June 29, 2020
Is the Worst of the COVID-19 Recession Behind Us?
Lawry Knopp, VP-Funding & Hedging
Optimism that the economy is in the early stages of recovery following the COVID-19 outbreak and related shutdown continues to fuel gains in the equity markets, while U.S. Treasury yields have gradually increased from the March 9 lows. The action for the equity markets has been more robust as the S&P-500 has recovered about 800 points of the 1149 point drop from the mid-February record high of 3386 to the March 23 low of 2237. Aided by significant monetary and fiscal stimulus, equity markets have recovered quicker than analysts expected. However, some investors and traders worry stocks may have run up too far and too fast, which can increase the risk for a period of market volatility.
Recent signs of a second wave of the coronavirus have added new uncertainty to market sentiment, which may generate another round of volatility. In the U.S, new cases are focused in Texas, Florida and California, with hospitalizations starting to trend higher while the number of deaths is stable. Globally, new cases in the major European economies and Asian countries continue to moderate. However, new cases in Brazil, India and South Africa are climbing. Some speculate despite an increase in the number of cases, government authorities may be reluctant to require the same level of economic shutdown implemented in March and April. Nevertheless, continued improvement in economic data and the extremely accommodative Federal Reserve have been a tailwind for the market. The dollar continues to weaken from its recent mid-May high as investors’ needs for safety have subsided and risk has been added to investment portfolios.
Following the dramatic decline and volatility in oil prices, West Texas Intermediate crude has risen from a record low of -$37.63 on April 20 to nearly $39 per barrel. U.S. crude oil futures moved below zero for the first time in history due to a collapse in demand as shelter-in-place directives took effect, which caused storage facilities to fill up. Futures prices pushed lower due to production already in the pipeline with no demand, while the cost of storage significantly increased.
Oil prices could trend lower on worries of increased production as Saudi Arabia has indicated they may be unwilling to maintain cuts in production, implemented on May 1. OPEC members and allies heavily reliant on oil-based income may be forced to ramp-up output in the coming months to support their struggling financial systems.
During the post-Federal Open Market Committee meeting press conference on June 10, Federal Reserve Chairman Jerome Powell suggested the COVID-19 related economic decline could inflict long-lasting damage on the economy, despite historic monetary and fiscal stimulus. Policymakers signaled the potential for policy rates to remain near zero out to 2022 and committed to expanding security holdings at the current pace of $120 billion per month to “sustain smooth market functioning.” The Fed’s balance sheet has increased from $4.2 trillion in late February to $7.2 trillion earlier this month. Furthermore, Treasury Secretary Steve Mnuchin has suggested the U.S. economy needs additional fiscal stimulus.
Overall, Chairman Powell's press conference and the FOMC's statement offered a dovish and more accommodative outlook than expected. The FOMC received a briefing on the historical experience of yield curve control (YCC), which amounts to the Fed managing Treasury yields within a tight band by buying and selling Treasury bonds. Still, Chairman Powell said the potential for YCC to complement the Fed's current forward guidance and asset purchase tools remains an open question. In a recent speech, Powell indicated central bankers are worried if the recovery takes an extended period to gather momentum, the passage of time could “turn liquidity problems into solvency problems.” The next FOMC meeting is July 28-29.
The May employment report was much stronger than expected. The Labor Department reported U.S. employers added 2.5 million jobs in May compared to projections for a decline of 7.5 million. The report was based on resumed economic activity as shutdown restrictions eased. Employment rose in leisure and hospitality, construction, education, healthcare and retail. The unemployment rate fell to 13.3% from 14.7%, versus the expected increase to 19%, while the broader U-6 (underemployment) rate dropped from 22.8% to 21.2%. Hours worked increased together with gains in average hourly and weekly earnings. Average weekly earnings rose 7.7% year-over-year, suggesting lower-paid workers are being called back to work. We will likely see the jobless rate remain above, or near, 10% for the rest of 2020.
Data collection issues persist, and the volume of unemployment activity remains overwhelming. Analysts are expecting May’s job losses to be revised higher, as many workers were incorrectly classified as “employed persons absent from work due to coronavirus-related business closures.” They should have been classified as “unemployed on temporary layoff.” If the workers would have been categorized properly the unemployment rate would have been closer to 16.3%. Nevertheless, much damage has been done to the economy. The total number of people out of work is nearly 21 million compared to just under 6 million a year ago. For comparison, during the Great Recession, from September 2009 to November 2010, the number of unemployed Americans was about 15 million and the unemployment rate topped out at 10.0%.
Continuing claims for jobless benefits remain stubbornly high. Some of the cause may be related to the additional $600 per week unemployment benefit, which is set to expire at the end of July. The COVID-19 outbreak had a greater impact on lower wage earners, and the additional benefit reduced the pressure and stress from shutdown-related job losses. However, as the recovery starts to get underway, extending the $600 per week benefit to the end of the year may result in many recipients weighing their options, and in some cases, being better off staying at home rather than going back to work. Congress may look for alternate measures to encourage workers to seek employment. Ideas being considered include a bonus to return to work or a reduction in the weekly payment to possibly $300 per week.
The final report on Q1 gross domestic product confirmed the economy contracted by 5.0%, on an inflation-adjusted annualized basis. Looking ahead to the Q2 GDP report, which won’t be available until late-July, analyst projections vary greatly as consumer and business spending continues to slow significantly. The Federal Reserve Bank of Atlanta is projecting a -45.5% Q2 rate of growth while the New York Fed forecasts -19.0%. This may be the low point for the economy as projections for Q3 call for growth to be around 14% and close to 10% for Q4. On a dollar basis, gross domestic product finished Q4-2019 at $19.2 trillion. As many businesses are only able to reopen at a reduce activity level, U.S. economic output may not return to the Q4-2019 level until late-2021 or sometime during 2022. This will result in lower capital efficiency and overall weaker economic productivity.
Core consumer price inflation fell for the third straight month in May as airfare and apparel prices led declines again. Headline inflation, including energy and food prices, fell slightly –
mostly due to lower gasoline prices as food prices rose modestly. Among the largest moving core categories, Owner's Equivalent Rent (a key measure of the cost of shelter) was up 0.26%, rebounding slightly from its slowest pace in over a year. Overall, the initial impact of the shutdowns due to the coronavirus is deflationary. Going forward, expect increased volatility in the coming months. However, the medium-term risks to inflation remain firmly to the downside.
Other major central banks are implementing monetary and fiscal policy measures to support their financial markets and economies. Fiscal policy measures range from 5-10% of annual GDP. Monetary policy stimulus includes lowering of policy rates and expanding central bank purchases of government and government-sponsored debt, short- and intermediate-term repo operations, buying other public, private and corporate debt obligations and providing loan guarantees.
View on Interest Rates
Look for the Fed to keep policy rates at the current level for the next 18-24 months. Their efforts will continue to focus on providing support to the financial markets through expanded purchases of both public and private debt and loan guarantees. Due to the Fed’s level of quantitative easing, longer term rates are expected to remain extremely low.
The 2-year yield will likely remain below 0.40% for the rest of 2020 while the 10-year yield trading range is 0.50-1.00%. We could see double-digit GDP growth in Q3 and Q4 provided social distancing and efforts by the medical community can control the advance of the virus and monetary stimulus and fiscal relief are effective. A larger than expected increase in a second wave of cases could delay the recovery. If the outlook for recovery begins to deteriorate significantly, credit, lending and equity markets could experience another round of extreme volatility as the economic narrative turns toward a deeper and longer recession versus the current view of a short recession.
The above commentary is a summary of select economic conditions prepared for Northwest FCS management. It is being shared as a courtesy. As with any economic analysis, it is based upon assumptions, personal views and experiences of those who provided the source material as well as those who prepared this summary. These assumptions, conclusions and opinions may prove to be incomplete or incorrect. Economic conditions may also change at any time based on unforeseeable events. Northwest FCS assumes no liability for the accuracy or completeness of the summary or of any of the source material upon which it is based. Northwest FCS does not undertake any obligation to update or correct any statement it makes in the above summary. Any person reading this summary is responsible to do appropriate due diligence without reliance on Northwest FCS. No commitment to lend or provide any financial service, express or implied, is made by posting this information.