May 28, 2020
Frances Donald, Chief Economist
Opposing economic forces formed in the wake of the COVID-19 outbreak are pulling the US economy in different directions. But as our Global Chief Economist and Global Head of Macroeconomic Strategy Frances Donald notes, economic headwinds are gathering strength and look set to outweigh the positive developments. In her view, the coming months could be challenging.
There can be little doubt that we’re in unchartered territory from a macroeconomic perspective and the investment landscape is shifting rapidly. We compiled what we’ve learned in the past two to three weeks that has influenced our three- to six-month month view. Try as we might to focus on bright spots, we concede that macro headwinds outweigh tailwinds in terms of number, likelihood of occurrence, and their likely impact on U.S. growth.
Broadly speaking, our view is that the macro narrative will transition from the tailwinds created by the now fully priced stimulus measures implemented—along with the reopening of the global economy—to one focused on headwinds created by a second wave of economic stress, which is amplified by heightened geopolitical risks and a near-term slowing of both monetary and fiscal support.
In our view, four of these headwinds deserve particular attention, especially in the next month or so.
It’s highly likely that we’re reaching peak monetary policy—which isn’t to say the Fed (and other central banks) are no longer easing. Instead, that the effectiveness of monetary policies has hit its limit, and the Fed will increasingly be passing the growth baton to fiscal stimulus. Several developments in recent weeks pointed in this direction:
We think there’s plenty of scope for disappointment in the months ahead. As existing stimulus runs out, future programs could falter on three fronts: timing, size, and execution. To be clear, we do believe that additional stimulus will arrive at some point and that the coming election could provide plenty of incentives for policy action. However, in our view, there will be a lag between when stimulus is most needed—in the next month or two—and when its impact begins to trickle into the real economy, which is later this summer.
The U.S. federal government has implemented four sizable programs so far, totaling US$3.2 trillion, which have been important for buttressing household incomes and keeping down small business costs. However, many of the initiatives are temporary: Stimulus checks were only issued once, the emergency Unemployment Insurance top-up expires on July 31 (an issue that’s proven to be politically divisive), and the Paycheck Protection Program (PPP) aimed at small businesses covers only eight weeks of expenses. Tellingly, demand for PPP has been lukewarm—two weeks after the program was relaunched on April 27, more than 40% of the money allocated to the program was left untouched.⁷ Feedback from small businesses suggest that the stringent conditions attached to the program made it less appealing; for instance, for the loan to be “forgivable,” businesses must commit 80% of the loan to wages and rehire all of their staff by the end of June, regardless of economic conditions. These are near-impossible demands—even the most optimistic economists among us aren’t expecting businesses to be back to 100% capacity by June 30.
The passage of any new stimulus program might take longer than it should. The reception to House Democrats’ US$3 trillion relief plan in Capitol Hill has been mixed—questions are being asked about the size of the proposed stimulus and its promised timing.
The hawkish response to the House Democrats’ proposal could perhaps be traced back to new estimates from nonpartisan sources such as the U.S. Congressional Budget Office, which showed that the United States is heading for record levels of debt along with deficits that hearken back to the 1940s, during World War II.⁸ That level of spending implies a future moment of austerity/rising taxes—or debt monetization—neither of which is particularly attractive. We expect calls for restraint to escalate.
On a related, but separate, note, although U.S. government spending at the federal level has been aggressive, it’s a different story at a more local level: State and local governments are already being forced into prescribing austerity measures as revenue shortfalls accelerate; they’re shedding jobs at a furious rate. This is a problematic development since state and local government jobs represent 10% of total nonfarm payrolls.¹ While the federal government is likely to step up its support for workers at the state and local level, we’re unsure these measures, when they arrive, will be sufficient in timing and size.
A myriad of headlines reemerged in recent weeks suggesting that U.S.-China relations could take a turn for the worse. In our view, financial markets are ill prepared for a resurgence in trade tensions. The U.S. Trade Policy Uncertainty Index has tanked since both sides agreed to the phase one trade deal in December.
It’s difficult to tell whether Washington will work hard to avoid a trade conflict with Beijing in order to lift the stock market. In contrast, we’re inclined to think that more political capital could be gained from striking an aggressive tone ahead of the U.S. election (and perhaps then resolving any issues by November) than focusing on supporting the stock market.
It’s also worth noting that Beijing’s approach to managing U.S.-China trade relations might have changed recently. In our view, China has pivoted from an engagement strategy to one that seeks to control or influence what happens next.
Finally, while the market has likely priced some probability of a second wave of COVID-19 outbreak, we don’t believe it has appropriately discounted an economic second wave that could develop in the coming three to six months. This economic second wave is likely to be characterized by (i) rising delinquencies and further credit downgrades, (ii) additional and more permanent layoffs that begin to more directly affect medium and higher-income jobs, (iii) a lengthening in the duration of unemployment, (iv) wage declines, (v) a further drawdown in inventories with no restocking activity, and (vi) a growth-detracting rise in precautionary savings.
In particular, we find the following two data points worrying:
It's fair to say that the next few months look set to be challenging for the United States, barring a significant medical breakthrough. In our view, policymakers will need to not only act swiftly, but also be receptive to look beyond traditional approaches in their search for the right policy mix. Above all, they’ll need to see beyond party lines and act swiftly to save jobs and steer the economy back to growth.
1 Bloomberg, as of May 14, 2020.
2 Macquarie Bank, April 28, 2020.
3 “Small Business Coronavirus Impact Poll,” U.S. Chamber of Commerce, May 5, 2020.
4 “Current Economic Issues,” federalreserve.gov, May 13, 2020.
5 “Treasury Announces Marketable Borrowing Estimates,” home.treasury.gov, May 4, 2020.
6 “Less than zero? Fed’s Powell shows no love for negative rates,” Reuters, May 13, 2020.
7 “Demand for Small Business Loans Cools,” Wall Street Journal, May 8, 2020.
8 U.S. Congressional Budget Office, April 2020.
9 Citi Economics, as of May 13, 2020.
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