We anticipate that gross domestic product in the Unites States will rebound at a 33.5% growth rate in the third quarter and 2.75% in the fourth quarter.
We anticipate that GDP will rebound at a 33.5% rate in the third quarter and 2.75% in the fourth quarter.
While this may seem optimistic, it masks the significant output gap that currently exists, and will exist, following the publication of the U.S. third-quarter GDP estimate on Oct. 29. That being said, compared to a year ago, the RSM Monthly Index of Economic Activity points to an economy that has not yet turned the corner and is not ready to accelerate toward an official recovery, much less expansion. We now estimate a 30% probability of a recession over the next 12 months.
The RSM monthly GDP index – which following the shock of the pandemic dropped below levels recorded during the Great Recession of 2008-09 — has rebounded but remains negative relative to last year.
Based on select variables used by the National Bureau of Economic Research to determine turning points in the business cycle, our index estimates that economic activity declined by 3.3% during the months of July through September relative to the previous year. Given the policy polarization in Washington, we do not discount the possibility of rough sledding in the final three months of the year and the first quarter of 2021.
That’s an improvement over the second quarter, when the index averaged an 8.2% year-over-year decline and actual real GDP suffered a 9% year-over-year decline. But we would argue that there are just too many uncertainties to declare a turning point. (Note that the NBER often takes several months to announce the start or end of a recession.)
Most important is the unrelenting spread of the coronavirus throughout the country. Whether or not this is the opening salvo of a second wave of infections, there appears to be a lot of time ahead before a vaccine is universally accepted and distributed.
Second is the extent of the damage to the world economy brought on by the pandemic and trade war, and the uncertainties over the rebuilding of trade and political alliances.
In the United States alone (and relative to activity in the same month in 2019):
- Industrial production growth has been in decline for 13 months in a row.
- Hours worked have been down for seven straight months.
- Payrolls have declined for six straight months.
- Manufacturing and trade sales growth has been negative for five straight months, with an estimated negative or flat sixth month.
- Inventory growth has been negative for seven straight months, with an estimated eighth month of decline.
- Real consumer spending has been in decline for six straight months, though it is estimated to be positive in September.
Finally, there are the uncertainties over the direction of government policy and the makeup of the legislature. The impact of politics on disposable personal income is the prime example.
Though real disposable income has been increasing for 13 months — as a consequence of extremely low unemployment at the end of 2019 and then government payments to low-income, unemployed families in 2020 – unemployment has skyrocketed and those payments have been allowed to expire. There is no guarantee of getting additional payments passed through a divided Congress or being signed into law by the next administration.
Analysis by the economists Bruce Meyer at the University of Chicago and James Sullivan of the University of Notre Dame found that poverty declined during the months when $600 a week additional unemployment benefits were available to low-income families. But those gains were erased after those payments were rescinded. (The authors also found that poverty was a function of the efficiency of unemployment insurance of each state.)
Our analysis has shown that because low-income households tend to spend everything they earn to keep food on their tables (higher marginal propensity to consume), the loss of those benefits and the subsequent multiplier effect on economic growth will be an unrecoverable drag on GDP growth. The figure below shows the divergence in real GDP growth and increased growth of disposable income in the opening months of the pandemic, which coincides with the enhanced unemployment benefits.
Clearly, the impact of those benefits on overall personal disposable income has subsided as the layoffs spread out from the hospitality sector. The benefits have expired, which is bound to hurt consumer spending as more families slip into poverty.
Regarding policy and relapsing into recession, there is precedence for recovery and relapse within downturns, most notably the 1933-37 expansion that ended the Great Depression.
That recovery ended in a relapse into another deep depression because of poor policy decisions – the adoption of both tight monetary and fiscal policies. More recently, there was the so-called double-dip recession of the early 1980s, which was the byproduct of energy shocks and the implementation of an extremely tight monetary policy to control the inflationary consequences of those shocks.
We should mention one more note on the depth of the second-quarter collapse and the strength of the third-quarter recovery. The running estimates of GDP growth by the Atlanta Federal Reserve (GDPNow) and the New York Federal Reserve (Nowcast) are calling for the third-quarter increases of 35.2% and 13.8%, respectively, which are the seasonally adjusted annualized rate of quarterly growth of approximately 7.8% and 3.3%. (That is, if quarterly GDP were to grow by 7.8% for four quarters in a row, annual GDP would be 35.2% higher than the previous year. Though that rarely happens, it is the convention commonly used to compare quarterly GDP growth.)
So when the third-quarter GDP number is announced and compared to the 31.4% second-quarter decline, it would not be fair or accurate to say that the recovery has wiped out all the losses of the previous quarter (or fallen short) based on those annualized rates.
Our monthly GDP index measures the yearly growth of activity in each month relative to the previous year, which at 3.3% lines up with analysts’ average forecasts for a 3.5% decline year-over-year in the second quarter and not the roughly 30% seasonally adjusted annualized quarter-over-quarter growth that will be touted as a complete recovery.
In the following sections, we take a closer look at the various components of the RSM model.
The labor sector
As we all know, the labor sector has undergone a horrific shock. In the 30 weeks since the economy was shut down, 64.5 million people have lost their jobs and filed for unemployment benefits. The headline unemployment rate is 7.9%, and 12.8% of the labor force is currently underemployed or marginally attached to the labor force.
The figure below shows the result of shutting down all non-essential industries and services. The dramatic drop in hours worked will have a short- and medium-term negative effect on consumer spending. Though there is clearly a partial recovery, hours worked remain 6% lower than last year at the same time. Without a concurrent increase in productivity, that implies a substantial decline in output and a drop in demand due to reductions in income.
The consumer sector
Real consumer spending rebounded from the 16% decline during the depths of the shutdown to a 3% decline in August. We are assuming a 2.4% increase in inflation-adjusted spending in September because of higher demand for cars and trucks and perhaps one-off back-to-school clothing purchases. (September’s actual real consumer spending data will be released on Oct. 30.)
The reluctance of consumers to relax social distancing practices as we enter the colder months will have an enduring impact on the way we shop and entertain ourselves, particularly as it pertains to indoor dining.
The commercial sector
Manufacturing sales peaked in October 2018, with the deceleration in sales coinciding with the U.S. trade war and the global manufacturing recession. Sales in the wholesale sector peaked in July 2018 and have decreased on trend since then. The combined manufacturing and trade (wholesale and retail) sales bottomed out in April at the depths of the shutdown and have recovered on the strength of the retail sector.
Interestingly, retail and wholesale trade inventories continue to shrink at a faster rate than manufacturing inventories. The decrease in inventory build-up reflects either a reliance on a faster supply chain or an unwillingness to bet on a sustained recovery.
The industrial sector
As the figure below shows, the business cycle closely follows trends in industrial production. We attribute this relationship to a virtuous cycle of industrial growth feeding into the labor market, feeding into wages and the growth of household spending.
Industrial production has been in decline since peaking in September 2018 and turning negative a year later. Industrial production this past March was down by 5% from the previous year, followed by double-digit declines from April to May. The losses continue, but at 7% in July through September, all relative to output in the same month of the previous year. The loss of output is a disconcerting predicament for the state of the economy and for the labor market.
The external sector
Note that our monthly GDP index excludes the impact the external sector can have on the national accounts. As shown in the first figure below, living in a global economy means that when demand drops (or rises) in the United States, it is most likely the case that demand in our trading partners will follow suit. So U.S. exports and imports will tend to have similar patterns of decline during economic downturns and increases during the subsequent recovery.
From time to time, however, there will be episodes when U.S. demand for foreign goods outstrips foreign demand for our exports. Though it results in a drop in net exports and is a drag on the national accounts, this is often a positive sign that the U.S. economy is growing faster than the rest of the world and will perhaps lead the global economy out of a recession.
In this episode, however, our trading partners are dealing with the implementation of U.S. tariffs and are looking to other markets. So it’s worth noting that while U.S. imports of foreign goods have recovered partially (to a year-over-year decline of 8.5%), exports of U.S. goods to our trading partners are 18% lower than the previous year.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
