Economic uncertainty
remains with
challenges ahead

Our overall view on the economy is still coming into focus, but data increasingly supports our theory, even if specifics remain unclear. The data continue to hint at a deep, short recession followed by a long, tough recovery period. Real personal spending increased in briskly in May following its largest decline on record in April. But the decline in personal income in May, after the initial boost from fiscal stimulus in April, demonstrates the challenges ahead for consumers: massive uncertainty concerning income could constrain spending in future periods.

That highlights a key risk to the near-term outlook: austerity. The data on incomes demonstrates that fiscal stimulus from the CARES act is helping to prop up incomes for many households, particularly lower-income households. Income growth from other sources remains tepid. But if the government withdraws or reduces fiscal stimulus when the programs expire over the next month, confusing cause and effect, income growth could once again turn negative.

That could create headwinds for the economy, because research shows that lower-income households are spending their stimulus funds. But higher-income households, who have fared better during this crisis than lower-income households, are spending at levels well below pre-pandemic levels. That helped push the savings rate to a record high. Many of the discretionary businesses that higher-income households frequent (e.g. high-end restaurants, hotels) remain closed or avoided out of safety concerns. But workers from lower-income households typically staff these businesses. Until these businesses can reopen safely, government support of lower-income households could prove necessary.

Other risks to the economy also emerged recently. Notably, the pandemic resurged over the last week, with new daily cases reaching a record high. The outbreak is growing fastest in new areas relative to the initial outbreak. At first, the pandemic centered on the New York City area, in New York and New Jersey. Recently, cases are rising the fastest in California, Texas, and Florida.  All three halted or reversed opening to some extent in recent days. That could present another headwind for the economy: California, Texas, and Florida together represent roughly 29% of the U.S. economy. By comparison, New York and New Jersey together represent roughly 11%.

Markets are trying to digest all this information. Equity markets in the U.S. recovered most of the pullback after bottoming out relatively quickly in March. Some of this logically stems from government policy from both the Fed and the federal government. But some also stems from relatively optimistic expectations for the future. But the Treasury market does not share such an optimistic assessment, with 10-year Treasury yields hovering just above record-low levels. The trajectory of the pandemic and government policy over the next couple of months should determine which market holds the better read on things.