Economic output has surged as lockdown restrictions have eased and some economic activities have been restored. Economic policy continued to be a key catalyst to growth, particularly fiscal policies that sustained household incomes despite a collapse in hours worked. After the remarkable rebound in Q3, growth will inevitably slow in the following quarters, but that slowdown could be intensified by several downside risks. A second wave of coronavirus infections could lead to tougher social distancing restrictions, which would impair further recovery; this second wave may already be underway in Europe as the region has seen second wave outbreaks. Fiscal stimulus from the CARES act has faded, and a near- term deal on further measures appears unlikely which could increase financial stress for unemployed workers, state & local governments, and small businesses. Economic activity has picked up strongly after nationwide shutdowns in March and April. It’s expected the third quarter will be the strongest quarter of growth in post-war history, as businesses continued to reopen as well as the continuation of aggressive monetary and fiscal stimulus.
Manufacturing purchasing manager indices (PMIs), which measures activity at factories, mines, and utilities, staged a V-shaped recovery, with most major economies signaling an expansion (survey of above 50). In the US, the ISM manufacturing survey surged past pre-pandemic levels, but readings on industrial production seem to be weakening. The ISM manufacturing survey’s headline composite declined from 56.0 to 55.4 in September, disappointing expectations. This decline followed strong increases over the prior few months and could mean the manufacturing data will turn more mixed over time as the sector transitions out of a period with robust growth that followed virus-related disruptions. Along with the disappointment in the latest ISM report, the separate Markit manufacturing PMI also came out below expectations, with the headline composite revised down from 53.5 to 53.2 between the flash and final September reports.
Trade-related frictions from the pandemic weighed heavily on net exports in 3Q20, pushing the deficit to the highest level ever at $1.0Tn in real terms. As a share of GDP, the trade deficit (-3.5%) was the highest in 8 years but significantly lower than the record of -5.9% back in 2005. Similarly, federal, state, and local expenditures also declined due to the drop in fees paid to administer the Paycheck Protection Program loans at the Federal level and dire fiscal positions of most state and local governments have led to nontrivial cutbacks.
For consumption, the unprecedented fiscal stimulus and pent up demand pushed durable goods spending up to $300bn on an annualized basis to 2.0Tn, nearly $215bn above the pre-pandemic levels. Consumer spending may have rebounded quickly in the third quarter, but is expected to slow into the end of the year. Fiscal stimulus from the CARES Act boosted household income through the summer, but that support is fading. $1,200 economic impact payments were a one-off measure in April and May, and the enhanced $600 per week unemployment benefits expired at the end of July.
For services, precautionary and compulsory distancing contributed to a muted recovery which remains well below the pre-pandemic peak. In fact, food service and accommodation, recreation, transportation and medical care services stand between 7 and 32% below pre-pandemic levels in spite of respective increases on an annualized basis in 3Q20, signaling the service sector remains on mend. Service spending is unlikely to fully recover as long as COVID-19 contagion remains widespread. Regional outbreaks could lead to new shutdowns and restrictions, and moving activities outdoors is less practical as the weather cools in the autumn and winter. Meanwhile, some of the strength in goods consumption could prove to be temporary – driven by stimulus payments or one-off purchases to adapt to lifestyle changes due to the pandemic. There is still room for consumer spending to grow above trend. Household finances were surprisingly healthy, given the weakness in growth and the labor market. This was due to several factors. Stimulus programs caused disposable income to rise during the peak of labor market stress in April and May. The pullback in consumer spending led to a sharp increase in the savings rate. Lastly, a wave of mortgage refinancing also boosted cash flows for many households.
Prices, gauged by the Consumer Price Index, have normalized in some of the hardest-hit categories of spending – including travel, restaurants, and apparel. CPI started the quarter at a little under 1% and rose over 0.4% in August. With little change in September, headline CPI ended the quarter at 1.4%. Much of this healthy rebound in the third quarter has been primarily driven by a rise in the prices of core commodities, while core services continue to remain relatively suppressed. This trend is partially attributable to the tug of war in transportation commodities (i.e. automobiles and parts) vs. transportation services (i.e. airfares), another indication of the potential to unlock inflationary pressure resulting from a significant advancement in Covid-19 treatments. Furthermore, the recent rise in the demand for housing and subsequent increases in prices is likely to contribute to further inflationary pressure. Inflation expectations over the next 5-years remain anchored around 1.8%. Potential supply-side pressures remain, albeit less so than the risk of a major negative demand-side shock or spillovers from a sharp fiscal contraction. BBVA USA Research’s base scenario assumes CPI growth will grow moderately this year and next.
Coinciding with the strong recovery in economic growth, the labor market continued its improvement with strong gains in leisure & hospitality, retail, and professional & business services. Nonfarm payrolls have increased by 10.6M after declining 22M in March and April, resulting in a net drop of 11.5M since the start of the pandemic in February. While the pace of the improvement in employment will likely be more gradual, there are several factors that may indicate a higher possibility of a more rapid recovery than expected. Job opening from the Bureau of Labor Statistics vs. unemployment, indicates the current level of job openings has historically coincided with much lower levels of unemployment. The most recent NFIB Small Business Jobs Report indicated a significant rise in the Small Business Job Openings Hard to Fill Index. Furthermore, eventual progress in advanced therapeutics and/ or a vaccine may unlock a wave of job openings across the services sector, and while this may not occur in the near short-term, it’s very possible in the next one-to-two years.
The change in the Federal Reserve’s forward guidance signals they intend to keep interest rates at the zero lower bound indefinitely. The Fed communicated it intends to remain very supportive through 2023, and communicated no meaningful changes to their current strategy on asset purchases. While the Fed’s economic outlook depends significantly on the course of the virus, the committee’s projections improved noticeably from June. Based on the latest statement and changes to the committee’s Longer-Run Goals and monetary policy strategy, BBVA USA Research believes the Fed will raise policy rates no earlier than 2025.
In the absence of strong Covid-19 lockdown measures, US activity should continue to grow, although at a slower pace, in the last quarter of 2020. BBVA USA Research anticipates U.S. GDP will end the year with a 4.6% decline. Uncertainty around the outlook for 2021 remains elevated and conditional on how effective the next administration and Congress are at tackling the economic costs of the pandemic, and how quickly the economy can adapt to the post-Covid reality without extended monetary and fiscal support. BBVA USA Research implies that under a more optimistic scenario, GDP could return to pre-pandemic levels as early as 1Q22. However, under more pessimistic conditions, the full recovery could take much longer.
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