The recovery is likely to move sideways for a month or so before restarting due to the implementation of the new COVID-19 budget package and a decline in new cases.
The past few weeks have shown signs that the recovery has stalled. Initial unemployment claims edged up, high-frequency indicators of retail sales are stalling, and the New York Fed Weekly Economic Index has moved south. The slowdown reflects the surge in COVID-19 cases since mid-June that has seen several states slow or partially reverse their re-openings.
Economic activity, however, is better correlated with mobility indicators than re-openings, as shown for instance by an IMF study of US states and EU countries. Mobility is, of course, a high-frequency proxy for rather than a causal driver of economic activity. Confidence likely drives both. A very large increase in savings reveals household loss of confidence since the pandemic (see Three Conditions For a Lasting Inflation Acceleration). A significant share of those savings have ended up in liquid assets such as bank deposits or money market funds.
I expect a recovery in confidence that will see households and businesses dip into their savings and re-energize the economic recovery. I believe the recovery in confidence will probably come from the implementation of a further COVID-19 relief budget package and from a decline in new COVID-19 cases, possibly to very low levels.
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The recovery is likely to move sideways for a month or so before restarting due to the implementation of the new COVID-19 budget package and a decline in new cases.
Lower Risk Aversion Rather Than Regulations Will Drive Recovery
The past few weeks have shown signs that the recovery has stalled. Initial unemployment claims edged up, high-frequency indicators of retail sales are stalling, and the New York Fed Weekly Economic Index has moved south. The slowdown reflects the surge in COVID-19 cases since mid-June that has seen several states slow or partially reverse their re-openings.
Economic activity, however, is better correlated with mobility indicators than re-openings, as shown for instance by an IMF study of US states and EU countries. Mobility is, of course, a high-frequency proxy for rather than a causal driver of economic activity. Confidence likely drives both. A very large increase in savings reveals household loss of confidence since the pandemic (see Three Conditions For a Lasting Inflation Acceleration). A significant share of those savings have ended up in liquid assets such as bank deposits or money market funds.
I expect a recovery in confidence that will see households and businesses dip into their savings and re-energize the economic recovery. I believe the recovery in confidence will probably come from the implementation of a further COVID-19 relief budget package and from a decline in new COVID-19 cases, possibly to very low levels.
Next Round of COVID-19 Relief Could Be More Efficient
Pandemic unemployment benefits as well as debt forbearance measures expire on 31 July, which leaves Congress under strong pressure to reach an agreement on the next round of economic support. The House Democrats have passed a $3.5tn bill in May, while the Senate Republicans’ recent opening bid is $1tn.
The most likely outcome is some compromise worked out over the next few weeks, for instance around $1.5tn, with additional unemployment benefit above $200 and below $600. While both sides claim to be distant, a fiscal cliff would be devastating for the economy with about three months to go before the elections. Most importantly, the compromise would provide funding until the end of the year, which would lower household income uncertainty.
New COVID-19 Cases Could Fall to Very Low Levels
The surge in COVID-19 cases is abating: new cases and test hit rates are falling on average in the US, though they are still rising mainly in mid-western and southern states (Chart 1). New cases could fall below the early June low since the susceptible population has shrunk.
The Panic Epidemic Could Subside
Perhaps the biggest difference between COVID-19 and other post-WWII pandemics such as the Hong Kong Flu of 1967-69 is the existence of social medias. The economic incentive for the medias are to maximize the number of clicks rather than the quality and objectivity of information. With the human brain hard-wired for negativity, media coverage has erred on the side of pessimism.
‘Experts’ have reinforced this bias by predicting catastrophic outcomes that never materialized but remained in the mind of the public. Furthermore, largely thanks to social medias, the scientific community’s internal debates have taken place in front of a general public poorly equipped to form a valid opinion. Finally, the lack of WHO and federal government leadership has contributed to the public panic and confusion.
Ebbing of Panic Epidemic to Bring Unemployment Below 10% by End-2020
Likely but unexpected developments such as a decline in new cases, a mass vaccination programme, or a highly publicized breakthrough treatment could cause a substantial decline in household and business risk aversion and precautionary saving. This suggests that, while the recovery has likely paused for the next month or so, it will probably restart in late Q3/early Q4.
Overall, I see the economy still on track for a V-shaped recovery. In fact, the decline in unemployment in May and June has been much sharper than I had expected under my May V-shaped scenario. I have therefore updated my unemployment scenario. I am now expecting unemployment to stagnate or even increase somewhat in July-August and fall again in September, to end 2020 well below 10%, against 10% in my May scenario (see U And V Shaped Risks Compared).
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.)