Biden's infrastructure plan will pass in late 2021 and boost growth next year, Morgan Stanley says

• Morgan Stanley boosted its 2022 growth forecast to 3.4% on the likelihood of Biden's infrastructure plan passing.
• The economists expect spending and hiring to boom as the US reopens further through the summer.
• Rising rent prices risk turning stronger inflation permanent as costs rebound through 2022, they say.

President Joe Biden faces a steep uphill battle to pass his infrastructure bill.

Republicans have balked at its $2.3 trillion price tag, and moderate Democrats aren't entirely sold on its necessity. The president has held bipartisan meetings to iron out disagreements, but Democrats' soft deadline of a July 4-passage remains ambitious.

Morgan Stanley, however, is optimistic a deal will be done. It'll just take some more time.

Economists led by Ellen Zentner expect the president to sign an infrastructure spending package in the fourth quarter of 2021. The plan's anticipated approval adds 0.4 points to Morgan Stanley's 2022 growth forecast, bringing it to 3.2% on a fourth-quarter-by-fourth-quarter basis. The bank reiterated its above-consensus forecast for 2021 GDP at 8%.

To be sure, the spending package's passage will come as the country is already rocketing out of its COVID-19 slump. The economists see US GDP returning to its pre-pandemic peak in the third quarter before surpassing its estimated maximum potential by 2.7% at the end of this year. That overshoot - also known as a positive output gap - will widen further to 4% in 2022, a level of overheating that might inspire concern among more conservative policymakers.

Job growth and spending look good ...

The forecast comes after some reports hinted at the recovery slowing in recent months. Retail spending held steady in April as support from Democrats' latest stimulus package dried up. And last month's disappointing jobs report showed hiring slow sharply despite millions of Americans still seeking work.

Both spending and job growth will rebound through the summer, Morgan Stanley said in the Sunday note to clients. Households have roughly $2.2 trillion in pent-up savings, a sum bolstered by three stimulus bills and more than a year of economic restrictions. Americans are likely to draw down their savings as the US reopens further, particularly on services that have been closed for much of the past year, the team said.

Hiring will also accelerate in the coming months, according to the team. A collection of factors will drive a stronger recovery through the second half of the year and bring the unemployment rate to 5% by the end of 2021. The rate will slide further, to 3.9%, in the fourth quarter of 2022. Rising labor costs hindered job creation in April but should fade as the country swings into a new normal, the bank said.

"Above-trend economic growth, vaccination progress, a relaxation of public health restrictions on activity, and a reduction in unemployment benefits drive our expectation that the labor market recovery will come back more strongly later this summer and into next year," the economists added.

Inflation is worrisome

Where Morgan Stanley is less bullish than the crowd is in its inflation forecast.

Most of Wall Street has sided with the Federal Reserve and its forecast that reopening will drive a temporary bout of stronger price growth. Some of the inflation that's already emerged is indeed likely to be transitory, Morgan Stanley said. Supply shortages and bottlenecks are lifting prices throughout the economy as demand surges. The categories of inflation also show sharp accelerations in price growth for services associated with reopening, such as airfare and hotels, the team said.

But as reopening-fueled inflation is expected to die down, the bank has found signs of "more persistent inflationary pressures percolating beneath the surface." The more concerning price growth has been most prevalent in rents and owners' equivalent rents. While prices sit well below their pre-pandemic levels, they're rebounding more quickly.

Shelter prices "remain key to watch" since they represent more initial and persistent pressures on inflation, the team said. As broad inflation cools, it's possible that shelter price growth normalizes at a level well above 2%, they added.

Morgan Stanley expects core Personal Consumption Expenditures - an inflation measure that strips out food and energy costs - to peak at 2.8% in May before averaging 2.4% throughout 2021. The gauge will then remain elevated at at a year-over-year reading of 2.3% by December 2022.