US GDP will return to pre-pandemic highs by the end of March, Morgan Stanley says

• The US economy will grow 8.1% in 2021 as the coronavirus threat fades for good, Morgan Stanley said.
• GDP will return to pre-pandemic levels by the end of the first quarter, the bank's economists added.
• Unemployment will fall to 4.9% in 2021, the bank said, still above the rate from before the crisis.

Morgan Stanley has lifted its forecasts for 2021 economic growth in the US, citing a collection of encouraging trends for its brighter outlook.

Gross domestic product is now expected to grow by 8.1% on a fourth-quarter-by-fourth-quarter basis, up from 7.6%, the team led by Ellen Zentner said in a Tuesday note. Growth for 2022 was revised 0.1 percentage points lower to 2.8%.

The bank also said it expected US GDP to fully rebound to its pre-pandemic level by the end of the current quarter. The output gap - a measure of how growth compares with maximum growth estimates - is expected to turn positive and reach 2.7% by the end of the year as the economy roars out of its virus-induced downturn. That would be the highest reading since the 1970s, according to the Bureau of Economic Analysis.

Economic reopening, a faster rate of vaccination, and stronger job growth all contributed to the adjustments, the economists said. New stimulus likely to win final approval in the House on Wednesday is in line with what the bank expected, but its earlier timing and the pace of first-quarter growth also added to optimism, the team added.

Morgan Stanley sees the unemployment rate tumbling further, though taking longer to reach lows seen before the pandemic. The gauge is projected to average 4.9% by the fourth quarter of 2021, down from the previous 5.1% estimate. Unemployment will sink further to 3.9% over the following year, the team said.

"A more robust return to work will be somewhat offset by rising labor force participation, but economic activity is strong enough to still generate a sharp decline in the unemployment rate," the bank added.

The faster recovery will come at a cost, and Morgan Stanley's latest inflation projections signal price growth will firm up later this year. Higher prices for rent, healthcare, and staples will lift inflation to 2.6% in April and May before it eases to 2.3% at the end of the year, according to the economists' forecasts. Inflation will hold at the elevated level well into 2022, meeting the Federal Reserve's above-2% target, they added.

Still, significant tightening of monetary conditions isn't likely to take place until 2023, the bank said. Policymakers will likely reiterate their dovish guidance when they meet next week and project near-zero rates staying at least through 2022. But the recovery and related effects on inflation and hiring will lead the Fed to begin shrinking its asset purchases in January, Morgan Stanley said.

"By the middle of the year we expect the cloud of COVID will have thinned and the recovery will have picked up meaningfully enough that the Fed will see it as appropriate to begin taking its foot off the gas pedal," they added.