September 2020 Economic Commentary: Incremental Improvement in August

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The gradual re-opening of businesses across the country enabled the economy to register incremental improvement during August; however the pace of improvement appears to be slowing from earlier in the summer while the economic hole caused by the pandemic remains substantial. Uncertainty about the path of the virus, the inability of government leaders to agree on continued fiscal stimulus, and election rhetoric are contributing to ongoing cautiousness being exhibited by households and businesses. While these concerns have been attracting most headlines, an important policy change was made by the Federal Reserve toward the end of the month. A discussion of these points follows.

The August employment report was better than anticipated with nonfarm payrolls increasing by 1.37 million and the unemployment rate dropping to 8.4%. Half of the jobs lost in March and April have now been regained. The expiration of the $600/week unemployment bonus at the end of July apparently caused many people to re-enter the labor force. The August gain in payrolls, while significant, was the smallest gain since April and is evidence of the slowing momentum in the labor market. Future gains in the labor market are expected to be harder to achieve as many furloughed workers are being permanently laid off due to soft economic conditions.

As stated many times before, with the consumer accounting for 70% of GDP, high unemployment and low labor participation have a negative impact on overall income growth, and consequently overall GDP. The most recent report on consumer spending confirms slowing in this important metric.

The second revision to second-quarter GDP was released in late August and included a report on corporate profits, which were down 20% compared to the second quarter of 2019. Lower corporate profits are causing businesses to maintain cautious spending policies on labor and capital expenditures.

On August 27, Fed Chairman Powell, while recommitting to keep interest rates low for the foreseeable future, announced a change to the Fed’s policy on price stability as measured by the inflation rate. Instead of targeting a 2% inflation rate - a level that has only rarely been achieved over the past eight years – the Fed will seek “to achieve inflation that averages 2% over time. . . following periods when inflation has been running persistently below 2%, appropriate monetary policy will likely aim to achieve inflation moderately above 2% for some time.” The Fed is effectively signaling that they will not raise rates at the first sign of higher inflation but will allow the economy to run hotter for longer even if inflation accelerates over 2%. Additionally, they will not hike interest rates just because unemployment is low as a pre-emptive move to head off potential inflation.

Higher inflation will result in higher long-term interest rates, which would likely slow economic activity and seem to be exactly the opposite of what the Fed wants to achieve by allowing the economy to run hot. This policy change, and its ramifications, then, bears watching.

In summary, despite the economic progress that has been made since April, the overall loss in economic activity since February remains substantial. Further progress will be dependent on the consumer’s ability and willingness to spend, which is directly correlated to the successful containment of the virus. Until effective therapeutics or a vaccine are developed, additional government programs to assist businesses and individuals are likely needed to avoid the economy stalling during the upcoming winter months.