UBS believes US economy will return to Roaring 20s

The European finance giant believes Uncle Sam is inching closer to a ‘Roaring 20s’ scenario, placing the likelihood of an incoming booming economic cycle at 50%.

The phrase harkens back to the same decade a century ago, when massive economic growth prompted a construction boom and rising prosperity for families.

With the benefit of hindsight, the 1920s had the hallmarks of a strong economic cycle: a wider adoption of electricity and automobiles, as well as a post-war boom in consumption.

At the time, the average person may not have realized their luck—and this is the phenomenon the U.S. finds itself in at present, writes Jason Draho, head of asset allocation Americas at UBS.

While economists are concerned about a potential rise in unemployment, a recession or stagflation, Draho argues the balance is only tipping higher towards a period of prosperity for Americans.

In a note released yesterday, Draho wrote that by the bank’s criteria the U.S. economy is already in another Roaring 20s.

He said: “It’s no longer too soon nor too optimistic to suggest that the US will experience a Roaring ‘20s economy. It already is by our criteria, with the relevant question being whether these conditions will continue, not whether they will materialize.

“The odds continue to rise for this bull-case scenario, with many recent developments on the demand side, supply side, and monetary policy all supportive.”

Investors are increasingly coming around to a soft-landing consensus, he added.

A September survey of 37 economists from the Financial Times found the majority did not expect to see a contraction in the next couple of years.

The survey—and its optimistic outlook—took place ahead of the Fed’s anticipated rate cut last month, which markets have since seen as a rebalancing towards the unemployment side of the Federal Open Market Committee’s (FOMC) mandate, thus ensuring a level of productivity and activity.

“The way things have been trending, it’s quite possible that by early 2025 only the most pessimistic investors will need rose-colored glasses to see a clear path to a Roaring ‘20s outcome,” Draho added.

Powell’s 2% target

Draho outlined UBS’s criteria to officially declare the 2020s as a ‘Roaring 20s’: sustained GDP growth of 2.5% or higher, inflation in the 2-3% range, a Fed funds rate around 3.5%, and the 10-year Treasury yield around 4%. 

According to the Bureau of Economic Analysis, real GDP for Q2 2024 increased at an annual rate of 3%—ticking the first box.

Following Jerome Powell’s intense wrangle with inflation, the 12-month CPI percentage for August 2024 came in at 2.5%—ticking the second box.

The fed funds rate—despite a higher-than-expected cut last month—sits above UBS’s threshold at 4.75% to 5%.

And in a bid to foster employment—and as a result productivity and consumer spending—Draho believes the Fed might have to compromise on its target inflation rate of 2%.

It’s a notion the likes of JPMorgan CEO Jamie Dimon has already floated, with Draho adding: “The relevance for the Roaring ‘20s outcome is that the Fed signaled a strong desire to preserve the soft landing and maintain full employment, even if it means inflation descends more gradually back to 2%.”

The FOMC would never publicly admit it would accept inflation above 2%, Draho added but countered: “A 50bps rate cut is not an explicit signal that the Fed is targeting this outcome, but the bread crumbs suggest a policy reaction function that is directionally supportive of a Roaring ‘20s outcome.”

Unemployment is the sticking point

Rising unemployment has been the factor which has caused even the more hawkish members of the FOMC to pause.

The Sahm Rule—which in the past has been accurate in predicting when an economy will enter a recession—was triggered back in July.

The Sahm Rule looks at two factors: the current three-month moving average of U.S. unemployment and the lowest three-month moving average of U.S. unemployment over the past year.

If the current average is higher than the lowest average by more than half a percentage point, the American economy is headed for a recession. Its latest reading for August sits at 0.57pp.

Draho admits that the labor market could prove to be the snag in America’s return to an economic heyday, writing: “Cooling over the past six months has done more than just rebalance the labor market, it has left it looser than it was pre-pandemic.”

“The US election and the escalating war in the Middle East are also sources of potential risks,” adds Draho.

Of course, the original Roaring 20s had their end as well. The Great Depression kicked off with the Black Tuesday Wall Street stock market crash in October 1929.