Democrats In Control Could Usher In A Full Economic Recovery And Another $1 Trillion In Stimulus, But Here’s The Catch

Topline

With two fresh Senate election victories clearing the way for a Democrat-controlled congress, Morgan Stanley economists expect a “substantial fiscal expansion” that should include as much as $1 trillion in additional Covid-19 relief–on top of the massive $3.5 trillion already authorized–laying the groundwork for a full economic recovery by the fourth quarter–but that big spending could spell inflationary trouble down the line.

Key Facts

The investment bank forecasts U.S. gross domestic product growth of 6% this year, taking on a more bullish stance than the average 4% growth consensus among other experts, Morgan Stanley said in a Thursday note to clients.

That should help the nation return to pre-Covid-19 GDP levels by late June, and it should also mean that the United States will be on track with pre-Covid growth expectations by the end of the year. 

Strong domestic growth, a widening U.S. trade deficit and a weakened dollar will also lead to a booming year for emerging markets, Morgan Stanley says, forecasting that their output will increase by 7.4% in 2021. 

Their growth should be bolstered by a Democrat-controlled government on the likelihood that the party welcomes a further widening of the U.S. trade deficit, which the bank’s analysts expect will remain robust, at about 10.7% of GDP in 2021, compared to 15.2% at the end of 2020.

The analysts also expect inflation–which experts have called the “biggest risk to markets” this year–could “overshoot” the longstanding Federal Reserve target of 2% this year due in part to “healthy private sector risk appetites.”

Morgan Stanley also said heightened government spending, which the firm acknowledged has been necessary to curb rising economic inequality, “will impart an inflationary impulse,” echoing comments from St. Louis Fed President James Bullard Thursday in which he said this year could bring volatile pricing and “higher inflation than we’re used to.”

Chief Critic

On Thursday, Chicago Fed President Charles Evan said it would take years to reach 2% inflation, beckoning: “We just have to experience inflation before I’m going to feel confident that things are really changing… Show me the inflation. We need to see it.” Meanwhile, his Richmond-based counterpart, Fed President Tom Barkin, said hours before that the Democrats’ narrow margins in the House and Senate should mean “continued support for the least fortunate,” but more aggressive legislation will likely face “real constraints” and that “the spike in government spending is largely behind us.” 

Key Background

Concerned that inflation could trigger another recession, the World Bank warned Tuesday that the debt load governments like the U.S. are taking on to fund sweeping stimulus measures could stall economic growth for years to come once interest rates inevitably rise and make that debt more expensive. The institution urged nations to reinvest assets in order to become less dependent on debt, but in the meantime, the Covid-19 pandemic continues to rage on, exacerbating lower-income communities to a greater extent as relief measures run dry. Goldman Sachs said Wednesday it expects additional fiscal stimulus in the first quarter to total about $750 billion. 

Further Reading

Stocks Add To Record Highs As Goldman Ups Q1 Stimulus Expectations To $750 Billion (Forbes)

World Bank Warns Stimulus Spending And ‘Dangerous’ Debt Crisis Could Trigger Recession And Wipe Out A Decade Of Income Gains (Forbes)

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