The ongoing litany of bad economic news has started to abate, at least temporarily, and investors appear to be looking out 18-24 months to justify a stock market rally that has exceeded almost anyone’s expectations. There are “green shoots” starting to appear in various economic reports as a result of the extraordinary amount of fiscal and monetary support that was provided at the outset of the crisis. Whether these early signs of economic rebirth continue to grow or whither will depend on the successful reopening of the economy, the re-invigoration of the consumer, and the ongoing progress being made in controlling the virus. Let’s look at some of the data.
The report that took everyone by surprise was the May employment report, issued on June 5. After a decline of 20 million payroll jobs in April, expectations were for another 7 to 8 million jobs to be lost in May. Instead, the report indicated that nonfarm payrolls increased by 2.5 million. The unemployment rate fell to 13.3% from 14.7% in April. Employment gains were fairly widespread across all economic sectors. The improvement reflected the gradual reopening of the economy in many states.
Initial Jobless Claims have fallen from a record high of 6.8 million at the end of March to 1.9 million—still a historically high number. Continuing claims peaked in the second week of May and are down 3.5 million from the peak. This suggests that the worst is likely behind us and that the economy may have started the bottoming process. It is important to remember, however, how far the labor markets have fallen—payrolls are at levels last seen at the end of 2011. If history is any guide, it will take several years for the labor markets to get back to the levels of employment experienced as recently as February.
From the beginning of the crisis, government understood that consumer spending is 70% of GDP—thus support for individuals who lost their jobs has been a focus. Reflecting this, personal income rose 10.6% in April from March via government payments. Coupled with a record 13.6% decline in personal expenditures, the savings rate has soared to an all-time high of 33.0%. To be sure, this indicates that the consumer has funds to spend, but confidence remains low, and an extension of the $600-per-week coronavirus unemployment bonus due to end July 31 is not certain. Unless individuals are confident that they will be re-employed, they are likely to maintain conservative spending habits.
Anemic consumer spending slows overall GDP growth and restrains inflationary pressures. In the 11 recessions since 1948, inflation has always been lower 18 months after a recession’s end compared to where it was at the beginning of the recession. Assuming March marked the beginning of a new recession, the starting point for inflation was around 2%. If history is any guide, inflation will remain below 2% at least well into 2022. Consequently, it can also be assumed that long-term interest rates, which are strongly influenced by the inflation rate, will remain near historic lows for the foreseeable future.
The Fed’s big concern is that inflation rates turn negative resulting in deflation. Even during the expanding economy of the past 10 years, inflation was unable to stay consistently above the 2.0% target that the Fed set. If inflation remained subdued during a record-long economic expansion, what is it likely to do as a result of the swiftest contraction of the economy since the Great Depression? This suggests that monetary policy will remain accommodative for quite some time and calls for additional fiscal stimulus will likely be made.
Pace of Recovery
In short, the “green shoots” that have started to sprout are likely to need continued nurturing in order to fully develop. The pace of any economy recovery will be dependent on the consumer and his willingness to spend. Thoughtful monetary and fiscal policies will need to remain as credible backstops for the consumer to be confident enough to support the recovery. With the possibility of a second wave of the virus in the fall, effective therapeutics, or a vaccine remain critical to the restoration of confidence.