Hotter U.S. Economy Risks Faster Cooldown as Biden Pushes Plan

(Bloomberg) -- The U.S. economic recovery from the pandemic collapse is starting off a lot hotter but could end up cooling much sooner than the record 10-1/2-year long upswing that preceded it.

With a surge of government spending already in train and President Joe Biden’s promise on Wednesday of yet more to come, gross domestic product is primed to skyrocket -- beginning with what some economists see as a double-digit annualized rise in the second quarter.

U.S. manufacturing growth roared ahead in March at the fastest in more than 37 years, and government job-market data out on Friday are expected to show the first in a series of outsized monthly increases in payrolls that could reach as high as one million.

“This is a huge, fiscally-fueled recovery, the fastest recovery in the history of the U.S. over the next two years,” said Ethan Harris, Bank of America Corp.’s head of global economic research.

But the rapid rebound is not without its pitfalls, some economists say. While Biden’s latest program may well boost productivity over time, there’s still a risk that the exuberant expansion will pump up inflation and spur excessive leverage, laying the groundwork for the upswing’s eventual demise.

“It pulls forward the day of the next recession,” said Mark Zandi, chief economist for Moody’s Analytics. He hypothesized that the current expansion could end sometime in the middle of decade, well short of the run the economy enjoyed after the 2007-09 financial crisis.

That has implications for investors and policy makers. In a 62-page report in March, Morgan Stanley advised its clients to be prepared to rotate out of investments that have done well early in the economic cycle, like emerging market equities, into those like Japanese stocks that might fare better later in an upturn.

A shorter expansion may also limit how high the Federal Reserve can lift interest rates from their current setting near zero before having to cut them to combat a recession. “It means that you can never quite break out of that lower for longer world,” said Morgan Stanley chief U.S. economist Ellen Zentner.

Infrastructure Spending

Fresh off winning congressional approval of a $1.9 trillion economic rescue package, Biden unveiled an additional $2.25 trillion spending proposal on Wednesday aimed at rebuilding and refashioning the economy after the pandemic.

“It will generate historic job growth, historic economic growth, help businesses to compete internationally and create more revenue as well,” Biden said in a speech in Pittsburgh touting the plan.

The four-part, eight-year proposal dedicates $620 billion for transportation, $580 billion for strengthening American manufacturing and $400 billion to address improved care for the elderly and people with disabilities.

Unlike the rescue package, this one will be paid for, with increased taxes on corporations, but over a 15-year time horizon. That means the plan will modestly add to the federal government’s already mammoth budget deficit in the early years, pushing the economy further up against its limits.

Productivity Boost

Biden administration officials portrayed the program partly as an effort to boost the economy’s capacity to grow without overheating by promoting faster productivity growth.

“Well-designed public investment can spur innovation and can spur productivity and it can spur job growth all around America,” Brian Deese, director of the National Economic Council, said on Bloomberg Television Wednesday.

While the program could indeed help increase productivity growth, those gains are likely to be years in the making, outside economists said.

The current recovery is already looking a lot different from the last one.

A year after suffering the deepest quarterly decline on record as the pandemic struck, the economy is poised to regain its previous peak in less than half the time it took to achieve that goal after the 2007-09 financial crisis.

U.S. manufacturing is a bright spot, expanding in March at the fastest pace since 1983, catapulted by the firmest orders and production readings in 17 years, according to Institute for Supply Management data released Thursday.

Treasury Secretary Janet Yellen sees the U.S. returning to full employment next year -- something that didn’t occur in the last expansion until 2018, when the jobless rate fell below 4%.

What Bloomberg Economics Says...

The drawdown of a massive accumulation of savings since the start of the pandemic will bolster consumption, as will sizable wealth-effects from rising real estate and equity markets. Both factors should push output higher and sustain above-trend growth over a longer horizon.

--Carl Riccadonna, Yelena Shulyatyeva, Andrew Husby and Eliza Winger (Economists)

Click here for the full report

It’s not only fiscal policy that’s revving up growth. Fed policy is too, with a preponderance of officials forecasting they’ll keep interest rates pinned near zero through 2023 even as the economy roars ahead.

Fed Chair Jerome Powell has played down concerns by former Treasury Secretary Lawrence Summers and others that the big bounce-back will cause the economy to overheat, arguing that strong global disinflationary forces will keep price rises from getting out of hand.

Some economists are not so sure. Ex Fed official Peter Hooper sees at least a one-in-five possibility of inflation rising to 3% or more over the next few years, markedly above the Fed’s average 2% target.

The $1.9 trillion rescue plan Congress passed last month is already set to push the economy toward the limits it can grow without overheating, according to Hooper. And that’s before taking account of any meaningful increase in spending by households running down the stash of savings they built up while shut in during the pandemic.

If inflation rises to 3% and looks to be persistent, “the Fed will get uncomfortable enough to start acting more aggressively and have more of a disruptive impact on financial markets and the economy,” Hooper, who is now global head of economic research for Deutsche Bank AG, said.

High Leverage

There’s another way the current upswing is different that might make it more vulnerable, Zandi said. Normally recessions end up purging the economy of excesses, forcing households and companies to reduce leverage and put their finances in better shape.

That didn’t happen this time, especially when it comes to corporations. Thanks in part to a since-ended emergency program from the Fed, even some of the riskiest companies have been able to ramp up borrowing.

“High levels or rapid increases in leverage can represent a financial vulnerability, leaving the economy more exposed to a future severe downturn in activity or a sharp correction in asset prices,” International Monetary Fund officials Adolfo Barajas and Fabio Natalucci wrote in a March 29 blogpost.

The past three expansions have lasted on average just under nine years. Given the way this one is starting, it may end up more in line with the 64-month-long, post-World War II average.

“We could be going back to some of the earlier cycles,” Zentner said. The current expansion may end up “closer to the five year mark than the 10 year one.”

©2021 Bloomberg L.P.