7 reasons why the US economy is set for take-off
Households and businesses are in good shape and vaccine-driven herd immunity will propel growth, writes Preston Caldwell.
The US economic recovery paused at the end of 2020, as a third wave of the coronavirus pandemic caused a retreat from the return to normal activity. This is no indication that the recovery is finishing up for good, however.
An end to the pandemic in the US is coming soon with the arrival of herd immunity following mass vaccination. We expect the US economy to take off like a rocket after that, as consumers are eager to spend, but their options are limited currently by the need to social distance.
Normalisation of behaviour following mass vaccination will mean a snap-back of consumer services, driving an overall GDP recovery (including a full recovery in the job market).
Households and firms alike are in good shape on average thanks to record stimulus in 2020, and another massive stimulus injection likely coming in 2021.
Altogether, there's little doubt now that the US economy will not only recover from the pandemic but that it will test its limits in a way that hasn't been done since before the Great Recession. The key question then turns to where the upper limit is.
We're now forecasting GDP to surpass our pre-COVID expectation (Exhibit 1). Yet we're not ready to match some of the more optimistic forecasts, as we think the US economy will probably start brushing up against capacity constraints around 2022.
We now forecast US GDP to surpass our pre-COVID expected growth path
Source: US Bureau of Economic Analysis, Morningstar.
Reasons for optimism
The outlook for the US economy is now stronger than before the pandemic. We're projecting US real GDP growth of 5.3 per cent in 2021 and 4 per cent growth in 2022. This aggressive growth is enabled by the historically large fiscal stimulus of 2020 and expected in 2021, along with mass vaccination allowing economic activity to return to normal. As a result, we now expect US GDP to surpass our pre-COVID growth path.
The recovery paused at the end of 2020, owing to the pandemic's third wave. Increasing cases in the final months of 2020 caused consumers to retreat from a return to normal activity, although activity certainly hasn't collapsed as it did during the first wave in March/April. US GDP growth slowed greatly in the fourth quarter of 2020 to 1 per cent from its blistering 7.5 per cent pace in the third quarter. But this doesn't mean the recovery is wrapping up for good.
The end of the pandemic in the US is coming soon. Thanks to mass vaccination, we expect that herd immunity (the point at which the virus can be suppressed even while social contact and other behaviour returns to normal) will be reached by May 2021.
The US economy will be ready for lift-off after mass vaccination. We believe consumers are eager to spend, but their full range of options is limited by the continuing need to social distance, which hampers services spending. In fact, the deficit in consumer-services expenditure now accounts for the entire GDP gap compared with pre-pandemic levels. We expect real services consumption to snap back after mass vaccination, growing 6.7 per cent for full-year 2021, driving a 6 per cent increase in overall consumer expenditure. The job market should recover in tandem with consumer services, as the sector accounts for most of the lost jobs during the recession.
Stimulus has caused private incomes to soar. Fiscal stimulus in 2020 reached a peacetime US record, with a deficit/GDP of about 16 per cent. This caused private after-tax incomes to soar, even with economic activity down for the year. This has already set the private sector up to spend eagerly in coming years, and another round of massive stimulus in 2021 should add to this.
Most households' finances will emerge from the pandemic better than ever. This includes even lower-income households (on average). While lower-income households saw the worst job losses during the pandemic, they received unprecedented levels of government relief. In particular, thanks to boosts to unemployment benefits under the stimulus, the average laid-off low-income worker received far greater than 100 per cent of his or her normal income in 2020.
More stimulus can do only so much for the long-run recovery. Some forecasters have taken their US GDP expectations up to sky-high levels (expecting 200 basis points more growth than us through 2022) as President Joe Biden's US$1.9 trillion ($2.56 trillion) stimulus plan looks like it may pass largely in full. We're more sceptical, as we think additional stimulus will have sharply diminishing returns in spurring demand. More importantly, stimulus is only effective in sustainably lifting up the economy if GDP is below its potential level, meaning there's still slack in the economy. We think the US economy may be brushing up against its potential by 2022 or so, with labour markets getting quite tight by then. However, there's high uncertainty about where exactly US potential GDP is, and this is the key driver of upside risk to our US GDP forecast.
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