Most economic analysis around the impact of the coronavirus has centered on supply shocks, but little has been said about demand destruction. We are now beginning to observe some demand destruction around the public health crisis, and we expect that this will be the major narrative once data begins to arrive in coming weeks.
Consumer spending has kept the economy afloat, but that is now in question.
Policymakers are quickly shifting to begin considering fiscal and monetary action to combat what we expect to be a sharp, albeit temporary, downturn in global and domestic growth. This is one of the primary reasons why the Federal Reserve cut its policy rate by 50 basis points in an intermeeting intervention into capital markets. We expect an additional 50 basis points of cuts by the end of the year and do not rule out a return to the zero boundary in the case of an exigent and unusual circumstance that the Covid-19 virus outbreak becomes widespread.
Finance ministers and central bankers of the G-7 indicated that they are considering all policy tools to address the crisis and stand ready to cooperate on further and timely measures. This may include coordinated monetary and fiscal action to offset the economic toll of the virus.
In addition, we now anticipate that the federal government will at a minimum inject $7.5 billion of fiscal stimulus in the near term and will most likely move to target firms and individuals at risk should there be a larger outbreak that results in lost economic activity. The scientific community has said that it needs $15 billion to properly address the public health emergency. It would not be surprising to see that amount targeted by Congress and the executive branch in the near term.
Consumer spending has kept the economy afloat, but took a sharp turn downward in January. We anticipate that, following a brief uptick in spending as households stockpile basics, household spending will slow noticeably in March and into the second quarter of 2020.
The recent financial shock will most likely cause upper-income households to pull back on spending. Roughly 40 % of households are responsible for 61.4% of overall spending. Because the upper two income quintiles are sensitive to volatility in asset markets, forward-looking policymakers, investors and firm managers should anticipate a temporary downturn in consumer demand. This will be most notable in large capital purchases such as auto and home purchases, as well as in services. Travel, tourism and transportation in particular are at a greater risk of experiencing severe downturns in demand.
Moody’s Analytics recently estimated that global demand for autos will decline 2.5% instead of 0.9% because of the Covid-19 virus. The revised estimate of global auto purchases indicated that the outbreak will reduce demand and disrupt supplies of parts and raw materials for the auto industry.
A decline in consumer demand will show up in large capital purchases such as homes and autos.
“If the rate of infection does not abate and the death toll continues to rise, there is the potential for more severe disruptions in manufacturing supply chains, including in the automotive sector,” Moody’s said in its report.
In the U.S., where 30% of all components used to build homes come from China, we expect a significant slowdown in construction over the next several months. The RSM Monthly Economic Activity Index is now suggesting underlying GDP growth of less than 1.5% in December and January (1.43% in December and 1.44% in January); that is one of the major catalysts for our downward revision of growth in the first quarter of this year to 1%, the second quarter to 0.7% and 1.2% overall for 2020.
The last time the U.S. experienced such a financial shock was during the last 90 days of 2018. During that period, retail spending contracted sharply during the following 60 days and overall household spending growth declined from 3.5% to an average of 1.2% during the next six months. While the downturn will be transitory, in selected sectors of the economy and the business community it will be large and the impact will be felt in coming days and weeks.
The downdraft in global asset markets and the resetting of the yield curve lower over the past month have generated concern about demand destruction in the global economy. Demand destruction is either a permanent or temporary move down the demand curve toward reduced levels of purchases. Such declines in consumption are typically connected to movements in commodity or oil prices, where higher prices can result in permanent declines in demand.
The global oil benchmark Brent crude is down 19.6% since the beginning of the year and West Texas intermediate has dropped 21.1% over that same period. This is the major reason why investors anticipate a significant cut in production by OPEC in coming months to put a floor under the global price of oil.
Because the Covid-19 virus is the “outlier of outliers,” firm managers, investors and policymakers need to begin making baseline estimations in temporary demand destruction that is occurring because of the breakout in 71 countries and a possible major outbreak in the United States.