Second Thoughts on the Second Wave
A resurgence in COVID cases in Canada and many European nations, a seeming echo of the U.S. summer experience, is unnerving investors and unsettling the economic outlook. In addition, a recent slide in new cases in the U.S. looks to be stalling (Chart 1). For at least some jurisdictions, the long-anticipated and much-dreaded second wave does indeed appear to be upon us. What does this rise in new cases, along with mounting U.S. election uncertainty, imply for the economic outlook now?
We don’t believe the sudden rise in virus caseloads in many economies significantly changes the fundamental forecast… yet. There are at least two major reasons: First, the public health policy response will likely be more targeted or surgical this time, compared with the broad-based, economy-crushing spring shutdowns. This is because lessons were learned in how to slow the virus through other steps (e.g., masks), and policymakers do not want (and, in some cases, cannot afford) to fully shut the economy down again. Moreover, the sectors that would be most affected by increased distancing measures are already struggling heavily, while much of the rest of the economy has largely learned to deal with restrictive conditions. Second, hospitalization and mortality rates are still well below spring levels (in part because the demographics of those falling ill are much younger now), so immediate concerns about overwhelming the health system seem overdone… so far.
Clearly, there is a real risk that caseloads could accelerate to the point where public health officials in some areas don’t have many good options. But, here the U.S. experience this summer may serve as an important lesson to other economies that are now in the early stages of a big upswing in cases. There, the case load sprinted in the summer, but with basic measures (masks, social distancing, and some rollbacks in re-openings), cases were eventually capped and came back down, with no major further economic damage in the ensuing weeks. From a health perspective, it may not be the best example to follow, but the U.S. experience was telling from an economic standpoint—the recovery did manage to soldier on even with a high case count, and reduced fiscal support. Finally, there is also still the entirely realistic chance of a positive surprise on the vaccine front—we have been cautious in our assumptions here—resulting in a better-than-expected economic outcome in 2021.
One key issue surrounding the potential for a true second wave is that fiscal and monetary policy is less well-placed to support the economy if more severe restrictions are required. A prime example is the U.S. fiscal front, where downside economic risks are escalating owing to the trifecta of ended or soon-ending federal income-support programs, pressure among state and local governments to balance their budgets, and the inability of Congress to pass another economic support package. Part of this inability is tied to the fast approaching election, the uncertain outcome of which is also imparting downside risk.
Detail on U.S. Federal Fiscal Support
There are three major U.S. federal income support programs for the unemployed. First, the Pandemic Unemployment Assistance (PUA) benefit is paid to workers not normally eligible for regular state benefits such as self-employed and gig workers. Second, the Pandemic Emergency Unemployment Compensation (PEUC) benefit is paid to workers normally eligible but whose regular state unemployment insurance (UI) benefits have run out. Both the PUA and PEUC programs are scheduled to expire at year-end, unless Congress extends them. Third, there is the top-up on all federal- and state-funded UI payments, which was already reduced last month, because Congress didn’t extend it.
The CARES Act’s $600 weekly top-up stopped being paid the period ending August 1. It was replaced by the Trump Administration’s Lost Wages Assistance (LWA) program, with a FEMA-funded payment of $300. The LWA also required a minimum pre-top-up UI payment of $100, which excluded some 3% to 6% of recipients (according to estimates). Also, states were requested to fund an additional $100 top-up, but only three states signed on. The program is scheduled to run until December 6 or until FEMA’s Disaster Reserve Fund (DRF) falls to $25 billion. As at August 31, the fund was $52.8 billon, with September top-ups and other DRP outlays (reflecting past natural disasters) estimated at more than $37 billion. As such, these top-ups are unlikely to continue past month end.
The number of Americans receiving jobless benefits has flattened recently, as rising PUA and PEUC recipients have offset falling regular state UI recipients (Chart 2). To roughly gauge the hit to incomes from the first top-up reduction, the total number receiving jobless benefits averaged 28.9 million during August, with 1.3 million seeing their $600 payment drop to zero (assuming a midrange 4½% didn’t qualify for LWA) and the remaining 27.6 million dropping to $300. This results in a $9.1 billion reduction in total weekly payments, or over $39 billion for the month and $471 billion at an annual rate. This is a 2.4% monthly hit to personal income (other things equal), but with the net spending impact dampened by August’s strong job growth and a likely lower personal saving rate.
The second top-up reduction, to be felt in October, will likely result in a smaller hit to incomes given lower numbers receiving jobless benefits and interim income growth. However, October job growth will probably be slower than August’s with the personal saving rate potentially not falling as much, providing less of a dampening impact on net spending. Indeed, this could become more pronounced by January even though the direct hit to incomes from the end of PUA and PEUC benefits will likely be less than either of the two hits from the top-up reductions.
PUA and PEUC payments are set at regular state UI payment levels. The latter averaged $378 per person, across all states, at the end of last year (according to the Department of Labor). Currently (four-week average ending September 5), there are 13.5 million receiving PUA benefits and 1.5 million receiving PEUC payments. At current recipient and income levels, these programs ending would result in a $5.7 billion reduction in total weekly payments, or almost $25 billion for the month and $296 billion at an annual rate. This 1.5% monthly hit to personal income would presumably be smaller by January given lower recipients and interim income growth.
The Paycheck Protection Program (PPP) closed on August 8, at which time the SBA had disbursed $525 billion of the $659 billion Congress had provided for the program (the undisbursed $134 billion goes back into Treasury’s coffers). The PPP provides forgivable loans to small- and medium-sized businesses that maintain their payrolls at prescribed levels. It’s unclear whether these funds would have been used if the program had been extended (for a second time). But with many small businesses likely to continue struggling, particularly those in the ‘in-person’ services segment, additional support will probably be required to prevent many of these firms from going out of business.
Fiscal consolidation at the state and local government level is forming another economic headwind, as these jurisdictions attempt to balance their budgets amid a recession-related reduction in revenue and spending boosted by the economic downturn and measures to combat the pandemic. Earlier this year, the National Association of Governors made a bipartisan appeal for an additional $500 billion in federal support, with the National Council of Mayors also making an appeal for $250 billion. Without additional support from the federal government, economic-growth sapping spending cuts (e.g., cuts to state and local government payrolls and infrastructure outlays) and tax/fee hikes loom.
Indeed, Democrats and Republicans disagree most on additional support for state and local governments, along with the fact that the deficit is already massive (a post-war high as a share of GDP) and should act as a constraint on the size of any new stimulus package (Chart 3). A compromise deal in the mid-$1 trillion to low-$2 trillion range was looking doable several weeks ago, but the odds of getting this done before the election, or done at all, have since dropped meaningfully. In addition to heightened partisanship heading into the election, the push to get a new judge on the Supreme Court to replace Justice Ginsburg before the election has shifted the focus away from another stimulus package. And, after the election, it’s unclear whether the lame-duck Congress or incumbent/out-going Administration will have any more success at getting a stimulus bill passed. It should also be noted that an election outcome that is not definitive or that gets dragged into the courts would further lessen the likelihood of a stimulus package and prod additional downside economic risk arising from any associated financial market weakness and volatility. Fed Chair Powell has consistently implored Congress to get its act together because “more fiscal support is likely to be needed” for the persistently unemployed, struggling small businesses and cash-strapped state and local governments. At risk is the health of the economic recovery.
Even Canada has a soupçon of fiscal policy uncertainty. This week’s Throne Speech still has to pass a confidence vote in Parliament with a minority government. Assuming an election isn’t triggered, the main message from the Speech was that the government will “do whatever it takes” to support the economy through the second wave. Thus, while any extra U.S. fiscal stimulus will need to await at least until after the November election, Canadian government spending looks to continue rolling in at full bore, even as the CERB winds down and is replaced by the expanded EI and a suite of other programs.
Meantime, the underlying economy has performed better than widely expected. For both Canada and the U.S., the recovery has been at the upper end of scenario ranges foreseen by the consensus at the depths in April. That’s especially the case for consumer spending and housing activity in both economies. There is little mystery on what’s going on here, as massive government support has lifted incomes above pre-pandemic trends, bolstering savings and actually strengthening household finances. However, there is quite clearly a two-track recovery at play—the so-called K-shape—with some sectors snapping back quickly, and others still bouncing along the bottom (Chart 4). Moreover, with virus cases rising in Canada and fiscal support fading in the U.S., the risk is now that the rebound in even the strong sectors could cool, or worse, stall.
So, where does this all leave us as we head into the U.S. election, and its aftermath? Even before the recent rise in cases, we have been assuming that, after the initial burst in activity as economies re-opened, growth will cool markedly. At the very least, we will see some real moderation in coming months, with even a small pullback for a spell in some economies possible, before a more complete recovery takes hold (Chart 5). However, we believe that even with stiffer headwinds ahead, the North American economy will avoid a full-on double dip (or W shape), but the road is about to get much bumpier.