COVID | Economics & Growth | Monetary Policy & Inflation | US
Market concerns over a new COVID-19 relief bill could be overdone. This is because the household savings rate is extraordinarily high, and a limited normalization could keep the recovery going without additional budget relief until January 2021. Of course, the recovery would weaker than if more relief was provided to households and businesses, but it might just muddle though.
Does the US Economy Need More Stimulus?
Until mid-summer, the recovery had been on a V-shaped trajectory. But since then, the August NFP have shown increasing signs of slowing consumption and labour market momentum (see August NFP Show Economy at a Crossroad, 7 September 2020). Retail sales have been weaker than expected, initial unemployment claims have stopped falling, and the NY Fed Weekly Economic Index is flatlining.
This is likely to reflect, in part, the end of the $600 weekly supplemental unemployment benefit at end-July. Based on the Monthly Treasury Statement, this could have resulted in a $55bn, about 15%, MoM decline in August unemployment payments. A further relief bill appears unlikely to be voted on before the 3 November elections and therefore may not be agreed until a new Congress convenes in January 2021.
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Market concerns over a new COVID-19 relief bill could be overdone. This is because the household savings rate is extraordinarily high, and a limited normalization could keep the recovery going without additional budget relief until January 2021. Of course, the recovery would weaker than if more relief was provided to households and businesses, but it might just muddle though.
Does the US Economy Need More Stimulus?
Until mid-summer, the recovery had been on a V-shaped trajectory. But since then, the August NFP have shown increasing signs of slowing consumption and labour market momentum (see August NFP Show Economy at a Crossroad, 7 September 2020). Retail sales have been weaker than expected, initial unemployment claims have stopped falling, and the NY Fed Weekly Economic Index is flatlining.
This is likely to reflect, in part, the end of the $600 weekly supplemental unemployment benefit at end-July. Based on the Monthly Treasury Statement, this could have resulted in a $55bn, about 15%, MoM decline in August unemployment payments. A further relief bill appears unlikely to be voted on before the 3 November elections and therefore may not be agreed until a new Congress convenes in January 2021.
Yet by historical standards, policy easing this time around has been exceptional. For instance, during March-June the Fed expanded its balance sheet by as much as it did during Q3 2008-Q2 2013! Relative to GDP, the FY2020 budget deficit is on course to be the largest since WWII. Its increase since April dwarfs the FY2008-10 increase.
In addition, since the policy easing was decided, market participants have reduced their estimates of the economic impact of the pandemic. Fed easing was based on a June forecast of a 6.5% 2020 GDP contraction that was reduced to a 3.7% contraction in September. The CBO and the professional forecasters that the Philly Fed surveyed have been playing catch up with actual unemployment. Both revised down their end-2020 forecasts in Q3, but their latest forecasts are still 1.5-2ppt above actual August unemployment at 8.4%.
While Chair Powell and other FOMC members have argued for further budget support, the St Louis Reserve Bank president, James Bullard, and some members of Congress have argued that the recovery has enough momentum as it is. In my view, the trajectory of the US economy without additional support depends largely on the household savings rate.
Limited Normalization of the Savings Rate Could Offset the Benefits Cut
Despite a sharp decline in employee compensation, household disposable income is higher than before the pandemic due to unprecedented government support. However, an equally unprecedented increase in the savings rate has offset the positive impact of higher income on consumption. This peaked at 34% of disposable income in May, against 7-8% before the pandemic, but has since normalized to 18% in August.
This increase in the savings rate is exceptional, especially as household balance sheets are, on average, in good shape. In Q2 2020, households actually reduced their liabilities. By contrast, during the GFC the household savings rate rose but only very gradually, from 4% in 2007 to a 9% peak in 2012 as households had to repair their balance sheets.
Because household balance sheets are in good shape, further savings rate normalization could offset the benefit cut’s negative impact on consumption. For instance, assuming only a 1% MoM increase in employee compensation in August, a decline in the savings rate of about 2.5ppt to 15% (twice the historical average) would be enough to keep August consumption at its July level. Because consumption represents 70% of US GDP, this could be enough to keep the recovery going.
Savings rate normalization in turn could reflect a more efficient policy response to the pandemic, which the forthcoming elections have so far politicized. While new cases have increased, this largely reflects higher testing. In addition, mortality is lower and symptoms less severe than in the spring. Furthermore, states are experiencing financial difficulties and are more likely to adopt targeted policies that protect public health with limited economic impact. A more efficient policy response could see household risk aversion and precautionary savings decline.
Market Concerns Could Be Overdone
There is a risk that market concerns over a lack of new budget support could be overdone. The US is a consumption-driven economy. If the unprecedented savings rates normalize, it may be enough to keep the recovery going without more budget support until January 2021. Of course, the recovery would be less robust than if a relief bill was voted in right away, but it might just muddle through.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(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.)