Morgan Stanley
  • Thoughts on the Market Podcast
  • May 27, 2021

2021 Mid-Year U.S. Economic Outlook - Growth Remains Strong

With Ellen Zentner and Andrew Sheets


Andrew Sheets: Welcome to Thoughts in the Market, I'm Andrew Sheetz, Chief Cross Asset Strategist for Morgan Stanley.

Ellen Zentner: And I'm Ellen Zentner, Morgan Stanley's chief U.S. economist.

Andrew Sheets: And on this special mid-year outlook edition of Thoughts in the Market, we'll be talking about the outlook for the U.S. economy. It's Thursday, May 27th, at 3 p.m. in London

Ellen Zentner: and 10 a.m. in New York.

Andrew Sheets: So, Ellen, let's start at the top, we've just gone through a large collaborative process at Morgan Stanley Research thinking about our outlook for the year ahead. How are you thinking about the U.S. economy and how strong do you think growth could be over the next 12 months?

Ellen Zentner: I think growth is going to be very robust this year. That may not be very surprising to hear, given that we're coming out from under the cloud of COVID, but we're looking for 8% GDP growth this year on a Q4 over Q4 basis. And I think it's all due to reopening, you know, how much consumers want to reengage with the economy? How much do they want to pull down of that trillions of dollars in excess savings? How many jobs will we bring back? And so I think all of that is looking quite positive for the U.S. and it's not without its risks. Right. COVID is still the number one risk to the growth outlook. For instance, if we go in to the fall and winter and variants come about that we're not able to battle with the vaccines or there's not a great take-up rate in terms of the boosters that we need to get. So in other words, households retreat, but there are also upside risks. You could have a much greater return to the labor market and in a much more reduced work from home environment then than we expect. You could have Fed policy that remains even more supportive for longer, more fiscal policy stimulus, for instance. So there are a lot of upside risks as well, but I'm feeling pretty comfortable with where we are on our growth outlook.

Andrew Sheets: Now, the flip side to stronger growth is that with stronger growth, often comes somewhat higher inflation. So what do you think the inflation outlook in the U.S. looks like over that same period? And what are the key variables that you're watching there?

Ellen Zentner: I think that inflation outlook is is much higher than it has been in previous forecast rounds. And, you know, there's there's a lot of been a lot of upside surprises there. So I think this near-term surge that we're going through now has been expected as we compare back to last year when we took the biggest disinflationary hit, but also because as you're reopening a lot of demand, strong demand hit supply constraints, and that's been both on the good side of the economy, in the services side of the economy. So this near-term surge in price is completely expected. But even there, the numbers have been coming in higher and we've revised upward our growth forecast for inflation and we don't have it backing off as much as we did previously over the summer months. And so that is something that the Fed is having to take a close look at. We believe that most of it is transient, but there are some underlying inflationary pressures that are building. And so we do see inflation remaining higher even after these covid related distortions passed this year. And so even into next year, we have higher inflation.


Andrew Sheets: So Ellen, when it comes to the labor market, I think you see a lot of different theories out there. So how do you think about those dynamics? And also how do you think about the wage side? Because obviously the other side of those higher wage pressures is that this is a good thing for consumers. They're earning more money for the same amount of work and that will allow them to spend more money in the economy.

Ellen Zentner: I think the departures from the labor market is a very real thing. I mean, we've seen a wave of retirements, so people leaving the labor market altogether and it's been much higher this time than what age alone would suggest. And so that that is a very real thing. And I think that we could expect some structural unemployment, higher structural unemployment from this cycle. I think, also, the points that that seemingly are keeping people from entering back into the labor market are up for much debate. You know, we've heard a lot about women with young children that have been affected by uneven school openings. Now we're moving into the summer where school is out and it may be not until the fall that they go back to work when the kids are back in school fully. But even there, there's competing studies on whether that's really having an effect or not, that generous unemployment benefits. We've got several states in the U.S. that have said that they would they are going to turn away the federal supplemental unemployment benefit because it's it's resulting in too much income replacement in their states, which which are keeping folks from going back into the labor market and particularly in those leisure and hospitality jobs. And then the health concerns, lingering health concerns, which I'm sure unemployment benefits are helping the folks make that decision to take those health concerns into account.

That said, I do think that the subpar growth that we saw in jobs in April of just  266,000 is a one off, and we do expect about 650,000 jobs to have been created in May. But the jury is out until we get several more data points on just what's keeping people from work. So what's happening then? Companies are having to pay up to get people back to work. And we're seeing that in the current labor cost data, the wage data, the employment cost index data, and it's particularly coming from the low wage paid segments. And so that's putting margin pressure on businesses and they're having to pass on that cost to consumers in the form of higher prices. So it's not just COVID related distortions, particularly on on price increases, but it's also labor costs. And we do think that those will be more sticky. And so, Andrew, you talked about something that kind of speaks to a virtuous cycle here, right? Is it so bad that that workers want more pay to go back to work because that's more income than they can spend more and that's more aggregate demand back in the economy. So it really kicks off that virtuous cycle. Where it becomes sticky for the Fed is are those higher wages outpacing prices?

Andrew Sheets: So let's stay with the Fed, because I want to touch on what I think is just kind of this really interesting dynamic for for like the last 12 months, the Fed's dual mandate of trying to obtain full employment with modest inflation. It's been really easy to justify aggressive Fed action. And yet now we're starting to maybe hit a part of the economic cycle where labor markets are getting tighter or there's a debate over how much slack there is in the labor market and prices are also starting to go up. And so if you're the Fed, how do you think they think about that dynamic and what sort of data are they going to be focused on?

Ellen Zentner: Right now, the Fed believes that most of those price pressures are transient, will fade. So you certainly don't want to act on policy and then have inflation come back off when they're looking to sustain higher inflation for some time. They also don't want to overreact to, say, declines in the unemployment rate. And so what does that mean? It means that they have to remain reactionary, which means they're lagged, which means you let price pressures build for longer and you let many more folks come back to the labor market with a much lower unemployment rate before you act.

And this is a position that the Fed is happy to be in because they know good and well what to do in order to bring inflation down. They they aren't so good at bringing inflation up. And so they're willing to air on the side of caution, even if it means that they run the risk of, say, more runaway inflationary pressures taking hold because they've pushed the unemployment rate unnaturally low, let's say. So that's a position that they would actually love to be in. But right now, you know, the argument for waiting and getting more data in hand is pretty strong. That said, they're not ignoring all of the price pressures. That said, they're not ignoring the price pressures altogether. We've seen from their recent meeting in April and the minutes from that meeting that more of them are starting to support the idea that they should be talking about tapering. So they should be taking that first step of taking their foot off the gas pedal. And we expect them to provide that forward guidance in September of this year.

Andrew Sheets: So, Ellen, what I'd like to finish with, thinking back to 2010 and 2011. And, you know, that was a period it was just after a recession, you'd seen big rises in commodity prices. When you think back to that period, you know, what do you think is is similar this time? What do you think are lessons that the investors today can take away from that environment that are similar? And what do you think are key differences between now and then?

Ellen Zentner: So I think I think there were a lot of things that we didn't quite understand fully when we went into that downturn around the financial crisis. One was that the household sector would be deleveraging its balance sheet for a very long time and that that would take some time. And two was just a general misunderstanding of just how deep and long that downturn would be. And so we didn't provide enough fiscal policy support. And I think that's where we can draw a direct line to why the Fed has learned its lesson, why the fiscal policy that we've seen today shows that a lesson has been learned, that you you air on the side of caution and you throw as much at the downturn in terms of policy support as you can. So think about this, what was happening specifically in 2010. So the first time homebuyer credit, which went into place in 2008, expired in 2010. And so we had given that credit to encourage millions of homebuyers to purchase homes when home values were still on the way down. And that expired in 2010. And so we lost that homebuyer support and we had to pay taxes on that homebuyer tax credit. We also had the cash for clunkers payback. So in 2009, we put in place this Cash for clunkers program. New vehicle sales surged and remained elevated. And then for all of 2010, they declined. And so those are just two examples of policy programs that were very important that continued to help support the economy artificially when we were going through a very severe balance sheet downturn. And so it sort of delayed the day of reckoning. So it was ill timed and too little fiscal policy support after the financial crisis.

Andrew Sheets: Ellen, thanks for taking the time to talk.

Ellen Zentner: Great speaking with you, Andrew.

Andrew Sheets: As a reminder, if you enjoy Thoughts on the Market, please take a moment to rate and review us on the Apple Podcasts app. It helps more people find the show. 

Despite some inflation and labor market risks, the outlook for the rest of the year anticipates strong growth in the U.S. economy. Chief U.S. Economist Ellen Zentner discusses with Andrew Sheets.

In this addition to the Thoughts on the Market series, Chief U.S. Economist Ellen Zentner translates the sometimes complex world of economics, helping investors identify early indicators of market-moving trends. 

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