The US economy has performed exceptionally well over the last five years despite massive disruptions caused by the COVID pandemic as well as the rise of inflation and interest rates. The extent of US exceptionalism is most evident in the performance of US real GDP versus other major economies (see Table 1).
Source: US Bureau of Economic Analysis, IMF1
US real GDP exceeds the pre-COVID level by more than 11%, while most major industrialized economies have barely reached the levels last seen before the pandemic.2 Furthermore, US real GDP exceeds its potential, while real GDP in all other major industrialized economies has fallen short of potential (see Table 1).3
China’s economy has grown more than the US economy since the outbreak of COVID, but it has fallen behind its potential as well.4 Moreover, China’s economy in USD terms has dropped from a peak of 75% of nominal US GDP in 2021 to less than 65% in 2024.5
In our view, US exceptionalism is the result of US strength as well as weakness of the other major economies.6 We believe that many factors behind the strengths of the US and the weaknesses of other economies are institutional and structural and unlikely to reverse quickly.
However, we also see the US facing more and new challenges, especially from policy, which will threaten US exceptionalism over time.
Dividing real GDP growth into employment and productivity growth is helpful for identifying the supply drivers of the US outperformance.7 Chart 1 shows employment growth and productivity growth for the US and other major industrialized economies since the end of 2019.8
The US stands out as having both strong employment and productivity growth. Especially productivity growth is exceptional. Of course, behind the aggregated figures are significant differences by employment sources and economic sectors.
The rise of US employment over the last 5 years was primarily driven by the immigration surge (see Chart 2). The foreign-born labor force is less than 20% of the total US labor force but accounted for about 80% of the labor force increase over the last 5 years.9
Source: US Bureau of Labor Statistics, OECD 10
Source: US Bureau of Labor Statistics 11
When it comes to productivity, the concentration is even larger. As Table 2 (following page) shows, more than half of the total US productivity growth over the last five years comes from four sectors that together account for less than 5% of the total employment. Not surprisingly, three of the four sectors are IT related.
1) 2019-24; 2) Share of US economy-wide productivity growth 2019-24.
Source: US Bureau of Economic Analysis, US Bureau of Labor Statistics
The IT concentration bears risks and could lead to excesses as in the dot.com bubble. The current AI boom, for example, could lead to a bubble with negative implications for the economy. However, the ability of the US to persistently innovate and put new technologies and products to broader use reveals key institutional and structural advantages compared to other major economies. In our view, these are:
Of course, economic growth is not just about supply factors such as employment and productivity. Demand matters as well and depends largely on business and household sector health.
Chart 3 shows the profit margin of the US corporate sector, which is currently much higher than it has been for the last 60 years.13 Not every firm is doing well, but the overall strength of profits is supportive for business investment and employment.
Source: US Bureau of Economic Analysis14
Businesses doing well and hiring are also good for household incomes and spending. Households have also done a good job since the financial crisis putting their balance sheets in order and locking in low mortgage rates before the Fed started to tighten policy.15 The result is visible in relatively low debt-service payments for the US household sector (see Chart 4).
Source: Board of Governors of the Federal Reserve System.16 The drop in debt-service payments in % of disposable income in 2020/21 were due to the temporary surge in disposable income caused by government transfer payments.17
Important support for both supply and demand conditions in the US economy came in recent years from the energy sector. Chart 5 shows that domestic energy production has matched and even exceeded consumption since 2019.
The energy independence of the US stands in sharp contrast to most other major economies. Especially Europe suffered badly when energy supply tightened and prices soared with the beginning of the Ukraine war.
Source: Energy Intelligence Agency18
In our view, the institutional and structural advantages of the US are unlikely to fade quickly, while the other major economies will probably not overcome their structural problems soon.19 As a result, we think US exceptionalism has a chance to last a while longer. However, we see new challenges, especially from the policy side, that put US outperformance at risk.
One concern is trade protectionism, especially if across the board tariff proposals get implemented. We fear this will result in retaliation and ultimately reduce growth and raise inflation. In our view, the evidence that tariffs work is weak. The US current account deficit has increased from less than 2% of GDP in 2017 before the introduction of new tariffs in the first Trump administration to over 3% this year.20
However, while we think that protectionism is generally harmful, we expect other countries, especially those that rely more on trade, to fare worse than the US, which has a larger domestic market. As a result, US outperformance may continue under increased protectionism in spite of its expected negative effects on the economy.
Another policy concern relates to immigration. As outlined before, immigration has been a key driver of recent employment and economic growth. Thus, plans to block immigration and to deport illegal immigrants are likely to undermine growth and fuel inflation, in our view. This could be potentially very harmful for US outperformance, but we also note that most other major economies face bigger demographic problems than the US and also struggle to implement efficient immigration policies.
Our last policy concern relates to fiscal policy. We believe the swift and large-scale response of US fiscal policy to the COVID pandemic was an important factor behind US outperformance over the last few years.21 However, there have been no attempts to scale back the fiscal deficit as the economy recovered.
Chart 6 shows the relationship between the unemployment rate and the federal budget deficit (rising unemployment corresponds to an eroding budget deficit and vice versa) and highlights the extent of fiscal proliferation in recent years. With unemployment around 4%, the federal budget should be roughly balanced based on past standards and not reach a deficit of 6.5% of GDP (trend rising).22
Source: : Office of Management and Budget and Bureau of Labor Statistics23
The upshot of the fiscal proliferation is rapidly rising government debt (see Chart 7). The Congressional Budget Office (CBO) estimates that the public debt/GDP ratio will increase by a quarter over the next ten years to 125% and the Committee for a Responsible Federal Budget forecasts that the debt burden will rise even further under the plans of the incoming Trump administration.
Source: : CBO and CRFB24
We do not expect the US government to face a funding crisis soon, but we view fiscal proliferation as bearing several negatives.
First, we see it as inherently inflationary. Second, it has a bias to crowd out private investment. Third, it risks leading to a debt spiral through rising interest payments. Fourth, it constraints the government’s ability to react to future shocks swiftly and with scale.
The mix of trade and immigration restrictions and loose fiscal policy is inherently inflationary in our view. Trade tariffs and immigration crack-downs curtail the supply of goods, services and labor, while tax cuts boost overall demand. And that is happening in an environment in which the economy is already running above its potential and at risk to overheat.25 In particular, wage pressure remains firm (see Chart 8). Against that background, we are skeptical whether inflation will move sustainably toward 2%. Instead, we fear that the economy could overheat and inflation reaccelerate.
In particular, wage pressure remains firm (see Chart 8).
Against that background, we are skeptical whether inflation will move sustainably toward 2%.
Source: Atlanta Fed26
Consumer prices are volatile on a monthly basis and produce short-term inflation swings (see Chart 9). In the third quarter of this year, consumer prices have reaccelerated after a pause in the second quarter.27
Looking through the volatility, the optimistic view is that the disinflation trend towards 2% is still intact. We observe, however, that the inflation dynamic is back where it was a year ago, namely above 3%. Thus, we think inflation is more likely to persist around 3% with a risk of reacceleration if the economy overheats.
Source: Bureau of Labor Statistics28
We are not in a position to rule out an economic downturn next year or the year after. In that case, we expect the Fed to ease at least as much as it currently projects or more.29 But the Fed faces a challenge if the economy holds up, as we expect, and if inflation fails to fall sustainably to 2%.
One possibility in that case is that the Fed will tighten again if inflation fails to reach 2%.
We think it more likely that the Fed will be prepared to tolerate moderately higher inflation as long as it does not spiral up again. In that scenario, however, we believe that the Fed has very little room to cut interest rates if any at all.
If we are right on growth and inflation, that implies that the Fed is unlikely to pull long-term interest rates much lower. Our fundamental 10-year Treasury model puts the fair-value yield currently slightly above 4% (see Chart 10).30
Source: Federal Reserve Board, ZAIS estimates31
Actual long-term yields are more volatile and may temporarily move lower, but we see two factors that are likely to prevent a sustained decline below 4%.
In addition, we see a risk that foreign capital inflows could slow, if the USD’s safe-haven appeal fades, while the Fed keeps offloading its Treasury and mortgage holdings.32
US exceptionalism is also visible in the performance of financial markets. The US equity market has outperformed all equity markets in the other major economies over the last 5 years (see Table 3). In local currency terms, the US equity market has outperformed its major peers on balance by about 100%. In USD terms, the outperformance has been even bigger, which implies that the USD has outperformed as well.
Source: MSCI33
Most striking is the contrast with the Chinese equity market. In our view, that highlights China’s struggle in overcoming the pandemic as well as the problems created by the housing bubble, overinvestment in state-owned enterprises and the government’s growing interventions in private enterprises.
In sum, we believe that US exceptionalism will prevail for some time longer but in a more diluted form.
In our view, the persistence of US strength as well as the structural problems in most other major economies will depend mostly on policy. The risk is that US outperformance could end faster but chances are probably similar that US outperformance intensifies, at least for some time, partly because of the relative weakness of other major economies.
For financial markets, that means to us that US financial assets and the USD remain in the pole position and have a good chance to stay at least initially in the lead.
However, we also expect financial performance to become more volatile due to external shocks (e.g., geo-political tensions) or policy events. That, we think, creates more downside risks not least because we view both US financial assets and the USD as overvalued, thanks to the long period of outperformance.
A tail risk that we will monitor closely is a loss of market confidence in the independence of the Fed and the sustainability of government debt. Such a scenario could occur if inflation moves higher from 3% and the Fed fails to act decisively, while the fiscal borrowing requirements continue to rise.
Turning to the ZAIS investment activities in US credit-related assets, we think our base scenario of ongoing solid US growth with moderately above-target inflation and only limited Fed easing provides a constructive background. The main risks to our investment universe are the same as for the overall financial market (overheating, inflation and policy credibility).
Furthermore, we believe that credit dispersion will persist and potentially intensify if overall market performance becomes more volatile.
In particular, given our view that interest rates will remain higher for longer, we see re-financing risks for weaker credits, notably in consumer finance, office-related loans and weak high-yield business loans and bonds. On the other hand, we note that our investment universe is well diversified, notably in the loan market and CLO structures, which allows us to manage the inherent credit risks.
As always, we are available to discuss our views with you. Please contact your Client Relations representative at +1 732 978 9722 or zais.clientrelations@zaisgroup.com
The information presented herein has been prepared and provided by and is confidential and proprietary to ZAIS Group, LLC, ZAIS Group (UK) Limited and their affiliates and subsidiaries (collectively, “ZAIS”). Accordingly, this material is not to be reproduced in whole or in part or used for any purpose except as authorized by ZAIS, is to be treated as strictly confidential and is not to be disclosed directly or indirectly to any party other than the recipient. By accepting receipt of this document, the recipient agrees to comply with this restriction and confirms its understanding of the limitations set forth in these disclaimers.
Unless otherwise noted, the source of information for the charts, graphs, and other materials contained herein is ZAIS. The charts, tables, and graphs contained in this document are not intended to be used to assist the reader in determining which securities to buy or sell or when to buy or sell securities. Additional information is available upon request.
This information has been prepared solely for informational purposes and is not an offer to buy or sell or a solicitation of an offer to buy or sell any security or instrument or to participate in any trading strategy which may or may not be made available. Any such offer of securities would, if made, be made pursuant to definitive final private offering documents, which would contain material information not contained herein (including certain risks) or material that differs from the information contained herein and to which current and prospective investors are referred. Any decision to invest should be made solely in reliance upon such private offering documents. In the event of any such offering, this information shall be deemed superseded, amended and supplemented in its entirety by such private offering documents. Information contained herein does not purport to be complete and is subject to the same qualifications and assumptions, and should be considered by investors only in the light of the same warnings, lack of assurances and representations and other precautionary matters, as disclosed in an applicable private offering memorandum and subscription agreement. No representation or warranty can be given with respect to the terms of any offer of securities conforming to the terms hereof. There is no guarantee that the strategies set forth herein will be successful. The information should only be considered current as at the date specified herein and is subject to change at any time and without notice. Statements made herein that are not attributed to a third party source reflect the views and opinions of ZAIS.
Certain information contained herein represents ZAIS's current reasonable opinion and is based on unaudited and forecast figures which have been derived from multiple sources and have not been subject to specific due diligence. The information has been provided in good faith but is not guaranteed and is subject to uncertainties beyond ZAIS's control and should not be relied upon for the purposes of any investment decision. ZAIS makes no representations or warranties and accepts no liability whether in contract, tort or otherwise for (1) the information not being full and complete, (2) the accuracy of any opinion, (3) the basis on which any comparison has been drawn or the facts selected to make such comparison and (4) the assumptions underlying any opinions. ZAIS does not undertake to update its opinions. No opinion of this nature can be, and this information does not purport to be, full, complete, comprehensive or to contain all relevant information. Statements made herein that are not attributed to a third party source reflect the views and opinions of ZAIS.
These materials may contain statements that are not purely historical in nature but are “forward-looking statements”. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “should” and “would” or the negative of these terms or other comparable terminology. These forward-looking statements include, among other things, projections, forecasts, estimates or hypothetical calculations with respect to income, yield or return, future performance targets, sample or pro forma portfolio structures or portfolio composition, scenario analysis, specific investment strategies or proposed or pro forma levels of diversification or sector investment. These forward-looking statements are based upon certain assumptions, some of which are described herein. Prospective investors are cautioned not to place undue reliance on such statements. No representation is made by ZAIS as to the accuracy, validity or relevance of any such forward-looking statement and the recipient agrees it is solely responsible for gathering its own information and undertaking its own projections, forecasts, estimates and hypothetical calculations. Actual events are difficult to predict, are beyond ZAIS’s control, and may substantially differ from those assumed. All forward-looking statements included herein are based on information available on the date hereof or such date specified and ZAIS does not assume any duty to update any forward-looking statement contained herein. Some important factors which could cause actual results to differ materially from those in any forward-looking statements include, among others, the actual composition of the investment portfolio, any defaults to the investments, the timing of any defaults and subsequent recoveries, changes in interest rates, changes in currency rates and any weakening of the specific obligations included in the portfolio. Accordingly, there can be no assurance that estimated returns or projections can be realized, that forward-looking statements will materialize or that actual returns or results will not be materially lower or higher than those presented. The value of any investment, and the income from it, may fall as well as rise. Accordingly, there can be no assurances that an investor will receive back all or any of the original capital invested. Further, the eligible investments may be leveraged and the portfolio of eligible investments may lack diversification thereby increasing the risk of loss.
ZAIS Group (UK) Limited is a company registered in England with number 08908933 and whose registered office is c/o Dixon Wilson, 22 Chancery Lane, London WC2A 1LS, United Kingdom. ZAIS Group (UK) Limited is an appointed representative of Infinity Asset Management LLP, which is authorized and regulated by the Financial Conduct Authority in the United Kingdom. ZAIS Group (UK) Limited’s status as an appointed representative of Infinity Asset Management LLP does not imply a certain level of skill or training. Investors will not benefit from the rules and regulations made under the Financial Services and Markets Act 2000 for the protection of investors, nor from the Financial Services Compensation Scheme in the United Kingdom. Nothing herein excludes any liability which ZAIS is not permitted to exclude by applicable law.
ZAIS Group, LLC’s registrations with the Securities and Exchange Commission (the “SEC”) and the Commodity Futures Trading Commission (the “CFTC”), and ZAIS Group (UK) Limited’s status as an appointed representative of Infinity Asset Management LLP (which is authorized by the United Kingdom’s Financial Conduct Authority (“FCA”), does not imply a certain level of skill or training.