP)









Fiscal balance (% of GDP) (EOP)









Federal funds rate (%)









*PCE Price Index
** Forecast



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