Economic Update QuarterlyLawry Knopp, VP-Funding & Hedging
Economic uncertainty abounds as world economies contend with the coronavirus outbreak. Other uncertainties weighing on the market include the upcoming U.S. presidential election, the recent change to the Federal Reserve Policy and potential follow-up legislation to the CARES Act.
Since late July, the number of new U.S. COVID-19 cases, hospitalizations and deaths have been trending lower. However, the rate of descent has slowed, with some people thinking the current trend has bottomed, and we may see an uptick in cases as schools and more businesses look to re-open. In the most recent data, new cases declined after two weeks of increased activity, but remain 40% below the late July peak. Hospitalizations are steady at a 3-month low, and the number of COVID-19-related deaths have improved to a two-month low.
Globally, the 7-day average of new cases is on an uptrend with India and Brazil being larger contributors. For the major European economies, the number of new cases has risen above 30,000 for the first time with elevated activity from Spain and France being reported. Increased restrictions have been imposed in France for at least two weeks. Nevertheless, hospitalizations and deaths are occurring at a fraction of the spring rate.
Markets remain sensitive to the prospect of a vaccine with the major U.S. equity indexes trending higher on positive news and vice versa when developments fall short of expectations. It’s anticipated a vaccine would allow more businesses to open and a relaxation of social distancing requirements. However, the upheaval in the retail sector from the outbreak has led to a record number of physical store closures and supply chain disruptions continue to cause sporadic inventory outages. Retailers with stronger online presence have fared much better as consumer willingness and acceptance to electronic ordering has benefited from the social distance and work-from-home trends.
Recent economic data has been a mixed bag. The jobless rate continues to decline, falling from 10.2% in July to 8.4% for August, which is a significant improvement from the peak of 14.7% unemployment reported for April. Following a combined loss of about 23 million jobs in March and April, nonfarm payrolls have increased by over 10.6 million for May through August. Declines in weekly initial claims for jobless benefits have fallen from a March 27 high of 6.9 million claims to the most recent report on Sept. 18 of 870,000 claims. However, the gains over the past few weeks have been much more modest, and continuing claims remain stubbornly high at 12.6 million. Look for the jobless rate to gradually decline over the next several months, with December’s projected unemployment rate near 7.8%.
The latest revision to Q2 gross domestic product confirmed the economy shrank by a stunning 31.7%, on an inflation-adjusted annualized basis. Consumer spending dropped 34%, while capital spending and residential investment fell by 26% and 38%, respectively. Nevertheless, most components of the economy ended the quarter a little less negative than was previously estimated. With the sharp drop in growth during the first half of the year, economic output fell from $19.25 trillion for Q4-2019 to $17.28 trillion by Q2. The economy is not expected to get back to the Q4-2019 level of activity until late 2021 or early 2022. Albeit, the good news is the weakness is largely behind us.
Looking ahead to the Q3 GDP report, which won’t be available until late October, analyst projections vary greatly as consumption, plus business and residential investment, are expected to accelerate sharply. The $600 per week in unemployment insurance benefits, which were in place until the end of July, provided a lift to consumer spending. Through executive order, President Trump provided $300 per week for an additional six weeks. The unemployment insurance benefits aided people most impacted by the COVID-19 shutdowns. So far, Congress has been unable to agree on additional support for unemployed workers, which means consumer spending may be weaker for Q4.
The Federal Reserve Bank of Atlanta is projecting a growth rate of 32.0% for Q3, while the New York Fed forecasts 14.3%. The actual results may be somewhere in the middle, likely closer to 25% GDP for Q3. Projections for Q4 indicate the economy should continue expanding, but at a slower pace of about 5%. Housing activity will likely be a larger source of strength for the second half of the year.
In August, core consumer price inflation rose modestly more than expected, as used car prices rose more than 5%, the second straight month of gains as demand for private transportation continued to increase during the pandemic. Airfare and apparel were also modestly higher. While auto prices may continue to push higher, most of the gains will likely prove transitory. Major core categories like medical care services and owner's equivalent rent were nearly flat and trending mixed to lower. Overall, while there are pockets of inflation that are still related to shifting demand during the pandemic, the trend remains muted, averaging a bit below 2% on a core basis.
Following the Sept.15-16 Federal Open Market Committee meeting, the press release indicated the Committee decided to hold policy rates steady with the federal funds target range at 0.0-0.25%, as the COVID-19 pandemic “poses considerable risk to the economic outlook over the medium term.” While stable prices and maximum sustainable employment remains the Fed’s dual policy mandate, policymakers updated the Fed’s guidance under a new “flexible average inflation targeting” (FAIT) regime. As inflation has been persistently below the Fed’s target of 2%, the Committee “will aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time,” and inflation expectations are well anchored at 2%.
In the post-meeting press conference, Federal Reserve chair, Jerome Powell noted that the economy has been "resilient to the lapsing of the CARES Act unemployment benefit," but the risks were to the downside, as some of the fiscal stimulus funds were saved and would now need to be spent. He also said, "My sense is that more fiscal support is likely needed." Quantitative easing purchases will be maintained at $80 billion per month along with the reinvestment of maturing principal payments from existing holdings. The next FOMC meeting is scheduled for Nov. 4-5, the days immediately following the presidential election.
The results of the elections will take time to impact the economy as significant policy initiatives, and structures will need to be approved by Congress. However, speculation in the market could generate elevated volatility.
View on Interest Rates
Look for the Fed to keep policy rates at the current level for the next 2-3 years, provided inflation remains within the Fed’s new strategic framework. Their efforts will continue to focus on providing support to the financial markets through purchases of both public and private debt and loan guarantees. Due to the Fed’s level of quantitative easing, longer term rates are expected to remain extremely low.
The 2-year yield will likely remain below 0.40% into 2021, while the 10-year yield trading range is 0.50%-1%. Look for the Bureau of Economic Analysis to report Q3 GDP growth around 25%, followed by a much slower growth rate for Q4. If we see a sustained increase in COVID-19 cases as winter approaches and/or the outlook for recovery begins to falter, credit, lending and equity markets could experience another round of extreme volatility as the economic narrative turns toward discussion of a double-dip recession.
The above commentary is a summary of select economic conditions prepared for Northwest FCS management. It is being shared as a courtesy. As with any economic analysis, it is based upon assumptions, personal views and experiences of those who provided the source material as well as those who prepared this summary. These assumptions, conclusions and opinions may prove to be incomplete or incorrect. Economic conditions may also change at any time based on unforeseeable events. Northwest FCS assumes no liability for the accuracy or completeness of the summary or of any of the source material upon which it is based. Northwest FCS does not undertake any obligation to update or correct any statement it makes in the above summary. Any person reading this summary is responsible to do appropriate due diligence without reliance on Northwest FCS. No commitment to lend or provide any financial service, express or implied, is made by posting this information.
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