FOMC continue to highlight concern over outlook. Q2 shock to be a multiple of Q1 decline.
The S&P 500 initially fell almost 35% in response to COVID-19’s spread across the world and to the US. However, the index has since rallied strongly off the late-March low, gaining over 30% to be just 13% below its prior peak.
While these gains are consistent with the desire of State and Federal government authorities to quickly re-open the US economy as well as the immense and open-ended support of the US Federal Reserve, they are at odds with the economic shock now being reported, as well as the highly-uncertain path back for the economy once this virus is brought under control.
In our discussions to date on the US economy, we have focused on initial jobless claims. By mid-April, some 26 million US workers had lost their jobs and filed for unemployment benefits. This loss of jobs will result in the unemployment rate rising from 4.4% at March to around 15% in April.
Further job losses are expected, and so the peak unemployment rate for this cycle is likely to be nearer 20%. Thereafter, it will take a long time for the unemployment rate to come back down to the GFC peak of 10%, let alone the 3-5% range the economy has become accustomed to.
It is not surprising then that activity collapsed mid-way through the March quarter as the lockdown hit the US. As a result, in annualised terms, GDP fell almost 5% for the quarter as a whole. Underlying this headline result, services consumption was down 10% in the three months to March, and demand for durable goods such as cars and household goods fell around 16% annualised.
While these outcomes are severe, they are merely the start. The June quarter will be materially weaker again, likely seeing an annualised GDP decline in the order of 25%, five times the scale of the loss seen in the three months to March. Again, this weakness will be concentrated in consumption, but will also be clearly apparent in housing construction and business investment.
If the US economy is opened up as authorities intend, then it will bounce back in the second half of 2020, offsetting some of the loss to June.
It is important to highlight however that this will not be a broad-based recovery. Pent-up demand amongst still-employed consumers will come to the fore, but those who have lost their jobs will remain income constrained, particularly as unemployment benefits expire.
Businesses meanwhile are likely to sit on their hands for an extended period, waiting to assess the full shock to their financial position as well as the state of demand for their output before committing to new capacity.
This view is also applicable to hiring, highlighting why the US labour market will take a long time to heal, and consequently why the economic recovery from this crisis will prove protracted. Following a decline of around 8% over the year to December 2020, Westpac only sees a 5% gain through 2021, leaving the US economy materially worse off in 2022 than at end-2019.
Even to our cautious view, there are downside risks. Chief among them is that the spread of the virus is not contained in the US as authorities hope.
There are now over a million cases of COVID-19 in the US, around a third of known global cases. While the crisis in epicentres such as New York City is subsiding, the spread across the nation is becoming pervasive. This means that, against current market expectations, it will be very difficult to sustainably and smoothly re-open the US economy.
As is apparent from the market’s response, the FOMC has done a lot to try and support the US economy in these troubled times, their balance sheet having increased from less than 4 trillion before COVID-19 to around 6.5 trillion currently, likely on its way to 8-10 trillion.
At their April meeting, the FOMC affirmed their confidence in these ‘forceful, pro-active and aggressive’ actions as well as a willingness to do more. Chair Powell further noted that there was likely going to be a need to do more if the recovery is to be robust.
However, during this discussion, he also noted that there are limits to what the FOMC can do, with its tools aimed at maintaining market liquidity and credit availability, instead of supporting demand directly.
This is a polite but clear message that for the US to see a lasting, robust rebound in demand, fiscal authorities have to do more. In stark contrast to Australia and New Zealand, US fiscal policy has been passive to date and has done little to preserve the relationship between employer and employee.
Much like the rapid scaling up of testing and tracking that has to be implemented to stem risks related to the virus itself, the US fiscal policy stance must change and change quickly if apparent economic downside risks are to be prevented from taking root.
