The Covid-19 pandemic undoubtedly created a combination of supply and demand shocks to the U.S. economy, deteriorating economic growth in the first quarter. In the first quarter of 2020, the economy declined at an annualized rate of 5.0% – the first time since the Financial Crisis. However, economic data released in the second quarter suggests the economy’s recovery began as state lockdown measures eased. BBVA USA Research expects the recovery will take an “incomplete V” shape, meaning it will be slower than anticipated and could be impacted by a second wave of new cases. The duration and magnitude of the recovery, however, remains highly uncertain and strongly tied to the government’s ability to contain the virus or the development of a vaccine. Members of the Federal Reserve have expressed similar sentiments – the U.S. is in for a slow and uncertain recovery. Philadelphia Fed President Patrick Harker expects the recovery is likely to look like “a swoosh, written with a very shaky hand.”
Amid the economic lockdown, industrial production, which measures activity at factories, mines, and utilities, hit a low of -12.7% in April. However, activity picked up in the second half of the second quarter as factories reopened. In June, industrial production rose a seasonally adjusted 5.4% up from 1.4% in May. Much of the recovery in June was attributed to the 7.2% gain in the manufacturing sector, the largest component of industrial production. Despite the gains in May and June, industrial production fell at an annualized rate of 42.6% in the second quarter, the largest quarterly decrease since World War II.
Manufacturing purchasing manager indices (PMIs) paint a similar story. While there is certainly still weakness in the manufacturing sector, two separate surveys suggest the sector may be poised for recovery. In June, IHS Markit reported its manufacturing PMI rose to 49.8 from 39.8 in May and its low of 36.1 in April. The Institute for Supply Management’s (ISM) PMI expanded in June at 52.6, a stark rebound from the index’s reading of 43.1 in May and 41.5 in April. Readings above 50 indicate expansion, while readings below 50 indicate contraction. Survey respondents have recently indicated demand has stabilized, evident by the strongest monthly gain in new orders since the start of ISM’s index. Similarly, the easing of stay-at-home orders has allowed manufacturers to reduce the number of layoffs to its workforce. Both factors caused an uptick in business sentiment, which could bode well for employment and business spending. Due to the recent uptick in the new coronavirus cases possibly triggering a reclosure of factories, it isn’t clear if the recovery is sustainable.
The Fed Beige Book, a compilation of business anecdotes, suggests that while recent business activity shows significant improvement, it may not be sustainable. Optimism remains muted as businesses remain uncertain about the future and hesitant to rehire workers given the continued “health and safety concerns” around the virus. Moreover, there were also talks of a new round of layoffs as the federal government’s Paycheck Protection Program nears its end.
This sentiment is a particular concern for the service sector, which accounts for roughly two-thirds of the U.S. economy. As states began to ease lockdown restrictions, activity in the service sector began to pick up. IHS’s services PMI rose to 47.9 in June from 37.5 in May. While these number still represent a contraction, it is a notably a significant improvement from the low of 26.7 in April, the height of the lockdowns. However, the recent resurgence in cases could undo the gains made in the sector as many states have already announced new restrictions on restaurants and bars in June.
Consumer spending, the primary driver of growth in the U.S. economy, is experiencing a similar trend. Spending was bottlenecked as consumers abided by social distancing and lockdown measures. As restrictions were rolled back and government stimulus measures, such as enhanced unemployment insurance and household stimulus payments, were implemented, retail spending bounced back. After plunging 14.7% in April, retail sales jumped 18.2% in May – the biggest gain since the Commerce Department began tracking the data. In June, retail sales rose to $524.3 billion or an increase of 7.5%, nearly back to pre-pandemic levels. Spending was largely attributed to big ticket items such as furniture and autos, but sales also picked up significantly on visits to restaurants and bars and gasoline. Meanwhile in June, spending at both grocery stores and online retailers declined from a month earlier. We could begin to see consumer spending weaken if layoffs resume due to dialed-back state openings and consumers’ incomes take a hit.
Consumer prices, gauged by the consumer price index, rose in June to an annualized rate of 0.6% after declining for the past three months. A large part of the gain in June was attributed to the rise in gasoline prices, which were hit hard by the coronavirus pandemic. Core CPI, which extracts the volatile food and energy prices, rose to an annualized rate of 1.2%. The snap back in prices implies the risk of deflation has declined, though it is unlikely we’ll see a significant spike in prices anytime soon. BBVA USA Research expects inflationary prices to remain muted for the rest of 2020.
The labor market will be important to watch in the coming months to gain insight on the magnitude and length of the current recovery. The U.S. economy added 4.8 million jobs in June on top of the 2.7 million jobs added in May. According to the Labor Department, these gains only reflect a partial recovery of the 22.2 million jobs lost in March and April. Moreover, we’ve seen a continued increase in permanent job losses which increased 588,000 to 2.9 million in June. The overall unemployment rate, however, declined to 11.1% from 13.3% in May, after hitting the record high in April at 14.7%. BBVA USA Research expects the unemployment rate to converge to 8.6% by the end of 2020. Recent initial jobless claim numbers, representing new applications for unemployment benefits, have been at least 1 million for the past 17 weeks, which could stall the recovery in the labor market.
The Federal Reserve has indicated it is committed to do whatever it can to support the economy. The Fed already cut its short-term interest rate to 0.00%, launched numerous credit facilities, and ramped up its bond buying program. If necessary, the Fed could continue to expand its balance sheet, already at $7 trillion, or provide more guidance about the future direction of interest rates. Various members of the Fed, however, have indicated that despite the “unprecedented monetary and fiscal stimulus,” more fiscal stimulus is needed to navigate the fallout from the coronavirus. Recently, Treasury Secretary Steven Mnuchin indicated the Trump administration is working with the Senate to pass a new bill for coronavirus-related economic aid by the end of July as enhanced unemployment benefits near expiration.
While economic activity has shown signs of recovery following the rollback of social distancing measures in May and June, risks to the downside remain elevated as the number of coronavirus cases in the U.S. continue to rise. BBVA USA Research anticipates U.S. GDP will decline to 5.1% in 2020.
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