This Is Not the V-shaped Recovery You Were Hoping For
Things are starting to look up for the US economy, but after months of lockdowns and vain economic reboots, are we really seeing the start of the sustained recovery we have all been hoping for? Looking ahead to what the September quarter has in store, while there have been some key data releases that can give us some idea of how the economy is tracking, we should be placing our hopes in the figures. There is simply too much uncertainty for any serious judgement to be made.
The coronavirus has seen the sharpest contraction in US GDP in post-war history. The hope is that such a precipitous decline will be followed by an equally steep recovery. Given the patchwork quilt of rules and regulations adopted by various states across the country, assessing the nationwide economic impact is an incredibly fraught task. As cases spike and hotspots develop in certain pockets, finding a pattern to the outbreaks and identifying their causes has health authorities working in overdrive. States that previously began opening up their economies have backed off, fearing that a resurgence in cases could quickly see health resources overwhelmed if things get out of control.
As the number of Covid-19-related deaths in the US tick over 150,000, it is possible that the country is entering a dangerous new phase of the pandemic, one in which further brutal lockdown measures will be needed in many cities to contain the spread. In my home city of Melbourne, Australia, our state premier has declared a ‘state of disaster’ (on top of the ‘state of emergency’ that was already in effect), along with a raft of strict new rules, including a curfew from 8pm to 5am (I just got back from the supermarket in the nick of time). On top of this, all non-essential businesses are to be closed, and some, including meat works and distribution centers, will be operating at 66 percent capacity, raising fears of food shortages.
If other governments are looking to us for a model of how harsher lockdowns can be implemented, then we may be in for some serious pain. Either way, if the US and other countries do see a dramatic rise in cases, then expect lockdown measures to be extended and expanded.
Tracing the shape of recovery
The impact of the coronavirus caused US GDP to shrink by an annualized 32.9% in the June quarter (-9.5% quarter-on-quarter), slightly better than the expected 34.1% fall, but still an utterly devastating result. Contractions were seen almost everywhere, particularly in personal consumption and exports, while federal government spending jumped in efforts to get income into the hands of households and businesses and keep as much demand in the system as possible.
Initial jobless claims for the week of 25 July showed 1.43 million people filed for unemployment benefits, largely in line with expectations of 1.45 million and the previous week of 1.42 million. Continuing jobless claims jumped more than expected in the week of 18 July to 17.0 million (16.2 million expected) as some state government paused reopenings and in some cases reintroduced restrictions. However, there has been some very good news on the data front. The July ISM Manufacturing PMI increased to 54.2, from 52.6, and came in ahead of the expected 53.6 (values over 50.0 points indicate the manufacturing economy is expansion). Compared to the very deep contractions of recent months, this is certainly positive.
Data for construction spending disappointed, falling 0.7% (versus the expected 1.0% growth), but overall things could be far worse on this front. The determining factor will be the course of lockdown policies. If the pandemic worsens, and lockdown policies are expanded, construction sites and factories will likely be the primary targets, which will result in a considerable drag on GDP.
Looking ahead to the September quarter, it is impossible to determine what the range of GDP outcomes will be based on such slim data pickings. However, if we were to take the good news at face value, we are looking at strong positive GDP growth between 10 and 20 percent. However, the problem with this data-driven approach to estimating GDP (what the Atlanta Fed calls a ‘nowcast’), is that it is highly contingent on what governments decide to do. Unfortunately, just because economic activity plummeted, does not mean it will bounce back just as strongly. A V-shaped recovery appears less and less likely as the pandemic drags on, with a U-shape or W-shape looking like a better bet. Let us hope it is not L-shaped.
Radio silence from the Fed
As the White House and state leaders scramble to hold press conferences and maintain a flurry of activity and communication, it seems the Federal Reserve has run out things to say. At its 31 July meeting, the Fed left rates unchanged at its target range of 0.00–0.25%, as expected. Policy makers outlined that the federal funds rate will remain near zero until the economy has weathered the pandemic. There was some commentary on yield-curve control, with Powell saying that the Fed will wrap up its deliberations on its long-running policy review, which could see changes in how the Fed conducts its policy action. But aside from that there was nothing new for the markets.
We are likely to see a more interesting announcement at the Fed’s September policy meeting, with a possible preview at the Jackson Hole Symposium later in August (likely without the usual frivolities). The Fed and the US Treasury injected about $5 trillion into the US economy in the June quarter, exceeding quarterly nominal GDP of US$4.85 trillion. It was not enough to forestall a 32.9% drop in consumer spending — an ugly result considering lockdown measures were being partially eased, pandemic assistance payments were being distributed en masse, and restaurants, schools and shopping centers were reopened, albeit temporarily in many areas.
Despite some promising signs for the September quarter, this is not the time to be getting too excited. If the current course of events play out, we could be in for a lot more pain ahead. The two sectors of the US economy that are feeding most of our hopes right now — construction and manufacturing — could be hit hard by further lockdown measures, while a lack of household spending could see aggregate demand remain at deeply depressed levels. Given the sheer degree of uncertainty, pinning our hopes on early economic data is a bad move. We should curb our hopes for now and wait to see how this all plays out.