A pivotal week
for the economy

More insights into exactly how the economy performed in the second quarter. Hint: it wasn’t great

July 28, 2020

The economy arrives at a pivotal juncture where we will obtain more transparency about where it stands and where it could head over the next 12 to 18 months. After likely passing its technical nadir in April, the economy showed signs of rebounding in May and June amidst tentative signs that the pandemic was abating. The labor market produced job gains in both months as some businesses reopened and rehired staff. Retail sales also bounced back during those periods, with consumers releasing pent-up demand once stores reopened and they felt safe enough to visit those establishments.

But by July COVID cases began increasing again, particularly in the Southeast and the Southwest. State and local governments began slowing or pausing re-openings and, in some cases, reinitiating lockdowns of businesses. Sentiment among consumers began to falter. Last week initial unemployment claims increased for the first time in 15 weeks and layoffs continue to transition from temporary to permanent. Understanding the path forward for the economy hinges on two key developments this week.

How big of a hole?

This week will provide the first view on real GDP growth for the second quarter. We expect, by a wide margin, the worst quarter for the U.S. in recorded economic history.  Our proprietary scenario forecasting model projects an annualized contraction in the -25% to -35% range across scenarios. But given the massive uncertainty pervading the economy, a result outside that range would not surprise us. Nonetheless, a clearer view on the damage to the economy during that quarter will help understand how large of a hole the economy must climb out of and provide a starting point for the next iteration of forecasting. Most of the downturn should come from consumption, though we expect that all major components of GDP declined during the quarter. Research indicates that most of the decline in consumer spending occurred because of fear over health concerns, not business shutdowns: consumers avoided many businesses and activities that remained open. Private investment also likely declined with organizations pulling back due to the substantial contraction in demand. Despite massive fiscal stimulus, government spending also likely contracted during the quarter. Governments themselves, across all levels, likely reduced spending amidst revenue shortfalls, budget crunches, and declining demand for some services. Even net exports hurt economic performance with exports likely falling more than imports. 

What happens with expiring policy?

Undoubtedly, the economy received support from stimulative fiscal policy during the quarter. We estimate that it positively contributed up to 1000 basis points (bps) to growth on an annualized basis. But some key policies that propped up the economy will expire at the end of the week. The additional unemployment assistance of $600 per week will expire on July 31, though technically some people will stop receiving payments sooner. The federal eviction moratorium will also expire then. Measures like these have helped consumers to reengage with the economy and to an extent support business. In their absence, it seems unlikely that the economy can recover normally. The usual mechanisms that cause the economy to reach a new, stable equilibrium after a contraction in aggregate demand will not work. Demand will remain impaired due to health concerns – no matter how low the price, some goods and services will not get consumed by many if doing so potentially puts their health at risk. And that will prevent the economy from snapping back the way it typically does after a recession.

Some have argued that the performance of certain components of the economy, such as the labor market and retail sales, demonstrate that fiscal support is no longer necessary. But that likely mistakes cause and effect. With consumers sitting on the sidelines out of health concerns, many businesses will operate at a limited capacity while others will fail outright. That will limit rehiring activity and economic growth. Some workers are also experiencing declines in pay due to weak demand, also hampering economic growth. While details of the next spending package remain unknown some broad outlines are emerging. An additional one-time stimulus of roughly $1200 should get included. Additional weekly unemployment insurance benefits will likely continue, but at a reduced amount. Incentives to hire and retain worker also looks set to continue as well as an extension of the eviction mortarium. The picture on aid should become clearer this week, even if legislation is not passed and signed into law by Friday.

The pandemic is the recession

The recovery of the economy depends upon the pandemic. They remain intertwined and not independent of each other. The recent pandemic flare up is creating a headwind to growth via both slowdowns and rollbacks of re-openings and via consumers’ concerns for their safety. Knowing how far we must climb and how much support the government will provide during that climb will help us plot the course forward. But ultimately the trajectory of the economy remains dependent on the pandemic which is proving both difficult to control and to predict. Just six weeks ago it seemed as if the U.S. had passed the worst of the outbreak, only to find itself soon after reaching record-high numbers of cases, making economic forecasting even more challenging than it already is during more benign economic times. 

|  What else we are watching this week  |

Updated readings on consumer confidence and consumer sentiment for July should provide some indication of how much the recent resurgence in cases and the slowdown in the labor market are dampening consumer spirits. We expect both measures to decline, particularly the expectations components, which could hamper future spending and economic recovery.

|  Thought of the week  |

Gig workers are facing increased competition from the ranks of the new unemployed. It is becoming harder to find work which is lowering incomes.