Focus
June 12, 2020 | 14:35
A Long and Winding U.S. Recovery Road
Economics
Economics
Economics
Economics
Fixed Income Strategy
Economics
Economics
Economics
Economics
Fixed Income Strategy
A Long and Winding U.S. Recovery Road |
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This week, the National Bureau of Economic Research (NBER)—the arbiter of business cycle dating in America—announced that the peak of the past cycle was February, on a monthly basis, and 2019 Q4, on a quarterly basis. Among the previous 33 cycle tops the NBER has dated back to 1857, the peak month has always occurred in, or within one month of, the peak quarter. The latest two-month deviation is unprecedented, and reflects the pandemic-related plummet in March economic activity that pulled Q1 outcomes significantly below their Q4 results. In turn, March and 2020 Q1 become the first full periods of recession. Payroll employment is one of the critical monthly indicators used by the NBER to identify business cycle turning points, and the May report on the employment situation was released just three days before the NBER’s announcement. Payrolls jumped by 2.5 million in May after plummeting by 20.7 million in April and 1.4 million in March. To the extent that May’s employment move is mirrored in other important indicators, April should end up marking the cycle trough, with May becoming the first full month of recovery [1]. Even allowing for strong May and June rebounds, the arithmetic impact of an extremely weak March-April should ensure that Q2 outcomes fall well below their Q1 results. This will make 2020 Q2 the trough and 2020 Q3 the first full quarter of recovery. The 2020 recession will have lasted for just two months, making it the shortest contraction in U.S. economic history. Up until this year, the shortest recession had been six months in 1980 followed by a seven-month downturn in 1918-19. The latter reflected not only the end of World War I but also the outbreak of the Spanish flu. In addition to being the shortest in history, the 2020 downturn is shaping up to be the deepest since before WWII and, thus, since the Great Depression—a title previously held by the 2008-09 Great Recession. Payroll employment plummeted by 14.5% in March-April, more than double the Great Recession’s cumulative 6.3% decline (Table 1) [2]. Real GDP already contracted 1.3% in 2020 Q1 (not annualized) with Q2 poised to pile on enough weight to more than double the Great Recession’s 4.0% cumulative decline (Table 2) [3]. Although the data to properly size this recession are still pending (e.g., the advance GDP estimate for Q2 is due at the end of July), with the economy now in the recovery phase, attention turns to what kind of recovery this is likely to be. A key characteristic of this recovery will be stellar hiring and sales growth rates at the outset. We saw payrolls expand by 1.9% in May alone, the most since 1946, as just over 11% of March-April job losses were gained back. A business going from 20% to 60% of pre-pandemic activity in a given period will register sales growth of 200%. In subsequent periods, the sequential growth rates will slow, but still remain strong, as greater shares of pre-COVID activity are achieved (e.g., if it were 80% in the next period and 90% in the one after that, the growth rates would be 33.3% and 12.5%, respectively). In terms of real GDP growth, 2020 Q3 is poised to be as strong as Q2 will be weak. But, how long will it take to get back to where GDP was in 2019 Q4, and where employment was in February 2020? Although the 2020 recession will greatly overtake the previous downturn as the worst in the post-WWII period, the Great Recession also exhibited the longest recuperation period in this history. It took two years for GDP to recover completely and 4¼ years to get back all the jobs lost, more than double the durations it took all other downturns [4]. Our Douglas Porter characterizes the recovery from the 2020 recession as a slow stair climb up after a fast elevator ride down. These “stairs” are fabricated from the various factors delaying full recovery for some businesses and industries, while denying it altogether for others. From a GDP perspective, we reckon the recuperation period from the 2020 recession will probably surpass the Great Recession’s, owing to the factors listed below (in no particular order). |
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Lack of confidence: Given the risks of a major second wave of COVID-19 or minor local outbreaks, we suspect business and consumer confidence are unlikely to rebound fully until there is a vaccine or an effective treatment. The lack of full rebound presents an economic headwind, particularly for capex and big-ticket consumer purchases (Chart 1). Even if allowed to, surveys suggest that some consumers will simply opt to avoid crowds until a vaccine is available, restraining recovery among affected businesses and industries. Persistent unemployment: Not everyone who was laid-off or furloughed will get their jobs back, creating a spending restraint and applying another damper on consumer confidence. Even the FOMC expects the jobless rate to run a couple percentage points above its pre-pandemic level past 2022 (Chart 2). Apart from some firms going out of business and an inadequate rebound in business confidence (mentioned above), post-recession hiring could be dampened by some firms permanently paring personnel to drive cost savings and efficiencies. Meanwhile, many industries will be facing operating constraints (such as physical distancing rules) and, thus, hiring constraints. |
Physical distancing/public health protocols: Across jurisdictions and industries, the transition from lockdowns and shutdowns to “business as usual” varies, mostly because of lingering physical distancing rules and other public health protocols. Consider the example of a restaurant with an indoor dining room: more spaced-out tables (less customers per period) and more stringent sanitation protocols (slower table turnover) will probably prevent recovery back to pre-pandemic activity levels. In addition to food services and drinking places, other industries facing similar full-recovery challenges include: transportation (particularly airlines, transit and cruise lines), accommodation, along with arts, entertainment and recreation. Private-sector debt burdens: With many of the federal government's measures to counter the pandemic involving a loan, in which some or all of it might not be forgiven, and all of the Fed's measures involving asset purchases to facilitate the credit creation process, the legacy of the recession is destined to be larger debt burdens among businesses both big and small. At a minimum, increased debt service payments, even assuming interest rates remain very low, should act as a mild constraint on business outlays—both hiring and capex. In 2020 Q1, as non-financial businesses tapped their credit lines, debt already hit a record 78.1% of GDP, with all-time highs on both the corporate and non-corporate sides (Chart 3). Insolvencies and bankruptcies: Whether it's the depth of the recession, the sluggishness of the recovery, or the burden of additional debt, some businesses are bound to succumb to insolvency and bankruptcy. As some of these firms subsequently close permanently, economic growth capacity will be clipped. Even corporations restructuring under bankruptcy protection are likely to curb their outlays on hiring and capex. |
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Fiscal consolidation: Government budget deficits surged massively, as measures were quickly introduced to address the health and economic crises caused by the pandemic. With businesses reopening and workers getting rehired, many of these measures are scheduled to end while others will be modified to better target their benefits. Looking ahead, with higher run rates for budget deficits and much larger public sector debt burdens, some efforts at fiscal consolidation will likely occur, particularly after the next election. After the first four fiscal support packages, the CBO estimated the 2020 federal deficit at $3.7 trillion (17.9% of GDP) and a still-large $2.1 trillion in 2021 (9.8%), compared to just under $1 trillion in 2019 (4.6% of GDP). The deficit surge is causing federal debt held by the public to swell. It should top 100% of GDP this year before rising to 108% next year (Chart 4). These are the highest public debt burdens since the end of WWII. Commercial real estate woes: Apart from the temporary impact of rents not being paid, tenant insolvencies and bankruptcies could have a more lasting negative impact on commercial landlords. Even before the pandemic, the retail segment was on a weakening trend owing to online shopping. However, the more dispersed adoption of digital distributive technologies because of the lockdowns and shutdowns should worsen this trend. The persistence of a sizeable work-from-home cohort is going to pressure the office segment. We doubt much development dollars will be flowing into these segments along with restaurants, bars and hotels. However, this should be partly offset by perked-up activity in warehouses, data centres and grocery stores. No takeoff for aircraft: As airlines around the world grapple with reduced passenger volumes, dampened global demand for new aircraft will weigh on Boeing and other firms in the aircraft and parts manufacturing industry. This sector was already reeling from the suspension of 737 MAX production, a suspension that had been expected to be lifted soon and boost industry output this year. U.S./China Trade War: Before the pandemic, with a Phase One trade deal signed, and Phase Two talks beginning, the economic drag from the U.S./China trade war was diminishing with the U.S. poised to get a growth boost from the extra exports. Currently, with the Administration blaming China for the pandemic’s economic devastation, and trade tensions intensifying, the trade war looks to continue acting as a drag on growth. Lower crude oil prices: Although prices have rebounded from their lows (in the futures market, the price of a soon-expiring contract actually turned negative at one point), a significant imbalance between global supply and demand lingers. Supply was initially jacked up as Russia and Saudi Arabia fought a price war, but they, along with the rest of the OPEC+ group, eventually agreed to production cuts. Meanwhile, the pandemic and corresponding hit to global economic growth dampened demand. It could be well past next year before prices return to pre-pandemic (>$50/barrel) levels with an interim commensurate constraint on U.S. oil sector activity. Slower global economic growth: This week, both the World Bank and OECD released their latest global economic outlooks. The World Bank forecast global GDP to decrease 5.2% this year and increase 4.2% next year. The OECD forecast “two equally probable scenarios”, depending on whether there’s another COVID-19 global outbreak. If no, world GDP would shrink 6.0% in 2020 and bounce back 5.2% in 2021. If yes, the global economy would contract 7.6% this year and rebound only 2.8% next year. Note that for both organizations, full global economic recovery is a 2022 story at the earliest. The IMF chimed in too, warning that its 3% global contraction forecast in April will be revised lower. A slower growing world economy is a headwind by dampening U.S. export growth and depressing important commodity prices such as oil. Above, we listed many factors that will likely lean on the robustness of the economic recovery, not only for GDP but also for jobs. We reckon the net risks lie on the side of an even weaker recuperation profile. However, given underlying potential growth in the 1¾%-to-2% range, even achieving a full recovery a couple years out will still leave a significant disinflationary output gap for policymakers to deal with. This suggests that any major Fed policy shift toward monetary restraint (like rate hikes) is unlikely something households, businesses and governments will have to worry about for a long while (2023 at the earliest according to the latest FOMC "dot plot"). Endnotes:[1] Other indicators deemed important for business cycle dating by the NBER include real personal income less transfers, along with real personal consumption expenditures, industrial production, initial claims for unemployment insurance, real wholesale-retail sales and household employment. GDP and gross domestic income (GNI) are the critical quarterly indicators, complemented by the averages of the monthly indicators. [^][2] Because several indicators go into their determination, business cycle turning points and the cyclical peaks and troughs in payroll employment rarely match; it has happened only once among the 11 post-WWII recessions (1960-61). [^][3] The cyclical tops and bottoms in real GDP align a bit better with business cycle turning points; it lined up four times (1973-75, 1980, 1990-91 and 2007-09). For the record, during the Great Depression, real GDP contracted more than 32% during the three years ended 1932 Q3. [^][4] For the record, after the Great Depression, it took 4¼ years for GDP to recover completely. Annual average civilian employment did not return to its 1929 peak until after the outbreak of WWII in 1940, more than a decade after the fact. [^] |