Ninety One multi-asset team analyst, Dan Morgan, discusses how US fiscal policy will continue to play an increasingly influential role. As investors navigate a new policymaking world, he considers what they should look out for.
In recent years there has been a definitive shift in fiscal policy from austerity to activism. A focus by policymakers on debt and deficits has been replaced by an expanded government role in managing downturns and industrial policy. The US budget deficit last year was 8.8% of GDP, at a time when unemployment was 3.6%. For comparison, in 2010, the US budget deficit was 11% of GDP, at a time when unemployment was coming down from 10%. We are in a different policymaking world.
Where does this leave investors? They need to focus on the impact of those deficits and expenditures on growth and inflation.
One consequence has been the resilience of the US economy in the face of an historically aggressive monetary policy tightening cycle. Without the support provided by fiscal expansion in 2023, it’s likely the US economy would have experienced a contraction in real GDP instead of +2.5% growth.
The basis for this claim is the +3% ‘fiscal impulse’ in the US in 2023. This measures the change in the government budget balance from one year to the next and is used as a first approximation of the impact of fiscal policy on overall economic growth. We focus on changes in the ‘cyclically adjusted primary balance’ – primary because it excludes interest payments and is cyclically adjusted to remove the automatic effects of the economic cycle, showing the impact of policy decisions.
For 2024, estimates of the fiscal impulse for the US economy vary but averaging forecasts from the IMF[1], OECD[2], and Brookings[3] suggests that the public sector will reduce GDP by about -1% and have a neutral impact on growth in 2025.
These forecasts only consider existing legislation and are updated infrequently. In which case, the market must take the news of fiscal consolidation or restraint with a grain of salt.
To get a more forward-looking view, investors have to analyse drivers not yet fully factored into these estimates. The most important of these are recent announcements on defence and student loans and the ongoing effects of industrial policy programmes.
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In April, national security bills provided for $95bn in new spending for Ukraine, Israel and the Indo-Pacific region. A portion of this represents humanitarian aid but the majority is military aid, which will boost demand and revenues for US defence contractors. The latest student loan cancellation measures are expected to add around $80bn to the fiscal deficit this year. The near-term growth impact of this may turn out to be lower; uncertainties remain around legal challenges; beneficiaries of these programmes could choose to add to savings or pay down debt rather than increase spending.
The follow-on effects of past spending decisions are still filtering through. The Biden administration’s industrial policy programme is defined by three pieces of legislation passed in 2021 and 2022 – the Infrastructure Investment and Jobs Act, CHIPS Act and Inflation Reduction Act. Given relatively long lead times on the projects, the majority of the spending driven by these bills remains in the future, peaking in 2026-2027. On top of the direct budgetary impacts captured by the ‘fiscal impulse’ measures, the new incentives created will drive private sector investment at a level that far exceeds the direct government spending.
Overall, we expect the impact of these policies will offset most, or all, of the negative fiscal impulse expected in 2024 and we do not view fiscal consolidation as a significant headwind to US growth this year or next.
Looking further ahead, the major fiscal event of next year will be the debate on the expiry of tax cuts in the Tax Cuts and Jobs Act of 2017. The outcome will depend on which party controls the White House and congress but expect most of these measures to be extended under any political configuration, implying higher deficits than in current official projections. From a narrow fiscal impulse point of view, this looks likely to offer further support for growth.
When will there actually be fiscal consolidation in the US? That decision will likely come from Wall Street, not Washington. Ultimately, it will come when markets decide they will not fund extraordinarily high through-the-cycle fiscal deficits at current prices.
