Weekly Economic Commentary

Depressing Thoughts

Chief Economist Scott Brown discusses current economic conditions.

The economic outlook has deteriorated sharply in the last few weeks. Wall Street economists’ forecasts of GDP growth have been revised lower day by day. This is going to be bad. The Federal Reserve has now thrown a ton of liquidity at the credit markets, and is likely to do more still. Lawmakers are nearing completion of a comprehensive stimulus package. These efforts won’t prevent the economy from weakening, but they will lessen the damage and help to support the eventual recovery.

“We spent our time focused on getting ready to make these policy announcements.  number of FOMC participants made the point that the economic outlook is evolving on a daily basis. [The Fed’s economic projections] depend heavily on the spread of the virus, the measures taken to affect it, and how long that goes on, and that’s just not something that is knowable. So, writing down a forecast in this circumstance didn’t seem to be useful, and in fact, could have been more of an obstacle to clear communication than a help.”

– Fed Chair Powell on why the Fed did not publish revised economic projections

First – and I can’t stress this enough – nobody knows what the economic impact of COVID-19 will be. In the near term, social distancing is having a huge negative impact on consumer services (including travel, tourism, restaurant sales, and leisure and hospitality). Supply chain disruptions have been in issue for many U.S. manufacturers, but social distancing is also a factor now. Last week, U.S. automakers announced a two-week shutdown in production, and that could last longer. Global growth is slowing sharply, which will be felt by U.S. exporters and firms doing business overseas. Layoffs are increasing, and the loss of wage income will have a further downward impact on consumer spending. The wealth effect  on spending is relatively small, but the decline in share prices has been large. The drop in oil prices, reflecting a decrease in global demand and tensions between Saudi Arabia and Russia will lead to a plunge in energy exploration, weakening business fixed investment (which is also expected to fall amid the heightened economic uncertainty).

Recall that Gross Domestic Product is a flow ($/time). Nominal GDP was $21.7 trillion in 4Q19 (that’s at an annual rate). We focus on GDP growth, the rate of change in GDP (also reported at an annual rate). If the level of economic activity were to contract by 5% in a single quarter (not unrealistic in the current environment), it would be reported as a 22% annual rate of decline. A 10% contraction in a single quarter would be reported as a -52% annual growth rate. These are eye-popping numbers, but they are amplified by the quarterly-to-annual arithmetic. Global trade is falling. Since U.S. imports exceed exports, the trade deficit will decline, adding to GDP growth (imports have a negative sign in the GDP calculation), but not enough to offset much of the weakness in domestic demand.

Job market conditions are expected to deteriorate rapidly. Last week, initial claims for unemployment benefits rose by 70,000, to 281,000, and should rise sharply in the next few weeks. Instead of being laid off, some hourly workers have had their hours set to zero, which prevents them from filing claims in most cases. Some unemployment offices may have difficulty processing claims. The March Employment Report will be released on April 3, and we can expect the job figures to understate the weakness. The Employment Report is made up of two separate surveys. The Household Survey (unemployment rate, labor force participation) samples around 60,000 households during the week that includes the 12th of the month. The Establishment Survey (nonfarm payrolls, hours, earnings) samples about 145,000 businesses and government agencies (representing approximately 697,000 individual worksites) for the pay period that includes the 12th. The pay period varies from firm to firm (weekly, bi-weekly, semi-monthly). Payrolls are counted for any work done during the pay period. Hence, the March report will miss much of the recent damage. Bear in mind, that the Bureau of Labor Statistic cannot sample new firms, and the business birth/death model it uses typically fails at turning points. Benchmark revisions could be substantial.

The deteriorating outlook has led to credit market disruptions, which threatens to further weaken the economy. The Fed has responded quickly, lowering the target range for the federal funds rate by 100 basis points, to 0-0.25%, and restarting large-scale asset purchases. The Fed has also taken several steps to improve liquidity, including establishing a Commercial Paper Funding Facility (CPFF), a Primary Dealer Credit Facility (PDCF), and a Money Market Mutual Fund Liquidity Facility (MMLF). To add to global liquidity, the Fed also expanded dollar swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank. Other central banks have also lowered interest rates and moved to boost liquidity.

Lawmakers are expected to pass a stimulus package of over $1 trillion, including checks to individuals, support for troubled industries, and loans to small businesses. This should help to ease a lot of the strains that are developing, but will need to be larger. Further support is likely. The federal budget deficit, already over $1 trillion, will double, but so what? The government has no problem borrowing right now. The demand for safe assets is huge.

The outlook for economic growth depends on the degree of social distancing, how long it lasts, and whether the spread of the virus will be constrained. At this point, the weakness in March appears to be significant enough to push GDP growth into negative territory in 1Q20, perhaps around -1.5 to -2.5% at an annual rate, with a sharper decline in 2Q120 to -15% to -25%. This is not expected to be a V-shaped recovery. The rebound is likely to be gradual. A base-case scenario (which is sketchy) would be around a 5% decline 4Q20/4Q19 (or -4% for 2020/2019). If we get lucky, GDP could fall 2.5% 4Q/4Q (-2% annual/annual). However, the economy could weaken a lot more (-14% 4Q/4Q or -10% 2020/2019).

A recession is not, as commonly believed, defined as two consecutive quarters of negative GDP growth. A recession is a broad-based decline in economic activity, observable in employment, personal income, business sales, and industrial production. It depends on the depth and duration (usually six months or more) of the economic decline. It’s very likely that the economic expansion ended in February, which would also be the start of the recession. Would this count as a recession if the economy begins to growth in June or July? We’ll have to see (it will be many months before the NBER’s Business Cycle Dating Committee formally makes a declaration). There is no formal definition of a depression (people have asked), other than “a severe recession.” However, much of this seems like navel-gazing. We know this will be bad. We don’t know how bad or how long it will last. We know that the economy will eventually recover. However, it may be several quarters before the global economy gets back to where it was – and the composition of the U.S. economy could end up looking a lot different than it did at the start of 2020. (M20-3006256)


The opinions offered by Dr. Brown should be considered a part of your overall decision-making process. For more information about this report – to discuss how this outlook may affect your personal situation and/or to learn how this insight may be incorporated into your investment strategy – please contact your financial advisor or use the convenient Office Locator to find our office(s) nearest you today.

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