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COVID-19 has brought a complete turnabout in U.S. risk sentiment. Markets cannot be calmed: safe-haven assets like U.S. Treasuries have fallen to record-low yields while equity market volatility has been substantial. The U.S. Federal Reserve executed a large, out-of-cycle interest rate cut, its first such action since October 2008.
While this has been the most challenging interval for the U.S. economy since the last recession, analogies to the global financial crisis are inappropriate. That was an era defined by bank failures, nationalization of the auto industry and consumers losing their homes. Outcomes thus far are nowhere near that severe, and are unlikely to be.
Current dour sentiments are driven by uncertainty. As long as new infections continue to be reported, fear will persist. Other countries’ experiences suggest news in the U.S. will get worse before it gets better. However, we are encouraged by the high worldwide survival rates of COVID-19 and by China’s return to production after its serious slowdown. Recession is not our base case, and we expect a return to trend growth in the second half of the year. But the situation is fluid, and downside risks are certainly present.
Key Economic Indicators
Influences on the Forecast
- The Fed’s surprise rate cut of 50 basis points was a strong signal. While monetary policy is not a vaccine, easier financial conditions may help prevent layoffs and defaults as the economy endures turbulence.
- With uncertainty growing and risk sentiment declining, the Fed will likely cut by another 50 basis points at its March 18 meeting. Monetary policy consensus has evolved toward acting before a crisis is at its peak, and the Fed is unlikely to wait for developments to become worse.
- On the fiscal front, bipartisan authorization of $8.3 billion to support vaccine development and other response measures is a good start, but measures of a much larger scale are needed. We expect more government interventions in the weeks ahead, but the specifics are unclear. The most straightforward policies to implement, like a payroll tax reduction, would not help the unemployed or workers who are losing hours. More comprehensive social support, like paid sick leave, is complex and politically tenuous.
- Resilient consumers have buoyed the economy during the past year’s uncertainty, but we are skeptical that spirits will stay elevated. Workers in the travel and hospitality sectors are facing layoffs and lost shifts; the substantial losses in equity markets will leave investors feeling a negative wealth effect. Though the virus may be transitory, lost wages are not.
- Credit markets have grown more cautious day-by-day, with demand for U.S. Treasuries pushing down yields at all tenors. Spreads on all asset classes are widening. BBB-rated companies, whose issuances have been attractive to yield-seeking investors, present the greatest credit risks in the event they experience defaults or downgrades. Defaults or bankruptcies caused by more expensive debt would be a lasting scar from the outbreak.
- Recent economic data releases were encouraging, but all came with the caveat that their time periods do not reflect the COVID-19 downturn. Employment had another outstanding month in February, with 273,000 jobs added and the unemployment rate holding at 3.5%. We’ll be watching upcoming readings on unemployment claims to see if there are cracks in the American job market.
- The Institute for Supply Management’s composite purchasing managers index (PMI) grew from 55.0 to 56.5, buoyed by strong growth in services and a return to expansion in manufacturing. Lower readings across all measures are certain in the months ahead, but if a slowdown is inevitable, it is best to start from a position of strength.
- Our other worries entering the year, including the fragility of the U.S.-China Phase One trade truce and the Boeing 737 MAX stoppage, have not abated. China will likely fall short of its purchase commitments this year, but the White House would have little to gain from raising tariffs in a stumbling economy. The MAX will eventually return to production, but it will be greeted by slower demand, as the travel sector has been immediately impaired by the virus.
- It is said that economists have predicted nine out of the last two recessions. Anticipating a downturn is not easy, but recent surveys place the odds of one occurring in the next twelve months at 35%-40%.
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