The Great Lockdown
At the start of 2020, the U.S. economy was poised for a year of modest economic growth. Now, only a few months later, the Covid-19 pandemic has caused an unprecedented deterioration in the growth outlook as a result of both dual demand and supply shocks within the domestic and global economies. The Organization for Economic Co-operation and Development (OECD) has calculated between 30% to 40% of total global economic output has been directly impacted by the widespread stay-at-home orders that have frozen economies. While the U.S. has implemented substantial fiscal and monetary stimulus measures to stabilize the economy, the most important factors influencing top line growth are the timeline of the virus and the length of the stay-at-home orders put in place to contain it.
Closed for Business
Industrial production, which measures factory, utility, and mining output, saw a sharp slowdown in March due to supply chain disruptions and weak demand. According to the Federal Reserve, industrial production fell 5.4% in March from a month earlier - its biggest monthly drop since the end of World War II. Manufacturing output, the largest component of industrial production, declined 6.3%.
The weakness in the manufacturing sector can also be seen in the erosion of manufacturing PMIs: the IHS Markit U.S. manufacturing PMI declined to 48.5 in March from 50.7 in February – the biggest drop since August 2009. Any reading below 50 indicates a contraction. Separately, the Institute for Supply Management’s (ISM) U.S. manufacturing index fell to 49.1 in March from 50.1 in February. Both reports show the continued toil from the impact of the coronavirus as the domestic economy saw a significant decline in new orders, production, and employment. These pullbacks, particularly in payrolls, suggest manufacturing is likely to remain weak in the coming months as factories won’t be able to immediately restore production to full capacity once strict stay-at-home policies are lifted.
Looking forward, the mining sector of industrial production, which includes oil and gas activity, is also expected to continue to weigh negatively on the economy as the sharp decline in demand more than offsets reduction in supply. With travel curtailed and people encouraged or required to stay-at-home, demand for oil has all but disappeared. At the same time, the market is overrun with supply. While OPEC, Saudi Arabia, and Russia agreed to slash production by nearly 10 million barrels a day from May to the end of June, the cuts are unlikely to be enough as oil stockpiles have risen dramatically. As a result, oil prices are likely to remain volatile.
The service sector has long kept the U.S. economy afloat, but no longer. Unfortunately, stay-at-home orders are perhaps having the biggest impact on the service sector as many non-essential businesses have been forced to close down. IHS Markit’s U.S. services index fell to a seasonally adjusted 39.8 in March, down from 49.4 in February – the steepest decline since the survey began a decade ago. It is important to note the data was collected before some state-lockdown orders were in place, suggesting we have further to fall. More importantly, as we begin to see stay-at-home orders lifted, activity is unlikely to pick up significantly until consumers are comfortable venturing out once again.
Fears surrounding the longevity of shutdowns coupled with the decline in business activity weakened business sentiment. In particular, the Conference Board’s CEO Confidence Index declined to one of its lowest levels since 2009 at 36 at the end of the first quarter from 43 in the fourth quarter of 2019. A follow-up survey from late March to early April showed the index declined further to 34. The readings suggest corporate profits, payrolls, and investment activity are likely to weaken further in the second quarter. In April, however, CEOs felt slightly less negative about the short- term outlook as stimulus measures were implemented.
Tightening the Purse Strings
As large swaths of the economy are frozen, consumer spending, which accounts for nearly two-thirds of GDP, responded in kind. While it is not surprising that Americans have cut back on travel spending and restaurant visits, they have also dramatically cut spending on other types of discretionary purchases as many workers have been furloughed and confidence in the economy has waned. According to the Commerce Department, retail sales, a measure of purchases at stores, restaurants, bars, and online retailers, registered a month to month decline of 8.7% (seasonally adjusted). Sales at clothing retailers plunged nearly 51%. Meanwhile spending on large purchases, like vehicles, furniture, and electronics fell more than 25%.
Some retailers, however, did post gains in March as Americans stockpiled food and did large amounts of purchases online. Grocery-store sales rose nearly 27%, while online retailers, like Amazon, rose a little over 3%. Consumer spending will most likely fall even further in April as businesses continue to shed jobs and stockpiling of goods cools. Americans, concerned about their finances, are more likely to save and continue to cut back on discretionary purchases until we begin to see some stabilization in the labor market, and thus confidence in the economy.
Data in the labor market perhaps sheds the most light on the magnitude of the current economic crisis. March nonfarm payrolls declined for the first time since September 2010 with the economy cutting 701,000 jobs. Meanwhile, the unemployment rate rose to 4.4% from 3.5% in February. An important indicator to watch in the coming months will be the level of temporary layoffs compared to permanent layoffs as many workers are expected to be rehired once social distancing guidelines are lifted. In March, almost half of the workers filing new unemployment claims indicated they were on a temporary layoff.
The March payroll report was just the start of the pain felt in the labor market as it was more of an indication of what was happening before many employers adjusted their payrolls to the current environment. Initial jobless claims, which measures the number of Americans seeking unemployment benefits and is reported on a weekly basis, captures a more realistic picture. By April 16th, the running 4-week total of initial jobless claims came in at approximately 22 million. The figure represents a near complete wipe out of the 24 million jobs created since the end of the Financial Crisis. This data suggests we may begin to see the unemployment rate jump to double digits in the second quarter of this year.
The government unleashed an unprecedented amount of fiscal and monetary stimulus to support the economy. In regards to fiscal policy, the federal government responded by committing roughly $2 trillion to the economy to soften the blow of the demand shock via the Coronavirus Aid, Relief, and Economic Security Act (CARES Act), which was signed into law on March 27th. The stimulus targeted small to mid-size business by guaranteeing loans while providing financial support to consumers via direct payments, expanded unemployment insurance, and tax relief provisions. Already, Congress and the White House are in motion to pass another stimulus package to provide additional support to the economy.
Meanwhile, the Federal Reserve adopted an aggressive “whatever it takes” approach to stimulate the economy and stabilize financial markets. In March, the central bank cut its benchmark rate to 0% at two unscheduled meetings and ramped up its bond purchases, also known as quantitative easing. In addition to its traditional tools, the Fed expanded its foreign exchange swap lines to provide dollar liquidity in foreign markets and unveiled a total of nine emergency lending programs spanning multiple markets. The lending programs are set to provide up to $2.3 trillion in loans to states, cities, and businesses of various sizes that have been impacted. Fed Chairman Jerome Powell indicated the central bank will maintain its crisis support for as long as necessary and would even expand the various programs if the need arises.
While economic growth was weak in the first quarter of this year, primarily in March, it is likely that we will see a further collapse in economic activity in the second quarter as lockdown measures continue. The stimulus measures should help mitigate the pain somewhat, but the timeline of the recovery is truly dictated by the virus’s progression. BBVA USA Research estimates GDP growth will decline by over 4% in the first quarter and then fall around 32% in the second quarter. If that is the case, it would be the largest drop since the Great Depression. We’re unlikely to see activity pick up until virus cases start receding in the U.S. and social distancing measures are lifted.
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