We are revising down our 2020 growth forecast because of supply, demand, and financial shocks rippling through the global and U.S. economies amid the spread of coronavirus.
While we do not foresee a recession at this time because of expected fiscal and monetary stimulus measures, we believe economic growth will slow noticeably in the coming weeks and months. Should the shocks turn out to be larger than we anticipate, we will move to quickly revise down our forecast.
Our RSM Monthly GDP model implied growth slowed to 1.4% through the end of February. We now estimate that growth in the first quarter will slow to 1% and to 0.7% in the second quarter of the year, both with significant downside risks.
The second part of 2020 will likely fare a bit better. We expect growth to rebound in the second half of the year with a 1.2% pace of growth in the third quarter and 1.9% in the final three months of the year.
Policy response
In our estimation, a rate cut by the Federal Reserve is imminent, though one question is whether that cut will be by 25 basis points or 50 basis points. At the time of this writing, the market was pricing in an aggressive 50-basis-point cut on or before the Fed’s meeting on March 17 and 18. The market is now pricing in a full 100 basis points through the end of the year.
Expect growth to slow noticeably in the coming weeks and months.
Given the decline in financial conditions across the international economy ahead of what is now widely expected to be a global recession, we do think that a coordinated policy move by the major global central banks is imminent.
With respect to the U.S., there will likely be special supplemental funding passed by Congress this week to provide at least $8.5 billion to address the public health crisis. Given that the scientific community has said it needs $15 billion to adequately address the crisis, this will most likely be a down payment and the first in a series of fiscal responses to the risk around the coronavirus and the economy.
In the event that the virus further spreads and there are quarantines in major U.S. metropolitan areas (31 U.S. counties are responsible for 32% of U.S. gross domestic product), the federal government will need to provide relief to the small and medium-sized enterprises that comprise the real economy.
The market is pricing in a full 100 basis point rate cut through the end of the year.
One would expect that the Federal Reserve would order regulatory forbearance — something the agency traditionally does following natural disasters — so that small and medium businesses that experience a disruption in revenues do not go bankrupt.
If the crisis is significant enough, we expect the fiscal and monetary authorities will construct a temporary lending facility, much like what was built during the financial crisis, to ensure firms can make payroll and remain in business. It is essential that the authorities provide the necessary funding to prevent a much larger disruption to the domestic economy.
What to watch
Data indicating damage such as job losses at major U.S. ports represents just one aspect of the coronavirus supply shock that is now affecting the national economy.
Trade, transportation, and tourism are experiencing disruptions in revenues. Over the next two to four weeks, we expect there will be reports of supply shortages across the industrial landscape, especially in the autos, aerospace, and housing sectors.
Residential construction will likely soon be a focus, for example, because the U.S. imports roughly 30% of the components used to build homes from China. That will feed through to the real economy in the second quarter of the year, resulting in a slower pace of residential investment. In the energy sector, there is considerable evidence of demand destruction in the oil market, where the price of West Texas Intermediate has declined by 25.7% since the beginning of the year.
After a brief increase in consumption linked to people buying supplies in case of a larger crisis, household spending will also slow. We expect the financial shock the economy is experiencing will directly translate to reduced spending by the upper two quintiles of income earners (40% of households) that are responsible for 61.4% of all spending and are quite sensitive to volatility in asset markets. As a result, demand for services will also slow.
The last time we experienced such a financial shock, during the last 90 days of 2018, retail spending contracted sharply in the following 60 days. Overall household spending declined from 3.5% to an average of 1.2% over the next six months.
Yes, the fallout from the coronavirus spread will be transitory, but in some portions of the economy it will be significant and the impact will be felt in coming days and weeks.
