IMF lifts US growth outlook for this year to 7%, says Fed may need to hike rates earlier than it expects

FILE PHOTO: The International Monetary Fund (IMF) headquarters building is seen ahead of the IMF/World Bank spring meetings in Washington, U.S., April 8, 2019. REUTERS/Yuri Gripas
FILE PHOTO: The International Monetary Fund (IMF) headquarters building is seen ahead of the IMF/World Bank spring meetings in Washington

  • The IMF raised its forecast for US growth to 7% for 2021, from the previously predicted 4.6%
  • The fund believes the Federal Reserve will need to hike interest rates in late 2022, or early 2023.
  • Last month, the Fed said it expected to raise rates in 2023, but individual policymakers expect earlier hikes.
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The International Monetary Fund has lifted its outlook for US economic growth to 7% for this year, and believes the Federal Reserve will raise interest rates by the end of 2022, as recovery takes root.

The IMF had previously anticipated an annual growth rate of 4.6% for this year. Should the US economy indeed by 7% in 2021 – as both the Fed and now the IMF expect – this would be the fastest expansion since 1984.

Kristalina Georgieva, the IMF managing director, said the improved outlook was based on the American Jobs and Families plans being implemented in line with the outlines presented by the Biden administration, as they appear likely to improve living and income standards in the long term.

“We believe that these two packages will add to near-term demand, raising GDP by a cumulative 5¼ percent over 2022-24. And-perhaps more importantly-our assessment is that GDP will be 1 percent higher even after 10 years, thanks to the significant, positive effects on labor force participation and productivity introduced by these two plans.” she said in a report released on Thursday.

Biden’s infrastructure plan was also referenced in the IMF’s assessment. The bipartisan program allocates $1.2 trillion over the next five years to improving things such as roads, broadband access and education.

The IMF also said it expected US interest rates to rise more quickly than the Fed currently anticipates.

“Presuming staff’s baseline outlook and fiscal policy assumptions are realized, policy rates would likely need to start rising in late-2022 or early-2023,” the IMF said.

At its mid-June meeting, the Fed said it expected to raise interest rates by 2023. Several individual policymakers have however since said they expect monetary policy to tighten sooner than this.

The Fed’s more hawkish outlook initially fueled some concern among investors, particularly relating to the implications for the central bank’s highly accommodative monetary policy stance. Stocks wavered for a few weeks, but have since recovered and hit successive record highs in the last week. Government bond yields have fallen to around six-month lows, highlighting that investors trust the Fed’s ability to target inflation without derailing the economy.

Both the IMF and the Fed expect inflation to be transitory and short-term, rather than weigh on markets for a prolonged period of time.

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The US economy is set to grow at the fastest pace since 1984 thanks to stimulus and the rapid vaccine rollout, the OECD said

GettyImages 1233170656
The US has rolled out coronavirus vaccines quickly.

  • The US economy is set to grow at the fastest pace since 1984 this year, the OECD has said.
  • US gross domestic product would grow 6.9% in 2021, after contracting 3.5% in 2020, it said.
  • The organization said the US’ huge stimulus and speedy vaccine rollout was boosting growth.
  • See more stories on Insider’s business page.

The US economy is set to grow at the fastest rate since 1984 this year thanks to government stimulus and the speedy rollout of coronavirus vaccines, the Organisation for Economic Co-operation and Development (OECD) has said.

In its latest economic outlook, the OECD group of rich countries said US gross domestic product would grow 6.9% in 2021, after contracting 3.5% in 2020. That would be the biggest increase since 1984, according to World Bank figures.

The OECD’s new US forecast was an upgrade from March’s prediction of 6.5% growth, which was itself a sharp improvement on a December estimate of 3.2%.

The successive upgrades reflect the impact of both President Joe Biden’s $1.9 trillion stimulus bill and of vaccines, which are allowing states to reopen their economies. More than half of the US population has now had at least one shot.

“Substantial additional fiscal stimulus and a rapid vaccination campaign have given a boost to the economic recovery,” the OECD analysts wrote in their report.

The authors said the recovery had picked up speed: “Indicators of consumption activity have risen, with strong household income growth and a gradual relaxation of containment measures boosting spending.”

They added: “The reopening of the economy due to widespread vaccination of the population will enable activity in more sectors to return to normal.”

The OECD is a global organization that promotes growth and trade, with 38 member countries. Its economic forecasts are closely watched.

It predicted that the global economy would grow 5.8% in 2021, up from its March forecast of 5.6%.

Yet the global recovery will be highly uneven, and the pandemic will hit some countries’ living standards hard, according to OECD chief economist Laurence Boone.

“It is with some relief that we can see the economic outlook brightening, but with some discomfort that it is doing so in a very uneven way,” she said in an introduction to the report.

“It is very disturbing that not enough vaccines are reaching emerging and low-income economies. This is exposing these economies to a fundamental threat because they have less policy capacity to support activity than advanced economies.”

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Biden sees a post-pandemic economic boom, but a small and short one

Biden
President Joe Biden.

  • Biden’s budget sees the economy booming for just two years before settling into slower growth.
  • GDP is forecasted to grow 1.8% annually in the mid-2020s, weaker than growth after past recessions.
  • The conservative estimates contrast with the Trump administration’s pattern of underdelivering.
  • See more stories on Insider’s business page.

The Biden administration sees a strong economic rebound in the cards. What’s forecasted afterward is less exciting.

President Joe Biden revealed his budget proposal for the 2022 fiscal year on Friday, laying out his plan to spend roughly $6 trillion on child care, clean-energy initiatives, and infrastructure improvements – and laying out a set of forecasts for US gross domestic product over the next several years.

The near-term estimates are promising. Biden sees GDP expanding 5.2% in 2021 and 3.2% in 2022, handily exceeding the annual growth seen just before the COVID-19 crisis.

But if the so-called Biden boom began with his $1.9 trillion stimulus plan in March, then his budget proposal sees it ending just two years later. The administration estimates GDP growth will slow to 2% in 2023 and then settle at 1.8% through 2027.

This is considerably weaker than recoveries from previous recessions. Annual growth averaged 2.3% from 2010 to 2019 as the US placed the Great Financial Crisis behind it. After the dot-com bubble burst in 2001, GDP grew at an average annual rate of 5.4% until 2008. And the output expanded at an annual pace of 4.4% from 1983 to 1989, after back-to-back recessions had kickstarted the decade.

Biden’s forecast, then, is notably conservative. It contrasts with statements he’s made publicly as recently as this week. Citing “independent experts” in a Thursday speech, the president said growth could come in at 6% or greater in 2021.

He added that his follow-up spending proposals would open the door to “faster” growth. Yet the rate of expansion forecasted in his budget sees growth slowing or holding steady through 2027.

It also falls short of forecasts from major Wall Street banks. Morgan Stanley sees growth coming in at 8% this year before cooling to 3.2% in 2022. Bank of America projects growth of 7% in 2021 and 5.5% the following year.

The modest estimates could reflect a desire to buck the trend seen throughout the Trump presidency, which underdelivered on growth, even before considering the economic collapse seen through 2020.

The Trump administration’s final budget expected GDP growth to trend at 2.9% through 2030. While that was published before the pandemic, it still handily exceed the levels forecasted by Biden.

To be sure, other estimates in Biden’s plan are much more optimistic. The White House expects the unemployment rate to fall from 6.1% to 5.5% by the end of 2021 and reach 4.1% by the end of 2022. The rate will then hold steady at 3.8% into 2031, just above the pre-pandemic lows of 3.5%, according to the plan.

Biden’s latest spending proposals – which include trillions of dollars for infrastructure and family support – are also engineered to provide sustained investment instead of an immediate burst like that seen with his stimulus plan. Both packages are meant to be spent over the next eight to 10 years, and administration officials argue such a timeline would minimize their effect on inflation.

The White House has also stepped up its calls to invest in economic growth while interest rates sit at historic lows. While deficits are traditionally measured as debt to GDP, interest-payments to GDP are a better measure for sustainable spending, Treasury Secretary Janet Yellen told lawmakers in a Thursday hearing.

The government should spend on investments that lift output over the long term while debt-financing costs are so low, she added.

“The president’s proposal will have a temporary period of spending and permanent increases that, beyond the budget window, will result in lower deficits and more tax revenue to support those expenditures,” Yellen told a House Appropriations subcommittee.

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US economic growth will hit 7% this year on major stimulus boost, BofA says in latest upgrade

People Shopping covid NYC
People shopping at the Union Square Greenmarket as New York City continues reopening efforts on December 4, 2020.

  • BofA lifted its 2021 US GDP forecast to 7% from 6.5%, the latest in several upgrades by the bank.
  • The firm sees strong spending already and unemployment falling to 4.5% later this year.
  • The White House’s plan for up to $3 trillion in new spending can further lift growth, the bank said.
  • See more stories on Insider’s business page.

The American reopening is already leading to stronger growth than banks expected. Just ask Bank of America.

On Thursday, BofA economists lifted their 2021 US growth forecast once again on hopes for past and future stimulus accelerating the economic recovery. The upgrade is at least the fourth the bank has made this year.

The team led by Michelle Meyer now expects gross domestic product to grow 7% this year, up from the previous estimate of 6.5%. Output will then reach 5.5% the following year, also an upgrade.

Growth on a fourth-quarter-by-fourth-quarter basis will total 7.7% in 2021 and 4.4% in 2022, the team added. That exceeds the Federal Reserve’s median estimates of 6.2% and 3.4% growth in 2021 and 2022, respectively.

The upward revision is entirely linked to stimulus. The $1.9 trillion measure passed by Democrats earlier this month is already fueling “exceptional consumer spending” according to credit- and debit-card spending data tracked by the bank. Distribution of $1,400 direct payments contributed to a 40% month-over-month spending leap among recipients. The boost might only just be getting started, the economists said in a note to clients.

Total card spending was up a whopping 45% from a year ago and 23% from two years ago for the seven days ending March 20, per BofA data.

“We think consumer spending is about to take off given the one-two punch of stimulus and reopening,” they added.

Hopes for a follow-up spending package added to the bank’s rosier forecast. The White House is organizing a proposal for up to $3 trillion in spending on infrastructure, climate, and education projects to further aid the country’s rebound. Such a plan would drive a more moderate boost to growth over a longer period of time, the bank said.

Tax hikes used to pay for a follow-up spending package could offset some gains, the team added.

Stronger 2021 growth should open the door for a swifter labor market recovery, according to the bank. The team expects a series of encouraging jobs reports starting with the March release scheduled for April 2. Payroll growth is projected to average 950,000 per month in the second quarter and pull the unemployment rate to 4.7% from 6.1%.

The rate will fall more modestly through the rest of the year to 4.5%, the team said. That matches the Fed’s own year-end estimate.

Bank of America’s bullish update follows similarly optimistic forecasts from Wall Street peers. Recent weeks have seen Morgan Stanley, UBS, and Goldman Sachs all lift their own estimates for 2021 GDP growth.

Morgan Stanley remains the most bullish of the bunch, estimating the economy will expand 8.1% this year and return to pre-pandemic output levels by the end of the first quarter. All three banks, along with Bank of America, hold decidedly more hopeful outlooks than the Fed due to expectations for another large-scale spending measure.

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Fed lifts estimates for US economic growth and employment as vaccination speeds up

Federal Reserve
  • The Fed boosted its estimates for economic growth in its projections since December.
  • US GDP is forecasted to grow 6.5% this year, up from the prior estimate of 4.2%.
  • The Fed also sees the unemployment rate sinking to 4.5% by the end of 2021.
  • See more stories on Insider’s business page.

Federal Reserve policymakers boosted their projections for the US economic recovery on Wednesday as new stimulus and vaccine rollouts pave the way for a summer reopening.

The Federal Open Market Committee’s median estimate for 2021 gross domestic product growth rose to 6.5% this year, and 3.3% for 2022. That compares to the previous forecasts of 4.2% and 3.2%, respectively. The unemployment rate is now expected to dip to 4.5% this year, an improvement from the prior forecast of 5%.

The FOMC released its quarterly summary of economic projections following the second day of its March meetings. The central bank elected to hold interest rates at historic lows and maintain its pace of asset purchases at $80 billion in Treasurys and $40 billion in mortgage-backed securities per month.

The estimates are the first to be published since December, and therefore are the first to include the impact the $900 billion stimulus package passed late last year, the $1.9 trillion plan signed earlier this month, and the improved pace of vaccination. The developments have all been viewed as major boons to the economic rebound and prompted several economists to lift their own growth forecasts.

The nation’s fight against the coronavirus has also shifted significantly since the December FOMC meeting. Daily case counts surged to a peak above 300,000 in early January but have since tumbled to around 50,000 as distancing measures and vaccination curbs the pandemic’s spread.

New stimulus has been criticized by Republicans for risking runaway inflation through the recovery. Fed officials have countered such concerns in recent weeks. Jerome Powell has repeatedly said that, although reopening and stimulus can produce a quick jump in inflation, the effect will likely be temporary and give way to a similarly sharp decline.

The FOMC’s latest estimates reflect such an outlook. Members see personal consumption expenditures inflation – the Fed’s preferred price-growth gauge – reaching 2.4% in 2021, up from the previous 1.8% estimate. Inflation will then fall to 2% in 2022 and reach 2.1% the following year.

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Biden’s stimulus will lift US growth to 8% this year, Goldman Sachs says – without factoring in another $2 trillion spending package

Biden signs American Rescue Plan
US President Joe Biden signs the American Rescue Plan on March 11, 2021, in the Oval Office of the White House in Washington, DC.

  • Goldman Sachs lifted its 2021 US growth forecast to 8% from 7.7%, citing new stimulus for the boost.
  • The bank also expects Biden and Democrats to pass at least $2 trillion in infrastructure spending.
  • That sum could hit $4 trillion if the deal includes education, child-care, and health-care spending.
  • See more stories on Insider’s business page.

Goldman Sachs joined its Wall Street peers in revising its US economic outlook on Saturday, pegging an increasingly bullish forecast to Democrats’ latest stimulus package.

The team led by Jan Hatzius now expects US gross domestic product to grow 8% in 2021 on a fourth-quarter-to-fourth-quarter basis, according to a note published Saturday. That’s up from the previous estimate of 7.7%. The bank’s full-year growth estimate climbed to 7% from 6.9%.

The current-year projection largely hinges on President Joe Biden’s stimulus plan, as Goldman had initially expected a $1.5 trillion deal to reach Biden’s desk. The $1.9 trillion plan signed by the president on Thursday will accelerate the nation’s economic recovery through the middle of 2021 before tapering off into 2022, the bank’s economists said. Stimulus checks’ rollout over the coming months will concentrate the plan’s positive impact in the second quarter, they added.

Democrats’ stimulus package is probably the last major pandemic-era relief deal, but key tenets of the plan are set to be renewed as the economy climbs out of its virus-induced hole. The bill’s expansion of the child tax credit will probably be extended or made permanent by Democrats, according to Goldman.

The $300 supplement to federal unemployment benefits will expire as planned in September, but expanded eligibility and benefit duration policies included in Biden’s package could be prolonged, the team said.

Next stop: Infrastructure

Biden has said he aims to pass a massive infrastructure measure to further juice the US recovery. Such a plan will come with a price tag of at least $2 trillion, though details are scarce for now, Goldman said.Inclusion of funding for child care, health care, or education could push the sum to $4 trillion, though tax hikes would probably be needed to fund such a package, the bank added.

Biden campaigned on a $2 trillion package, though some Democratic senators indicate they favor even larger spending. Sen. Joe Manchin of West Virginia, an influential moderate member of the caucus, has said he could support up to $4 trillion, while Sen. Dick Durbin of Illinois, a member of party leadership, has said he could support $3 trillion.

Infrastructure spending would have a less pronounced impact on growth, but Goldman still sees the package driving a stronger expansion through 2022. The economy will expand 2.9% next year on a Q4-Q4 basis, up from the bank’s prior forecast of 2.4%.

House Democrats began planning their infrastructure push on Friday. House Speaker Nancy Pelosi said she hopes to hold bipartisan talks on improvements to broadband, energy, and education, among other sectors. Yet after passing the stimulus bill without a single Republican vote, garnering support across the aisle could be difficult.

Goldman’s update follows similarly optimistic changes elsewhere on Wall Street. Morgan Stanley lifted its forecast on Tuesday to 8.1% on a Q4-Q4 basis. US GDP will fully rebound to pre-pandemic highs by the end of the first quarter and trend higher in the coming months as the economy fully reopens, the team led by Ellen Zentner said.

Separately, UBS projected growth would reach 7.9% from Q4 2002 to Q4 2021 as stimulus, falling COVID-19 case counts, and continued vaccination opened the door for a strong recovery. The bank, like Goldman, had expected Republicans to water down the size of the latest relief package. Passage of the full bill can help consumer spending lift the ailing services industry into 2022, economists led by Seth Carpenter said in a note to clients.

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The US economy will grow 7.9% in 2021 as stimulus juices consumer spending, UBS says

US Capitol
The US Capitol building exterior is seen at sunset on March 8, 2021 in Washington, DC.

  • UBS economists lifted their 2021 Q4-Q4 growth estimate to 7.9%, citing Biden’s huge stimulus plan.
  • Another relief package will extend strong growth through 2022, the team added.
  • Inflation will surge through reopening but quickly calm as the economy normalizes, the bank said.
  • Visit the Business section of Insider for more stories.

Another massive tranche of fiscal stimulus is on the brink of passage, and UBS sees the measure fueling strong growth well into next year.

Economists led by Seth Carpenter expect US gross domestic product to grow 7.9% from the fourth quarter of 2020 to the fourth quarter of 2021. Growth on a calendar-year basis will total 6.6%, a larger-than-usual difference due to depressed first-quarter gains.

The economy will continue to expand at a robust pace in 2022 as a new fiscal support measure further boosts the recovery, the team projected.

The bank’s previous baseline scenario assumed Republican opposition would force President Joe Biden to shrink his $1.9 trillion stimulus plan, but that hasn’t taken place. With House Democrats poised to approve the measure in a final vote on Wednesday, the bill is set to lift the last pockets of the economy still struggling through lockdowns.

“The manufacturing sector is robust. The housing sector is surging. The part of the economy that is lagging is consumer spending on services,” the team said in a Tuesday note. Their updated forecast sees spending more evenly spread between goods and services.

Nearly all signs point to a healthy recovery in the coming months. The average rate of vaccination has stabilized above 2 million shots per day, according to Bloomberg data. At the same time, daily case counts are down significantly from their January peak and hospitalizations have similarly plummeted.

The pace of the rebound has raised questions as to whether Biden’s massive relief plan is necessary. Where Democrats claim the hole in the economy is large enough to warrant nearly $2 trillion in fresh aid, critics argue the proposal will overheat the economy and send inflation soaring.

UBS sees little risk of a lengthy inflation overshoot. April and May will likely see price growth sharply accelerate, but that rally will quickly give way to moderately higher inflation in line with the Federal Reserve’s target. The roughly 10 million jobs still lost to the pandemic are proof that there’s room for stronger-than-usual inflation, the bank said.

“We see sustained growth, well in excess of the long-run sustainable pace, but we also see a substantial amount of labor market slack,” the team added.

The outlook matches that outlined in recent weeks by Fed Chair Jerome Powell. The central bank expects reopening to lift prices at a fairly quick rate, but the decades-long trend of relatively weak inflation won’t “change on a dime,” Powell said in a late-February House hearing.

The Fed’s preferred inflation gauge will only trend at its 2% target by the end of 2023, UBS said. Rate hikes likely won’t arrive until 2024, though tapering of the central bank’s asset purchases could arrive as soon as October if the recovery surprises to the upside, the economists added.

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US GDP will return to pre-pandemic highs by the end of March, Morgan Stanley says

Mall coronavirus retail
  • The US economy will grow 8.1% in 2021 as the coronavirus threat fades for good, Morgan Stanley said.
  • GDP will return to pre-pandemic levels by the end of the first quarter, the bank’s economists added.
  • Unemployment will fall to 4.9% in 2021, the bank said, still above the rate from before the crisis.
  • Visit the Business section of Insider for more stories.

Morgan Stanley has lifted its forecasts for 2021 economic growth in the US, citing a collection of encouraging trends for its brighter outlook.

Gross domestic product is now expected to grow by 8.1% on a fourth-quarter by fourth-quarter basis, up from 7.6%, the team led by Ellen Zentner said in a Tuesday note. Growth for 2022 was revised 0.1 points lower to 2.8%.

The bank also expects US GDP to fully rebound to its pre-pandemic level by the end of the current quarter. The output gap – a measure of how actual growth compares to maximum potential growth estimates – is expected to turn positive and reach 2.7% by the end of the year as the economy roars out of its virus-induced downturn. That would be the highest reading since the 1970s, according to the Bureau of Economic Analysis.

Economic reopening, a faster rate of vaccination, and stronger job growth all contributed to the adjustments, the economists said. New stimulus likely to win final approval in the House on Wednesday is in line with what the bank expected, but its earlier timing and the pace of first-quarter growth also added to optimism, the team added.

Morgan Stanley sees the unemployment rate tumbling further, though taking longer to reach lows seen before the pandemic. The gauge is projected to average 4.9% by the fourth quarter of 2021, down from the previous 5.1% estimate. Unemployment will sink further to 3.9% over the following year, the team said.

“A more robust return to work will be somewhat offset by rising labor force participation, but economic activity is strong enough to still generate a sharp decline in the unemployment rate,” the bank added.

The faster recovery will come at a cost, and Morgan Stanley’s latest inflation projections signal price growth will firm up later this year. Higher prices for rent, healthcare, and staples will lift inflation to 2.6% in April and May before it eases to 2.3% at the end of the year, according to the economists. Inflation will hold at the elevated level well into 2022, meeting the Federal Reserve’s above-2% target.

Still, significant tightening of monetary conditions isn’t likely to take place until 2023, the bank said. Policymakers will likely reiterate their dovish guidance when they meet next week and project near-zero rates staying at least through 2022. Yet the recovery and related effects on inflation and hiring will lead the Fed to begin shrinking its asset purchases in January 2022, Morgan Stanley said.

“By the middle of the year we expect the cloud of COVID will have thinned and the recovery will have picked up meaningfully enough that the Fed will see it as appropriate to begin taking its foot off the gas pedal,” they added.

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US GDP growth will likely miss a key forecast if the global economy falters, Dallas Fed says

US Mall coronavirus
A shopper goes up in the escalator in Baldwin Hills Crenshaw Plaza on Tuesday, Dec. 8, 2020, in Los Angeles.

  • Weaker-than-expected global economic growth could hinder the US recovery, Fed researchers said.
  • The CBO expects US GDP to grow 4.6% in 2021, but the chances of that fade on slower global growth.
  • The Fed simulated 2021 growth 1 million times and found weak global growth almost guarantees US underperformance.
  • Visit the Business section of Insider for more stories.

The US economic recovery hinges a great deal on how the rest of the world rebounds, according to researchers at the Federal Reserve Bank of Dallas.

For the moment, the US is expected to fully recover from its virus-induced downturn by the end of the year. The nonpartisan Congressional Budget Office projects gross domestic product will expand by 4.6% in 2021, offsetting the 3.4% contraction seen in 2020.

Yet global risks could drag US growth below the baseline forecast, Fed researchers Jarod Coulter and Enrique Martínez-Garćia said in a study published Tuesday. A model of cross-country growth dependencies shows significant downside risks, and even that outlook is a relatively conservative scenario, according to the team. The data doesn’t reflect cross-country events linked to the pandemic.

Accordingly, the Fed’s estimates suggest a greater likelihood of weaker-than-expected global growth. And further modeling suggests a weaker global rebound would cut into growth in the US. 

By simulating 2021 growth 1 million times, the team found that disappointing outcomes practically guaranteed the US would miss the CBO’s estimate.

Fed
Chart via Federal Reserve Bank of Dallas.

In the worst-case outcomes – 0.5th percentile – global growth coming in below 2.7% equated to a near statistical certainty the US would grow by less than 4.6%. There was also a 55.3% chance that US growth would come in below 1%, essentially relegating the country to another year of bleak economic performance.

Even the bottom 25th percentile of scenarios, in which global growth is less than 5%, show a sizeable impact on the US recovery. Such outcomes set a 95.8% chance that US growth would land below the CBO’s projection, and a 17% chance it would come in below 1.9%.

The study suggests that, in “not particularly severe” tail events, poor global growth often coincides with US GDP growth that’s below the baseline estimate.

“The more extreme the negative global growth outcome becomes, the more likely that the US recovery would falter in 2021,” the team said.

Such global spillover can also erode the US’ long-term economic potential, the researchers added. The CBO revised its projection for potential real GDP slightly lower from January 2020 to February 2021, implying that, even after the virus subsides, the economy’s maximum possible output has been dented.

The central bank’s modeling signals the US’ path forward is notably vulnerable to a slowdown in the global recovery, and that growth through 2021 is critical to the country’s ability to return to pre-pandemic output.

“The longer the recession drags on, the more significant the impact on the U.S. economy’s potential can become – mostly through its impact driving up long-run unemployment – and the longer it may take for real GDP to return to its prerecession path,” the Fed researchers said.

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Despite Trump’s promises, the US trade deficit hit record highs last year. But it’s set to shrink in 2021 – and that’s good news for the economy.

us trade american flag
An American flag flies nearby with shipping containers stacked at the Port of Los Angeles in the background, which is the nation’s busiest container port, on November 7, 2019 in San Pedro, California.

  • The US trade deficit blew out to record levels in 2020 due to the pandemic.
  • But that should turn around in 2021, as the US starts exporting more goods.
  • The will help boost the US economy and weaken the US dollar.
  • Neil Dutta is head of economics at Renaissance Macro Research.
  • This is an opinion column. The thoughts expressed are those of the author.
  • Visit the Business section of Insider for more stories.

For years, the Trump administration drew attention to what the former president called the US’s “unacceptable” trading relationship with the rest of the world. 

Ironically, by the time President Trump’s time in office was up, the real trade deficit widened to a record. The widening of the trade deficit was a meaningful drag on growth over the second half of 2020, a time when the broader economy was in recovery. 

Screen Shot 2021 02 04 at 11.25.45 AM

But this year, trade is likely to provide a lift to US growth, and the narrowing of the trade deficit may also push up the value of the US dollar against the currencies of its major trading partners.

Why the trade deficit grew in 2020

To understand why the trade deficit will narrow this year, let’s first look to why it widened so sharply in the first place. 

Despite a pandemic, US consumption of goods was relatively buoyant. Indeed, real goods consumption is running about 1.0% above its pre-pandemic trend. This is remarkable given the scope of the job loss in the US and elevated levels of uncertainty in the economic outlook. Purchasing decisions behind big-ticket items tend to be hard to undo. Moreover, many big-ticket goods could be purchased without making physical trips to the store. 

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While the US is a relatively closed economy, goods represent the main source of imports. In 2020, goods accounted for 83% of US imports, broadly in-line with the average over the last three decades. 

But while American households were buying goods from abroad, the same cannot be said of other countries buying our goods. About two-thirds of US exports are goods. These exports dropped more sharply during the depths of the pandemic and have recovered more slowly, leading to the wider overall trade deficit. But there is reason to expect goods exports  to pick-up in the year ahead. 

Why the trade deficit will shrink in 2021

Much of the trends that helped drive the record trade deficit in 2020 are about to see a turnaround, which in turn is good news for US economic growth.

Global manufacturing has picked up, and most of what is manufactured in the US is tradable goods. For example, the ISM new export orders index is consistent with solid growth in goods exports over the next few quarters. So American exports should pick up as well, helping narrow that side of the deficit.

In the year ahead, as the economy reopens, the amount of goods purchased by Americans will level off because they are already running so close to the pre-pandemic trend. Also as vaccines are distributed and people emerge from pandemic restrictions they will be much more likely to spend on services – dining out, going to the movies, amusement parks, etc. 

As it stands, services consumption is currently 9% below its pre-pandemic trend. Service-sector consumption, by its nature, tends to require close physical proximity to consumers. This is one reason why they aren’t really tradeable and why they disproportionately suffered during the pandemic. 

Screen Shot 2021 02 04 at 11.26.12 AM

The composition of consumption in the US this year lends itself to a narrowing of the trade deficit as consumers rotate into services, which are not really imported, relative to goods, which are.

All that adds up to a stronger dollar and growth

The narrowing of the trade deficit will likely have interesting implications for the US dollar exchange rate and our trading partners. 

As a rough rule of thumb, a wider trade deficit tends to weaken the exchange rate. If the trade deficit narrows, the opposite is true. Advanced economies represent the major trading partner for the US. OECD countries account for 60% of US imported goods. Thus, if US import growth slows, it will tend to come at the expense of these economies. As a result, we could see currencies like the euro, pound and yen weaken relative to the US dollar. 

Moreover, there is substantially more upside to growth in emerging economies than there is in our major advanced economy trading partners. 

For example, according to data from the IMF, in Asia’s emerging markets excluding China, the 2022 GDP level is roughly 8% lower relative to its pre-COVID trend. For Latin America and the Caribbean, the GDP level is about 7% lower than its pre-COVID trend. By contrast, advanced economies are off just over 2% relative to the pre-pandemic peak. That there is significant room for EM to strengthen bodes well for EM currencies. 

In short, there is more upside to EM and if goods imports to the US moderate that will tend to hurt advanced economies, at least relative to most emerging market economies. 

There are compelling investment implications. If EM begins to catch up to its pre-crisis trend, that will lift EM currencies, loosen financial conditions across the region, and provide a lift to EM stocks. In developed markets, there is reason to see the US outperforming Europe in the year ahead. Thus, we’d expect the euro and pound sterling to weaken this year.

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