Election focus issue: What lies ahead for the US economy?

22 September 2020

Kevin CumminsSenior US Economist

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As ever, the state of the economy is going to be at the forefront of voters’ concerns. Our Chief US economist outlines our current outlook. 

With the whole world still focusing on coronavirus, presumably the health crisis being brought under control is what will matter most to American voters when they cast their vote for the presidency in November? It seems this might not be so. We’ve conducted a poll with over 130 respondents and the results below the state of the economy is seen as a more important issue – by a four to one margin.

Source: Twitter and LinkedIn poll

You can find all our analysis and views on the upcoming US election here, but with the poll results above in mind, let’s now turn to the all-important outlook for the US economy.

The US economy’s recovery after the record-breaking decline in activity in Q2 has been quicker than expected. The rebound occurred thanks to two main factors. First, the move from widespread lockdowns to more targeted restrictions, and second, the exceptional fiscal and monetary stimulus implemented in response to the pandemic.

But these effects won’t last forever, and in particular the boost provided by fiscal stimulus is now fading. In fact, we expect consumption to slow substantially in Q4 as aggregate income is now falling, as we can see in the chart below.

Real GDP growth vs. real disposable personal income (DPI) growth

Source: Bureau of Economic Analysis and NatWest Markets estimates

Still, most economic data are signalling that the economy continues to grow (albeit more slowly than before) rather than contracting.

Until now, we’d assumed a fiscal package would be agreed ahead of the Presidential election, but that no longer appears to be the case. So we no longer expect additional fiscal support this year.

With this in mind, we’re now forecasting that the US economy will grow by 2.7% quarter-on-quarter (annualised) in Q4, down from our earlier 4.4% prediction. Similarly, we’re expecting 2.8% growth in Q1 next year, having previously expected a much healthier 4.8% expansion.

What about full-year figures? Our forecasts are now for a 2.9% contraction in 2020 followed by 3.2% growth next year. But of course these forecasts are highly uncertain because they depend on how the pandemic unfurls, with the timing of a potential vaccine that is effective and can be widely administered of huge importance.

After sizeable increases in August, Consumer Price Inflation rose again in September, with both the headline and core rates up by 0.2%. But we still view most of this strength as a reversal of the falling prices linked to all the coronavirus disruption we saw in previous months. In aggregate, we still see COVID as disinflationary, due to a large net rise in slack.

Even with August’s and September’s increases and upwards revisions to the June and July readings, we don't expect any acceleration in core personal consumption expenditures inflation over the remainder of 2020, with our forecast staying steady at 1.6% until the end of the year.

Next year, though, could be a slightly different story. We expect inflation to pick up again in 2021, helped by a low base effect in H1 2021. We expect it to peak at 2.5% year-on-year in Q2 before drifting down to 1.9% by the end of the year, slightly under the Fed's 2% longer-run target. So we don’t expect a major inflation overshoot. In our opinion, inflation risks are to the downside.

Following the Federal Open Market Committee’s decision at the end of August to adopt flexible average inflation targeting, it changed its forward guidance on the funds rate to say:

"The Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and expects it will be appropriate to maintain this target range until labour market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time." 

However, the statement retained maximum flexibility in that it didn't specify how much above 2% inflation will be tolerated before a rate hike. Judging by other Fed officials’ recent comments, a hike’s unlikely before inflation moves close to 2.5%.

In other words, rates are unlikely to be hiked for a very long time.

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