The U.S. economy is storming ahead: What are the key risks to the outlook?

 

However, not everything is plain sailing. In early August we polled our network on LinkedIn to examine the key risks to the outlook: Over 300 people took part in the poll, with 34% naming the emergence of new Covid-19 variants as the main risk, followed by monetary tightening, political gridlock and rising tensions with China. We take a look at each risk in turn, and what they mean for the U.S. economy.

 

 

  • New Covid-19 variants: 35%

New strains of the virus would likely provoke economic damage if they evade current vaccines, as this could lead to a large increase in mortality and a snapback of restrictive measures, at least until modified vaccines are rolled out to tackle the new strain. However, assuming vaccines retain their efficacy, the fallout from new variants should be limited, giving the fairly high percentage of the population already immunized, and the U.S. government’s higher tolerance of infections than other countries—particularly those in Asia. Indeed, cases have risen sharply in recent weeks on the back of the Delta variant, without provoking harsh restrictions or putting a notable dent in economic momentum.

“Despite rising risks, we think it is unlikely the resurgence of new Covid-19 cases in the U.S. will derail the economic recovery materially for two main reasons. First, the risk of broad-based restrictions remains low as long as the overall healthcare system can successfully avoid becoming overwhelmed and the pace of new deaths remain stable. Second, the sensitivity of consumers’ activity to successive waves of Covid-19 has decreased since the onset of the pandemic in early 2020.” – Analysts at Nomura

 

  • Monetary tightening: 32%

The strong economic performance, coupled with supply constraints and labor shortages, has fed through to higher price pressures in recent months. In June, inflation was running at 5.4%, well above the Fed’s 2% target. The risk is that high inflation proves more persistent than the Bank is currently hoping, and that inflation expectations begin to become de-anchored, which could cause the Fed to lose its nerve and begin reining in monetary stimulus—with a knock-on effect on the economy.

“We are of the view that labour supply will only improve gradually. […] This is a challenging situation for U.S. companies with the implication being that we expect to see companies not only having to pay more to recruit new staff, but also raise pay more broadly in order to retain staff. […] Rising employee costs could be a key factor to watch that will mean inflation stays higher for even longer. As such we continue to see the risks skewed towards earlier Federal Reserve stimulus withdrawal with a QE tapering announcement before year-end and the first interest rate hikes coming next year.” – James Knightley, chief international economist at ING

 

  • Domestic political gridlock: 18%

The U.S. has become markedly more politically polarized since the 1980s, with the disappearance of many centrist voters and the rise of more extreme politicians on both sides of the political spectrum. This, together with the country’s institutional quirks—such as the Senate filibuster, which allows a minority party to block most legislation, and midterm elections, which often see the president lose control of Congress—has led to prolonged paralysis in recent years, with successive leaders struggling to enact their agendas.

The persistence of this phenomenon could stall needed reforms to address structural impediments to growth, such as an underperforming education system, subpar infrastructure and elevated social exclusion. However, recent signs offer some hope: In early August, the Senate passed a USD 1 trillion infrastructure bill in a bipartisan vote. The struggle for hegemony with China was likely a motivating factor behind many Republicans’ decision to back the bill. As such, even though Sino-U.S. tensions are a key downside risk, they could simultaneously galvanize greater political unity at home.

“The country remains heavily divided on many issues, which will continue to drive political tensions in 202125. […] Biden won the election with relatively thin margins in a handful of swing states. Voter turnout in 2020 spiked to 66.7%—the highest in 120 years. This sets the U.S. apart from other established democracies, which tend to see much lower rates of voter participation. However, it also points to deepening polarisation of the electorate, which could strain the electoral system in the future, as it did in 2020.” – The Economist Intelligence Unit

 

  • Rising tensions with China: 15%

Anyone harboring hopes that Biden’s administration would bring about the repair of ties with China has been left disappointed: The U.S. president has adopted a hawkish approach, recently expanding a blacklist of Chinese firms which are barred from U.S. investment and imposing sanctions over alleged human rights abuses in Xianjing. A further unravelling of ties ahead is a concern, with potential implications for American exports and investment interests. The possibility of conflict between the two powers—albeit still remote—is a further risk.

“The risk that China will try to annex Taiwan will increase in the coming decades as the balance of power between China and the U.S. shifts in China’s favour. In such a scenario, the U.S. would be compelled to intervene militarily (both in the physical and cyber spheres) to defend Taiwan. […] The implications of such a scenario on the global economy would be massive and go far beyond the U.S. and China. The cyber-attacks that would accompany the conflict would severely disrupt international telecommunications, satellite and transport links, cratering economic activity across the world.” – The Economist Intelligence Unit

 

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