A Jobless Recovery?

Summary

• Even with more fiscal support, the mid-year economic bounce is likely to turn into a sluggish, jobless recovery.
• As a result, expectations of fast growth and inflation acceleration in 2021-22 will probably be disappointed.

Market Consequences

• Medium term; negative BE, commodities, gold, equities; flatter curve.

   

The Q1 Bounce Is Turning Into a Jobless Recovery

Employment bounced back strongly around mid-year but has slowed since then. This probably signals that the economy is headed for the kind of jobless recovery that has been typical since the 1990s. This is for the following reasons.

Reason #1 – Reallocating Workers Across Sectors Takes Time

Jobless recoveries have been typically attributed to structural changes in the economy that increase frictional unemployment because workers must be redeployed to expanding sectors. Reallocation this time around is unprecedentedly high, which makes sense as workers need to move to pandemic-proof sectors. Simultaneously, the pandemic has accelerated pre-existing trends such as the move away from brick-and-mortar retail, deglobalization, the increasing reliance on AI and robots, etc.

Reason #2 – Income Distribution has Become Even Less Consumption Friendly

A more important cause of jobless recovery in my view is the loss of workers’ market power – one of the hallmarks of the Great Moderation (Three Conditions for a Lasting Inflation Acceleration, 16 July 2020). As a result, workers’ share of domestic income has been steadily falling. Because the propensity to save is greater out of profits than out of wages, this makes for mediocre inflation and growth. The pandemic has further worsened income distribution. This is because the employment recovery in low-skill services involving face-to-face interaction, for instance retail or restaurants, has lagged the rest of the economy.

Reason # 3 – Balance Sheet Risks are Rising

Since the Great Moderation, low inflation and real rates have typically brought about excess leverage and balance-sheet-driven recessions. Addressing these imbalances requires bankruptcies and restructuring that take time and delay the employment recovery. Addressing these imbalances requires bankruptcies and restructuring. These take time and delay the employment recovery. A recent BIS study found that, for a given GDP contraction, job losses can be three times as high when bankruptcies are elevated than when they are not.

This time around, the US has so far avoided massive bankruptcies. September electronic bankruptcy filings are up, but the National Association of Credit Managers’ index for bankruptcy filings has improved (Chart 4). This reflects a combination of regulatory forbearance, the Fed backstop for corporate issuance, and transfers to households (Could a US Credit Crunch Bring About a debt Holiday?, 7 May 2020). Yet regulatory forbearance is expiring at end-December, and, as mentioned above, transfers to households have been cut. The recovery’s flatlining suggests corporate cash flows are not strengthening and balance sheet risks are rising.

Reason # 4 – The COVID-19 Policy Response Is Counter-Productive

By contrast with most European countries, the majority of US schools are closed or only partially open. Meanwhile childcare options remain limited in many states due to mandated business closures. School openings in European countries reflect the very low medical risks children face. School closures and lack of childcare options have lowered women’s participation in the labour force; this had been increasing prior to the pandemic. Hispanic women’s participation has been hit hardest.

Reason # 5 – Fear Will Be Difficult to Root Out

An incoherent narrative from elected officials and health authorities has left the media highlighting deaths and case numbers. This has resulted in fear levels disproportionate to the medical risks, which will be hard to correct. Eventually the media will catch up to science. Meanwhile, its impact on public perceptions of the pandemic will probably slow the recovery.

Reason # 6 – New Policy Support Will Take Time to Impact the Economy

Even if Congress could close a deal providing support to households before end-year, it may have little impact on the economy because the household savings rate remains elevated.

Against the backdrop of high a household savings rate, delivering effective economic support could require increasing public investments, i.e. spending on goods and services. This would, however, take much longer to implement than household transfers or tax cuts. In addition, increases in public spending on infrastructure tend to be more politically contentious than transfers or tax cuts. Alternatively, support could be delivered directly to employers through an extension of the Payroll Protection Program, though this type of support could slow the necessary reallocation of labour across sectors.

Market Implications

Even if, as investors expect, the Democrats manage a clean sweep of the White House and Senate and implement more fiscal easing, the impact on growth and inflation next year could disappoint. As result, inflation hedges such as BEs, commodities or even gold could weaken. In addition, equities could sell off and the curve flatten, especially at the long end.