The American economy is simultaneously absorbing three distinct shocks, each of which will act as a large drag on economic growth during the current and second quarters of the year. The impact of the coronavirus will cause a disruption to American society that will last well beyond the current crisis and will affect growth over the next three to four years.
The need to slow down the economy to eradicate the virus may play a much larger role in the policy response in the coming days, and that may make our otherwise prudent forecast look somewhat optimistic. Here are some key things to watch as this situation continues to unfold:
- Three shocks: Supply, demand and financial
- Collapsing consumer spending
- Oil price collapse a net negative for economy
- Policy stimulus: 2% of GDP, with more to come
The impact of the coronavirus will cause a disruption to American society that will last well beyond the current crisis.
Given the five standard deviation shock to the economy, which will exact a powerful toll on overall household spending, we now anticipate that growth in the first quarter of the year will decline by 2.1%, followed by a 5.9% contraction in the second quarter of the year. Then we expect a modest rebound, fueled by a robust policy stimulus in the second half of the year with growth in the third quarter of 1.5% and 2.9% in the final three months of the year.
The key to the rebound will be the mix of policies put forward by the monetary and fiscal authorities. We now expect the fiscal response to be in excess of $1 trillion, depending on how severe the outbreak becomes.
While we are encouraged that a consensus is emerging inside Washington, D.C., that a stimulus should be front-loaded with direct cash transfers to American households, it will most likely not be sufficient, nor timed well enough, to prevent a large increase in bankruptcies, unemployment and underemployment.
We do not expect a V-shaped recovery. Rather, we expect that the recovery will vary by industry. Private equity will most likely experience a V-shaped recovery, while retail and the broader service sector will not.
Our baseline expectation is that the recovery will look like the Nike swoosh. A sharp decline followed by an elongated and somewhat frustrating recovery will be uneven across income groups and industrial ecosystems.
The evolving shutdown of the economy guarantees that the economy will contract over the first half of the year, with the risk of a greater drag into the third quarter. Based on our estimates, portions of the service economy that comprise just under $1.5 trillion and employ more than 12% of all workers will suffer a significant shock that will bring economic output in that cohort close to zero for the better part of the month. The immediate risks to the economy revolve around travel, tourism, and eating and drinking establishments.
For example, according to the Bureau of Economic Analysis, the shutdown of the travel and tourism industry, which comprise roughly 5.3% of gross domestic product, places significant risk around our forecast to the downside. The numbers are sobering: According to the American Hotel and Lodging Association, 45% of all hotel jobs will be eliminated.
According to the American Hotel and Lodging Association, 45% of all hotel jobs will be eliminated.
At the same time, the food service industry accounts for 4% of gross domestic product and employs 12.2 million people, or 8.1% of the total workforce. Given the virtual shutdown of those sectors, the numbers will be staggering and fiscal policy will need to be targeted at both large firms and small and medium-sized enterprises that populate those industrial ecosystems.
One of the reasons why we expect an elongated and frustrating recovery is that shocks to these ecosystems tend to cause long-lasting damage to balance sheets that will take time to repair amid demand destruction that may never return.
Energy and capital expenditures
The 56% decline in oil prices since early January will provide a solid cushion for consumers who will pay less for gasoline and home heating oil. Traditionally, such drops have supported greater overall household spending.
Given the unique circumstances and the structural changes in the economy over the past decade toward oil production, mineral and energy extraction has changed the equation on how falling oil prices influence the domestic economy.
The size and magnitude of the decline imply that fixed business investment and capital expenditures will most likely exert a powerful downward drag on growth this year on the back of a sharp decline in demand for energy, especially retail gasoline sales. This will most likely combine to offset the modest tailwind to consumer spending because of the decline in retail gasoline prices.
We anticipate that the initial fiscal stimulus will be in excess of $1 trillion. The response appears to be coalescing around the idea of sending $1,000 checks to individual Americans to offset the slowdown. That would imply something in excess of $500 billion. Forward-looking firm managers and investors should expect something along $250 billion in emergency loans for small businesses inside the $850 billion fiscal package.
This may also include a temporary payroll tax holiday and bailouts for the airlines and other industries. In addition, we would not be surprised to see a provision attached to the bill for a national minimum wage that eventually reaches $15 per hour. Add it all up and the final total will most likely be larger than $1 trillion when finally passed.
So far, the monetary authority has provided the primary policy response. This includes the decision to reduce the policy rate to effectively zero and inject $2 trillion of liquidity into the front end of the market. But there is also a $10 billion backstop behind the Commercial Paper Funding Facility and the Primary Dealer Credit Facility, both put in place to support lending to households and firms.
The policy objective of both lending facilities is to support a wide range of economic activity, supplying credit and financing for auto loans and mortgages as well as liquidity to meet the operational needs of a wide range of companies. More important, the goal is to prevent a larger catastrophe that includes soaring bankruptcies, unemployment and underemployment.
We expect that the Fed will consider a far wider range of lending and liquidity facilities before the American economy reaches its nadir. Stay tuned.