US forecasts—my own included—have shifted to project a 30%+, saar, slump in Q2
Such an extreme decline implies an awful April (look out of the window)
An H2 rebound remains my central view, helped by better medical conditions and policy
The resulting level of public debt (explicit and implicit) will be a drag for years
This week, I updated my US economic forecast for 2020 and 2021. I have been forecasting the US economy for about 35 years and have never projected such a dramatic view of the next few quarters ahead.
I expect real GDP to have been down 7%q/q, saar, in the quarter just ended; to fall a further 32%q/q, saar, in Q2; to rebound 32%q/q, saar in Q3; and then falter 3.5%q/q, saar in Q4, to end the year down 5.1% (20Q4/19Q4). This volatility would be unprecedented in post-war history (Chart 1).
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- US forecasts—my own included—have shifted to project a 30%+, saar, slump in Q2
- Such an extreme decline implies an awful April (look out of the window)
- An H2 rebound remains my central view, helped by better medical conditions and policy
- The resulting level of public debt (explicit and implicit) will be a drag for years
This week, I updated my US economic forecast for 2020 and 2021. I have been forecasting the US economy for about 35 years and have never projected such a dramatic view of the next few quarters ahead.
I expect real GDP to have been down 7%q/q, saar, in the quarter just ended; to fall a further 32%q/q, saar, in Q2; to rebound 32%q/q, saar in Q3; and then falter 3.5%q/q, saar in Q4, to end the year down 5.1% (20Q4/19Q4). This volatility would be unprecedented in post-war history (Chart 1).
Such volatility is not so out of place when viewed through the prism of the interwar years (Chart 2; the interwar data would be even more extreme if they included the 1918-22 period). But the difference is that from 1923 to 1939, volatility resulted from an economy dominated by the more typically cyclical goods sector and the absence of a public policy geared to stabilization.
Forecasting in the Fog of COVID-19
The peculiarity of COVID-19 makes any forecast hazardous. A month ago, my forecasts for GDP growth were 1.2%q/q, saar, and flat q/q for Q1 and Q2, respectively. That changed when significant parts of the US economy shut themselves down in the second half of March. The result was the most dramatic rise in first-time jobless claims recorded in the post-war period (Chart 3).
I am certainly not alone in dramatically revising my view in recent weeks. Bloomberg summarizes the views of respected forecasters (not me), and I have calculated a rolling average of the latest five forecasts (Chart 4). These have converged on estimated declines of 4%q/q, saar, and 27%q/q, saar, for Q1 and Q2, respectively. This contrasts the current GDPNow (nowcasting) Q1 projection from the Atlanta Fed of 1%q/q, saar, which uses current traditionally cyclical information and remains ignorant of the virus (although it would have woken up by now if its inputs included weekly jobless claims).
In the US, official GDP data come from a demand-side (expenditure) calculation. There is a separate income-based measure (which adds up wages, profits, rents etc.). In 2016-19, the real growth rate of GNI was 1.9% per year, versus 2.4% for GDP (Chart 5). The expenditure measure is also mapped to an output-based measure (which gives the same growth rate), and it is this measure that has come into its own in recent weeks.
It is conceptually much easier to think about a supply- than demand-side shock when forecasting COVID-19 effects. Timely information received (jobless claims and other labour market data) relates more to the former than latter, so calibrating early estimates is easier from a supply-side perspective (although that raises a mapping risk to demand; another near-term data risk is that report quality may deteriorate and show bias to the healthier sectors and areas that can report).
I have consequently constructed my 2020 view by imposing an assessed output shock by sector, starting in March (Chart 6). I estimate that national GDP fell about 7%m/m, sa, in March, led by a 71⁄2%m/m, sa decline in services output and a 31⁄2%m/m, sa decline in goods output (all changes in this paragraph are not annualized). These losses will increase in April (broader shutdown, covering a wider range of states), with service output down 11%m/m, sa and goods output down 6%m/m, sa. My monthly GDP measure would then be down 91⁄4%m/m, sa. I would expect states to begin to relax restrictions in early May as infection rates fall. The first signs of a hesitant recovery would then be evident and monthly GDP could actually rise by about 41⁄4%, sa, in May followed by a monthly gain of close to 5%m/m, sa, in June. Averaging these data across quarters gives the GDP estimates noted earlier. The timing of any rebound is tentative, conditional on the diffusion of the virus.
But Will it Blend?
As noted, US GDP data are actually calculated using expenditure-side data. It is therefore important to map from these output-based estimates to their expenditure-based counterparts as a cross-check.
Consumer spending accounted for 68% of GDP (as of 2019Q4). Consumption of services accounted for about 47% of GDP. Within these totals are important components that will have been resilient. Rental of owner-occupied housing accounted for 7.9% of GDP. This is imputed and will not have changed through the consumption slump. Food and drink purchased for consumption at home accounted for about 4.8% of GDP and utilities consumption for about 1.6% of GDP.
In my H1 growth estimates, I expect real consumption to decline by about 7%q/q, saar, in Q1 and by about 32%q/q, saar, in Q2 (capital spending will be a drag in Q2, but this cycle will be all about consumption). Assuming that about one-quarter of consumption is stable-to-up in both quarters, this implies that “discretionary” spending on goods and services will be down about 9%q/q, saar in Q1 and by 39%q/q, saar, in Q2.
January-February real consumption levels have already been reported. It would take a 61⁄4%m/m, sa, decline in March real consumption to generate a 7%q/q, saar, decline in Q1 (assuming no revisions). March auto sales fell 32%m/m, sa. An April consumption decline of 9%m/m, sa, followed by gains of 4%m/m, sa, in May and 41⁄2%, sa, in June would leave Q2 consumption down 32%q/q, saar.
On the income side of the economy, nominal GDP in 20Q2 is likely to be about $19.4 trillion, saar, down from about $21.7 trillion in 19Q4. This $2.3 trillion (saar) income decline will be felt across income categories. As is always the case, however, corporate profits and SME operating surpluses (a combined $3.3 trillion, saar, in 19Q4) will need to absorb much of this decline.
Assessing the H2 Recovery
There are two ingredients to my projected H2 recovery and two important constraints.
The most important ingredient is a slowing in the diffusion of infection. This would indicate that social distancing restrictions are working and could possibly begin to be relaxed. My assumption is that the easing in the pace of infection growth slows by enough into the later part of April that easing moves begin early in May (Chart 7). The combination of the chaotic Federal response and the ability of states to set their own agenda on what to open when (or keep open) raises the risk of persistent flare ups in infection. My H2 rebound view might then be too sanguine.
The second key ingredient to an H2 recovery is support from monetary and fiscal stimulus, which has become vast and so blurred that it is hard to distinguish between the two. In my view, both fiscal and monetary policies were too loose heading into the crisis. This has compounded the degree of difficulty of the problem to solve, in part because so many agents (especially corporate borrowers) were being encouraged to operate on a risky edge leaving no margin for error. The Federal budget deficit will rise to about 15% of GDP in FY2020, and the Fed’s balance sheet is likely to balloon above $10 trillion (50% of a diminished GDP). High deficits seem likely to persist in the next few years. The Federal debt/GDP ratio is likely to rise above the 1946 peak of 120% of GDP well within the next presidential term (Chart 8).
The main case against a rebound is that the dislocation of the current period and next few weeks will do persistent damage to the supply-side of the economy, resulting in mass unemployment and corporate insolvency (especially among SMEs). Based on claims data, the unemployment rate may already be about 12.2% (the highest since late 1940, Chart 9). I expect the rate to rise to 20% by the end of Q2. This labour market shake-out will be far more severe than implied by a typical Okun coefficient model. I’m also conjecturing that it will be short-lived, with the unemployment rate falling to (a still stunning) 10% by the end the year.
Corporate solvency will be a major concern. This can be mitigated by Small Business Administration and Fed lending. Significant parts of the retail, travel and leisure sectors were already under pressure pre-crisis. Likely changes in consumer behaviour post-crisis could make it very difficult for many of these firms to survive into the next recovery. Resources sectors (and their lenders) will also be under significant pressure. It seems inevitable that US oil production will fall back sharply in coming months. Oil-related capital spending has been weak for a while, so the persistence of strong oil output gains has looked increasingly tenuous (Chart 10).
Medium-term Tensions Already in View
Two medium-term tensions are worth highlighting. First, another sustained shift in risk from private to public balance sheets is underway—the second huge shift in just over a decade. The financial and political costs of managing this will be substantial and persist for far longer than the virulence of COVID-19. The decade since the financial crisis has been one of financial repression, and these forces are likely to intensify. The last time US public debt was this high (in the 1940s), the Treasury and Fed worked together the peg yields low. Group-think of policy economists will view this (yield curve control) as a good thing.
The second medium-term tension is that wartime debt ratios such as we are approaching have historically been whittled down by unanticipated inflation. The condition under which an inflation tax works well is one where, as now, bond market inflation expectations are very low (Chart 11).
Phil Suttle is the founder and principal of Suttle Economics.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)