US fiscal cliff or private boom?

This debate matters a lot to H2 markets. There was roughly USD5tr in US fiscal stimulus in the second half of last year that won’t happen this year. This is an enormous growth headwind.

But, of course, the private sector economy will be reopening at the same time, providing an enormous catch-up growth tailwind.

Which wins out may well determine how markets fare for the next 6-9 months.

Morgan Stanley is sanguine:

As recoveries progress and economies move towards a self-sustaining path, it is only natural for policy-makers to start thinking about exit strategies. However, we believe that neither fiscal nor monetary policy support will be removed at a faster pace than warranted. The US economy is already on a strong footing. Wage incomes stand at 105% of pre-COVID-19 levels, real investment is already 4% higher and GDP has reached its pre-COVID-19 path. While the fiscal impulse is turning negative this year, its impact on growth has been overstated. That’s because fiscal measures have largely taken the form of transfers to households. In fact, the excess transfers are still sitting on household balance sheets, waiting to be spent. US households have accumulated US $2.3 trillion in excess saving, and our strong US GDP growth forecasts of 7.1%Y for 2021 and 4.9%Y for 2022 don’t assume that this stock will have to be drawn down. As regards the Fed, our chief US economist Ellen Zentner continues to expect forward guidance in September and an official announcement of tapering in March, with the risks skewed towards an earlier start. By the time tapering starts we forecast that the US economy will be well above its pre-COVID-19 path, core PCE inflation will exceed 2%Y sustainably (adjusted for base effects and transitory factors) and U-6 unemployment (the broadest measure) will reach~8.5% (versus a pre-pandemic low of 7%) as compared to 13% during the time of tapering in December 2013–hardly conditions that indicate the withdrawal of accommodation is premature.

Deutsche is soberer:

Over the past year, US households have accumulated around $2.4 trillion insavings in excess of what would have been expected given pre-covidbehavior. How this more than 10% of GDP in additional savings gets drawndown is a critical question for the economic outlook and especially risks of overheating. In this report we assess the likely path for this excess saving sover the coming quarters and trace out the implications for the output gap. The primary conclusion from our analysis is that a baseline view that excess savings will be run down slowly over time appears to be well supported bya few factors, though risks are skewed towards a faster reduction that lifts growth even more.

First, updating previous work, we show that this build up in savings is heavily skewed towards higher income and older households. These households had higher savings before the pandemic and tend to have lowernear-term marginal propensities to consume. Moreover, the sharp rise inretirements could be a by product of this rise in savings and wealth, suggesting older households might factor this savings into retirement income and spend it down gradually over time.

Second, historical evidence demonstrates that downturns concentrated inservices – as is the case with the pandemic – tend to produce less of an overshoot given more limited scope for pent-up demand for theseconsumption items. While we would caution against simply extrapolatingthat experience to the present situation, some recent indicators, such asstill subdued vacation plans, suggest that the past may be prologue on thispoint.

Based on these factors, our baseline outlook anticipates a relatively slowreduction in excess savings over time, with about 15% spent over the nextsix quarters. Under this baseline scenario, the output gap approaches 2%by year-end and 2.5% by end-2022, which would be the highest level sincethe mid-1970s, though less than half of the peak in the mid-1960s. To reach those record levels, about one-third of excess savings would have to bespent in the coming quarters

I am inclined to agree with Deutsche. That the services spending ramp-up will be steady not spectacular. This means that the fiscal headwind will push down growth a lot by the fourth quarter.

Putting a number on it is impossible but 2% annualised seems about right. That will not be enough to support high asset prices with very high expectations for profits growth, especially as China also slows sharply and the global inventory supercycle deflates.

This is why my risk case for a decent correction in stocks though H2 is so high at 50%.

That said, I’d buy any such dip with both hands given its temporary nature and the looming Biden stimulus.

Of course, this very fact may be enough for markets to look across the valley.

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