There are several key risks to the U.S. economy right now that could reduce the country’s growth rate. The spread of the Omicron Coronavirus strain threatens to reduce U.S. employment and economic activity, and increased economic uncertainty will contribute to inflation. A new outbreak of the infection in the country could lead authorities to halt certain sectors of the economy again to save the lives of citizens. New restrictions will lead to lower tax revenues for state and local budgets, which could create difficulties locally, especially for the poor. However, the market situation became calmer amid doctors’ and scientists’ comments that the disease is mild and has no severe consequences.
In addition, the current problems in the Chinese real estate market may be fraught with consequences for the U.S. economy. China’s financial difficulties may put pressure on global financial markets due to worsening investor sentiment. This circumstance could slow down economic growth because the level of indebtedness of Chinese companies in the U.S. is extremely high. In addition, some investors warn of the risk of a recession in the near future amid a slowing global economy and the trade conflict between Washington and Beijing. The Chinese authorities are expected to inject liquidity into the markets to normalize the situation. However, China’s softer monetary policy could, on the contrary, be a positive factor for the markets.
Economic Situation
Overall financial conditions remain favorable, reflecting in part measures of economic support and credit inflows to U.S. households and businesses. The country’s economic development continues to depend on the spread of the virus. The impact of the crisis can be adjusted if vaccination stays as intensive as it is now. Local administrations are beginning to tighten quarantine measures due to the outbreak of a new strain of the coronavirus. Washington, D.C., in particular, has imposed a requirement that only vaccinated people be admitted to any public establishments. In addition, rising energy prices can provoke a rise in inflation. It should be noted that crude oil and natural gas prices have reached a seven-year high. These price increases have the potential to slow the U.S. economic recovery. Generally, however, the country has the resources to make a breakthrough by the new economic cycle.
Inflation
The first thing to note is that inflation was particularly high this year. At the end of 2019, the level of overall price growth for goods and services was 1.8% (Statista Research Department, 2021). In December 2020, the U.S. Federal Reserve reported an inflation rate of 1.2% (Statista Research Department, 2021). Forecasts were also released for the country’s economic growth and expected inflation for the following years. The inflation rate was expected to be 1.7% in 2021 and 1.9% in 2022 (Statista Research Department, 2021). However, inflation in the U.S., the nation with the largest economy, was at a 30-year high in October (Statista Research Department, 2021). Investors, who did not expect such inflation figures, reacted by selling out in the markets. The Federal Reserve declared that the price increases would be temporary but acknowledged that inflationary pressures had continued longer than expected. Experts say the following are the reasons why inflation is so high. Due to the pandemic, it became more challenging to produce and deliver products amidst lockdowns. In addition, governments supported the population during the crisis, so households were eager to spend money.
Fiscal Policy
The budget deficit is the negative balance of state budget revenues and expenditures. For the calendar year 2019, the U.S. budget deficit was $1.02 trillion, the Treasury Department announced in early 2020 (Cox, 2020). At the same time, the Treasury Department was generally optimistic about the results of President Donald Trump’s economic policy. The 2019 tax cuts have given added impetus to an already robust U.S. economic recovery (Cox, 2020). However, such a fiscal measure threatens to increase government spending and the budget deficit in the long term. Budgetary measures in 2020 included additional unemployment insurance benefits and a wage protection program that proved quite effective (Cox, 2020). The U.S. budget deficit for the fiscal year 2021 was $2.8 trillion (Rappeport, 2021). This is $360 billion less than the record-high budget deficit for 2020 (Rappeport, 2021). In 2021, laws reducing the tax burden on companies and individuals were introduced as support measures. Consequently, there has been an improvement in the economy, due in large part to the expansion of the COVID-19 vaccine. Faster and broader economic growth has resulted in a smaller budget deficit than initially projected.
Stage of Business Cycle and Interest Rate
It can be concluded that the U.S. is now in mid-cycle expansion as corporate profits rise and economic recovery measures are being implemented. The FRS has cut interest rates three times in a row in 2019. The Federal Reserve System had previously cut interest rates three times in a row only in 1998 and 1995-1996, both times avoiding a recession (Fitzgerald, 2019). In 2020, the country had to cut the rate to nearly zero because of the coronavirus (Schneider & Neuman, 2020). In 2021, the rate will average 0.1%, but an increase should be expected in 2022 (Trading Economics, 2021). The global economy’s emergence was paid for by a money issue unprecedented in human history.
Trade Balance Data
The trade deficit shows the excess of imports over exports. The U.S. trade deficit narrowed in 2019 for the first time in six years. Lower imports in Q4, mainly due to the U.S. trade war with China (Setser, 2020). In August 2020, the U.S. trade deficit widened to a record $82.94 billion. (Haroon, 2020). The sharply negative trend in the indicator has continued since early 2020 on a wave of economic shutdown amid the coronavirus crisis and a faster recovery of major U.S. trading partners (Haroon, 2020). In 2021, the U.S. trade deficit narrowed as exports of manufactured goods, crude oil, and materials increased.
Credibility of Central Bank Monetary Policy
In 2020, the Federal Reserve undertook several significant monetary stimulus measures in addition to fiscal stimulus. They can be roughly divided into three categories, including interest rate cuts, credit, and asset purchases, and regulatory changes. Overall, the actions taken proved to be highly effective and made it possible to reduce the impact of the epidemiological situation on the country’s economy. After the crisis, the Fed stimulated the economy with near-zero interest rates and cash injections. It can be concluded that the measures taken by the government and the central bank are conservative, although reliable. The public, the market and lenders now trust the policy, which means they continue to invest and actively lend to the government.
Credibility of Government Economic Policy
With political and social pressures and high health care costs limiting governments’ efforts to reduce the deficit, high public financing requirements are a source of vulnerability in many countries. The money supply in the world’s largest economies grew significantly last year. The factor of money-pumping economies and excessive money liquidity makes the world’s central banks reduce monetary stimulus after a year and a half of record cash injections. This means slower economic growth and higher inflation; therefore, a judicious mix of both central bank monetary policy and government fiscal policy is needed.
Credibility of Government Fiscal Policy
The concern is Trump’s recent tax cuts and increased government spending. It gave a short-term boost to the economy. Still, with the budget deficit approaching $1 trillion, it will be difficult for the government to resort to fiscal stimulus again if necessary. In addition, inflation and its forecast remain below target, and the Treasury yield curve suggests that the interest rate is now too high. Concerns are heightened by the raging energy crisis in Europe and Asia. Extremely high energy prices negatively affect industrial production and drive up costs in other related markets. While China has managed to bring prices in the steam coal market under control, in Europe, electricity prices are again breaking records after a brief easing of fears.
General Assessment
In general, despite some current risks for firms, there is no need to give up financial activity. Since the beginning of the year, the S&P 500 Index has made new all-time highs. Positive for the time being, but it is worth considering the risks in the U.S. market in a historically challenging quarter. The markets are ready for the beginning of the QE program winding down. Nevertheless, the gradual reduction of asset purchases may cause a correction in the stock market. The fears of a stock market bubble and the risks associated with the stimulus rollback have increased significantly. New quarantine measures are one of the risks that companies will have to face again in the market. However, the process of large-scale vaccination of the population is mitigating the fears. Overall, the economic situation remains stable, so there is no need to refrain from participating in the market.
References
Cox, J. (2020). US budget deficit topped $1 trillion in 2019 for the first time in seven years. CNBC. Web.
Fitzgerald, M. (2019). When the Fed cuts interest rate three times and pauses, it works out great for stocks, history shows. CNBC. Web.
Haroon, A. (2020). US goods trade deficit hits record $82.9B as imports outpace exports. S&P Global. Web.
Trading Economics. (2021). United States Fed Funds Rate. Web.
Rappeport, A. (2021). The U.S. budget deficit hit $2.8 trillion in 2021, the second highest on record. New York Times. Web.
Schneider, A., & Neuman, S. (2020). Markets in Europe, Asia plummet after Central banks slash rates amid coronavirus. NPR. Web.
Setser, B. W. (2020). The U.S. shock to global demand in Q4 (before the coronavirus). CFR. Web.
Statista Research Department. (2021). United States: Inflation rate from 1990 to 2020. Web.