Flaherty & Crumrine Dynamic Preferred and Income Fund : & Crumrine Second Quarter 2021 US Economic Update

Second-Quarter U.S. Economic Update

September 2021

Summary of Recent Economic and Market Developments

The U.S. economy surpassed its pre-pandemic peak in the second quarter as COVID vaccinations ramped up and many consumers and businesses resumed activities curtailed during the pandemic. Real GDP rose 6.6%, slightly faster than Q1's 6.3% pace. Job growth and job openings rose, and the unemployment rate fell, although it remains elevated. Personal income plunged as transfer payments ebbed, but wage and salary income was strong. Personal consumption expenditures accelerated on renewed services spending. Residential investment declined as homes available for sale remained tight and construction was hampered by shortages. Home prices, however, continued a rapid ascent. Industrial production rose as weather improved and some shortages eased, but ongoing supply chain disruptions and labor shortages remain obstacles to faster growth. Business investment was sturdy despite continued weakness in structures. Government consumption slowed on lower federal spending after surging in Q1, while state and local spending was nearly flat. Inflation rose sharply, prompting the Fed to signal tapering of asset purchases later this year. Despite strong economic growth and much higher inflation, interest rates fell. Credit conditions generally improved further, and credit spreads narrowed.

Figure 1: Key Macroeconomic Indicators and Interest Rates

Economic Indicator*	2021:2	2021:1	2020:4	2020:3	2020:2	2020:1	2019:4	2019:3
Real GDP, Chg QoQ (%, SA, AR)	6.6	6.3	4.5	33.8	-31.2	-5.1	1.9	2.8
Real Personal Consump Expnds, Chg QoQ (%, SA, AR)	11.9	11.4	3.4	41.4	-33.4	-6.9	1.7	3.2
Real Business Inv ex Stuctures, Chg QoQ (%, SA, AR)	12.4	14.5	17.4	28.1	-25.5	-9.8	0.0	0.3
Real Residential Investmt, Chg QoQ (%, SA, AR)	-11.5	13.3	34.4	59.9	-30.7	20.4	1.1	3.6
Real Private Domestic Final Sales, Chg QoQ (%, SA, AR)	10.0	11.7	6.2	38.1	-32.6	-5.9	1.2	3.2
Nominal GDP, Chg QoQ (%, SA, AR)	13.2	10.9	6.6	38.7	-32.4	-3.9	3.6	4.1
Corporate Profits, After Tax, Chg YoY (%, SA, AR)	42.3	14.7	1.1	2.1	-18.3	-3.8	-0.3	2.8
Nonfarm Productivity, Chg QoQ (%, SA, AR)	2.1	4.3	-3.4	4.6	11.2	-1.8	0.6	0.8
Nominal Personal Income, Chg YoY (%, AR)	2.5	29.5	4.8	6.2	8.6	1.9	3.0	3.7
Personal Savings Rate (%, SA)	8.8	26.6	14.0	14.3	19.3	13.1	7.3	7.3
Unemployment Rate (%, SA)	5.9	6.0	6.7	7.8	11.1	4.4	3.6	3.5
Nonfarm Payrolls, Chg QoQ (000, SA)	1,845	1,554	638	4,025	-13,000	-1,079	590	609
Household Employment, Chg QoQ (000, SA)	754	1,018	2,287	5,443	-13,436	-3,199	505	1,099
Federal Budget, 12-moDeficit(-) or Surplus (% of GDP)	-12.0	-19.9	-16.6	-15.6	-14.8	-4.8	-4.8	-4.7
Consumer Price Index, Chg YoY (%, AR)	5.4	2.6	1.4	1.4	0.6	1.5	2.3	1.7
CPI ex food & energy, Chg YoY (%, AR)	4.5	1.6	1.6	1.7	1.2	2.1	2.3	2.4
Capacity Utilization (%, SA)	75.4	74.7	74.1	72.1	68.7	73.4	76.5	77.2
Rate or Spread (End of Quarter)	2021:2 2021:1 2020:4 2020:3 2020:2 2020:1 2019:4 2019:3
Federal Funds Rate Target (upper bound, %)	0.25	0.25	0.25	0.25	0.25	0.25	1.75	2.00
3-month LIBOR (%)	0.15	0.19	0.24	0.23	0.30	1.45	1.91	2.09
10-Yr Treasury Note Yield (%)	1.45	1.74	0.93	0.69	0.66	0.70	1.92	1.68
30-Yr Treasury Bond Yield (%)	2.06	2.41	1.65	1.46	1.41	1.35	2.39	2.12
ICE-BofAML US Corporate Index Spread to Worst vs Gvt	82	91	98	139	155	302	99	120
10-Yr Interest Rate Swap Spread (bp)	-2.6	3.6	0.8	2.5	-1.8	2.5	-2.8	-10.5
* Figures are either quarterly or, if more frequent, end of period.	f = Forecast1 ; N/A = not available	Source: Macrobond, ICE, Bloomberg LP

Legend for all Figures: AR = Annual Rate; SA = Seasonally Adjusted; MA = Moving Average; C.O.P. = Change over Period

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September 13, 2021

Economic Outlook

The U.S. economy continued to expand rapidly in the second quarter as COVID-19 vaccines became more widely available to U.S. residents, hospitalizations slowed, and many activities curtailed during the pandemic resumed. Inflation-adjusted gross domestic product (real GDP) rose by 6.6% in Q2, slightly faster than the first quarter's 6.3% pace. Growth appears to have slowed in July and August, and forecasts for the second half have moderated. Economists now expect Q3 and Q4 GDP to expand by 5.0% and 5.3%, respectively, down from forecasts of 6.8% and 5.6% a month earlier.1 Solid U.S. growth is expected to continue next year, with the consensus 2022 GDP forecast currently at 4.2%, little changed from August's estimate.

As expected, the U.S. economy surpassed 4Q2019's level of real GDP in the second quarter. It remains on track to recoup growth lost to the pandemic in the next few quarters, but it seems unlikely to do so by year-end 2021. Rising COVID-19 infections from the Delta virus variant, labor shortages, supply chain disruptions, and higher inflation have been headwinds to the economy in recent months, and they are likely to persist through 2021. As those diminish next year, the current economic recovery should continue at a slower but still above- trend pace and push the level of real GDP above its pre-pandemic trendline (about 2% growth) sometime during the first half of 2022.

Before turning to a review of the major sectors of the U.S. economy, it is worth noting that the National Bureau of Economic Research in July officially set April 2020 as the end of the recession triggered by the COVID-19 pandemic. At just two months in duration, it is the shortest U.S. recession since records began in 1857; a six-month recession from January to July 1980 is runner-up. Although the 2020 recession was short, it was severe, including a 22.4 million decline in nonfarm payroll employment and an 18.0% (not annualized) plunge in real personal consumption expenditures. Of course, COVID-19 cost much more than just lost jobs and output, but we are grateful to close that chapter of this terrible pandemic.

The labor market recovery accelerated in the second quarter. Nonfarm payrolls rose by 1.82 million jobs in Q2 compared to 1.54 million in Q1, and businesses added another 1.29 million employees in July and August. Overall nonfarm employment was 147.2 million in August (Figure 2). Although that remains 5.3 million jobs below the February 2020 peak, labor demand remains very strong. According to the latest job openings report, there were 10.9 million unfilled jobs in July, more than enough to absorb all unemployed persons age 16 and over (Figure 3). Of course, there are numerous frictions to matching employers and employees, including geographic and skill mismatches, generous supplemental federal unemployment payments (now expired) on top of regular state unemployment benefits, or difficulty finding suitable childcare, eldercare, or other assistance that potential employees might need to take a job. As daily activities gradually return to normal and in-person school and care services resume, some of those frictions should diminish. We expect sturdy employment growth for some time to come despite headwinds from COVID-19.

• Unless noted otherwise, forecasts are from the Livingston Survey, Federal Reserve Bank of Philadelphia, June 16, 2021 and Bloomberg® U.S. Monthly Economic Survey, September 10, 2021 and August 13, 2021.

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Strong demand for labor prompted faster wage increases. Average hourly earnings in August rose at a 5.7% pace over the past three months and 4.3% over 12 months, even as a rebound in lower-paid leisure and hospitality employment pulled down the average. The employment cost index, which adjusts for compositional shifts, was up at a 3.4% rate in Q2, moderately above its pre-pandemic pace. In addition, anecdotal reports, including the Federal Reserve's Beige Book, suggest continued upward pressure on labor costs.

Figure 2: Job Growth Accelerated

Figure 3: Job Openings Signal High Demand

	Levels of Employment and Initial Jobless Claims
	160	6
	155	5
		153 million
million	150	4	of .No
	147 million
ofNo.Persons,		millionPersons,
140
	145	3
		2
	135	1
		355000
	130	0
	JanFeb Mar AprMayJun Jul AugSepOct NovDecJanFeb Mar AprMayJun Jul Aug
	2020	2021

Unemployment, National, Jobless Claims, Initial, Total, 4 Week Moving Average, rhs Employment, National, 16 Years & Over, lhs

Employment, Payroll, Nonfarm, Payroll, Total, lhs

Source: Macrobond

		Labor Turnover and Unemployment, SA
	25
	20
	15
	10	10.93 million
	8.38 million
million	5	6.67 million
0	0.88 million
	-5	-5.79 million
	-10
	-15
	-20

Jan	Mar May	Jul	Sep Nov	Jan	Mar May	Jul	Sep
		2020			2021

Unemployment, National, 16 Years & Over

Labor Turnover, Openings (Worker Flows), Nonfarm, Total

Labor Turnover, "Hires, Nonfarm, Total"-"Separations, Total Separations, Nonfarm, Total" United States, National, Labour Turnover, Separations * -1, Nonfarm, Total, SA

Labor Turnover, Hires, Nonfarm, Total

Source: Macrobond

After surging in the first quarter thanks to fiscal stimulus2, personal income slipped in the second quarter (Figure 4). Nominal personal income fell by 21.8% in Q2 after jumping 56.8% annualized in Q1, although that still left overall personal income in June up 2.3% compared to a year earlier. Transfer payments were to blame; they plunged by 72.6% in Q2 after soaring 181% in Q1 mostly due to one-time stimulus payments. Excluding transfers, nominal personal income rose 9.1% in Q2 and 8.8% YoY in June. Since quarter-end, income was up 1.1% (not annualized) in July, including gains of 1.0% in wages and salaries and 2.9% in transfer payments as new advance child-care payments began. Looking ahead, we expect continued job gains and rising wages will support good growth in personal income.

Despite a sharp decline in income during the second quarter, personal consumption expenditure (PCE) accelerated. Nominal PCE rose 19.1% in Q2 and 13.7% over 12 months ending in June 2021 (Figure 4). Adjusted for inflation (the PCE deflator jumped 6.7% in Q2), real PCE rose by 11.9% in Q2 and 9.3% YoY. Nominal spending on goods (23.3%) still outpaced services (16.9%), but that began to shift during the quarter as services spending accelerated while goods spending cooled (Figure 5). PCE slowed in July, up 0.3% (not annualized) in nominal terms and down 0.1% after inflation; but nominal spending on services was up 1.0% while goods was down 1.1%. Many service sector activities that were restricted earlier in the

• The Consolidated Appropriations Act of 2021 passed on December 27, 2020 followed by the $1.9 trillion American Rescue Plan Act of 2021, passed on March 11, authorized payments to individual taxpayers of $600 and $1,400, respectively, and sharply raised personal income in 1Q2021.

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pandemic are now growing rapidly, especially in leisure and hospitality. The shift from goods to services spending is likely to continue and should sustain good growth in PCE over coming months. Of course, COVID-19 remains a particular risk to the outlook for services activity if a recent increase in infections persists and weakens demand for or prompts new restrictions on service activities again. For now, we are optimistic on consumer spending, but we remain watchful of COVID's ongoing impact.

Figure 4: Income Swings on Stimulus

Figure 5: Spending Shift from Goods to Services

		Nominal Personal Income, Consumption and Savings, YoY
	35										30
											25
	30										20
											PercentGrowth,Spending& Income
PercentRate,Savings	25										15
									12.1
											10.1
	20										5
											2.7
											0
	15										-5
	10										-10
										9.6
											-15
	5										-20
	Jan	Mar	May	Jul	Sep	Nov	Jan	Mar	May	Jul	Sep
				2020					2021

Total, Personal Saving Rate, lhs

Personal Outlays (PCE), Overall, Total, Current Prices, AR, SA, USD, rhs [c.o.p. 12 months] Income Approach, Employee Wages & Salaries, Total, SA, AR, USD, rhs [c.o.p. 12 months]

Personal Income, Total, USD, rhs [c.o.p. 12 months]

Source: Macrobond

	Personal Consumption Expenditures, SA
150
125
100
75
50
%
25	13.5
	5.7
0	-0.4
	-7.4
-25
-50
-75

Jan

Mar

May

Jul

Sep

Nov

Jan

Mar

May

Jul

Sep

2020

2021

Real, Total, Chained, Constant Prices [a.r. 3 months]

Goods, Total [a.r. 3 months]

Services, Total [a.r. 3 months]

Total [a.r. 3 months]

Source: Macrobond

Figure 6: Inventory, Prices Dampened Sales

New + Existing Home Sales, Inventories and Prices

Figure 7: Residential Investment Slipped

Residential Investment, Change P/P

	20.0
YoY percent	17.5
15.0
Index,
Price	12.5
-city Home	10.0
Shiller 20	7.5
5.0
S&P/Case-
2.5
	0.0

8

19.1

7

6.70 million

6

5

4

3

2

1.69 million

1

million Inventory, and Sales Home Existing + New

	60
	50
	40
	30
	20
Percent	10
	0
	-10	-11.5
	-20
	-30

Jan May Sep	Jan May Sep	Jan May Sep	Jan May Sep
2018	2019	2020	2021

S&P/Case-Shiller20-city composite Home Price Index, lhs [c.o.p. 1 year] Inventory of New + Existing Homes for Sale, rhs

United States, Real Estate Transactions, New + Existing Home Sales, SA, Volume, rhs

Source: Macrobond

-40

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

2018

2019

2020

2021

Gross Private Domestic Investment, Fixed, Residential, Current Prices, SA, AR, Change P/P

Source: Macrobond

Lower income and higher spending pushed the savings rate down to an average of 10.3% in Q2 and 9.6% in July (Figure 4). While that is a big decline in the savings rate from almost 27% in March, it follows a similarly outsized gain in Q1 from stimulus payments. It simply took consumers time to spend some of that money. We think rising employment and wages

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combined with still-high levels of personal savings mean PCE will remain a source of strength for the economy over coming quarters, although recent rapid gains are bound to slow.

The housing market slowed in the second quarter, with both home sales and residential investment pulling back. Combined new and existing home sales averaged a little over 6.5 million units in the second quarter, down from an average of 7.2 million units in Q1 (Figure 6), as low inventory of homes for sale and rapidly rising prices dampened sales. Housing starts fell by 16.3% in Q2 after rising by an equal amount in Q1, and housing completions plunged by 40% as shortages of homebuilding materials and labor slowed progress. As a result, residential investment slipped by 11.5% after three very strong quarters (Figure 7). Low mortgage rates, rising employment and wages, and strong household balance sheets kept housing demand firm, while the supply of homes available for sale remained very tight. Not surprisingly, prices jumped. The S&P/Case-Shiller20-city composite home price index rose 19.1% over 12 months ending in June, the fastest pace on record. With housing demand firm and some construction bottlenecks easing, we expect residential investment to resume growth over coming quarters - albeit at a slower pace than in 4Q2020 and 1Q2021.

Industrial production picked up in the second quarter as cold weather receded and some shortages eased. Industrial output rose 6.1% in Q2 and added another 0.9% in July, pushing output over three-months ending in July up by 9.4% (Figure 8). It was up 6.6% in July compared to a year earlier. Although the Institute for Supply Management's manufacturing survey retreated from a record high in March, it pointed solidly toward continued expansion at 59.9 in August (50 is neutral). Factory orders also posted strong gains, with overall orders up 12.6% in Q2, and orders for core capital goods (nondefense, excluding aircraft) up 18.6%. Rising orders prompted lengthening backlogs that should keep manufacturers busy for some time, even if consumer spending on goods slows somewhat. Materials and labor shortages eased in some areas and remained acute in others, but rising output signals progress on balance.

Figure 8: Output, Orders Up; Shortages Ease	Figure 9: Core Business Investment Strong
Industrial Production, ISM, and Nondefense Capital Goods Orders	Growth of Private Business Fixed Investment, Constant Prices, SA, Chained

	50	65.0			30
	40	62.5			20
	30	59.9
Percent					10
20	57.5
		15.7
Production& Orders,	10	9.4			0
Index ISM
-20	47.5	%
	0	52.5			-10
	-10	50.0
					-20
	-30	45.0			-30
	-40	42.5			-40
	-50	40.0

Sep Jan May Sep Jan May Sep	Jan May Sep Jan May Sep Jan	May Sep	-50
2016	2017	2018	2019	2020	2021		2012	2013	2014	2015	2016	2017	2018	2019	2020	2021
Business Surveys, ISM, Report on Business, Manufacturing, Purchasing Managers', rhs			Total, AR [a.r. 1 quarter]
New Orders, Non-Defense Capital Goods Excluding Aircraft, SA, USD, lhs [a.r. 3 months, m.a. 3 obs]			Structures, Total, AR [a.r. 1 quarter]
Industrial Production, Total, Constant Prices, lhs [a.r. 3 months, m.a. 3 obs]					Non-Residential Investment, Total excl. Structures, Constant Prices, SA, Chained, USD [a.r. 1 quarter]
					Source: Macrobond												Source: Macrobond

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