Halfway there: An update on the US economic recovery

Does the US economy have enough fuel to get back on track? Could it go off a fiscal cliff? Macro Strategist Juhi Dhawan responds to frequently asked questions on policy, employment, and the markets.

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In the face of uncertainty about the US election, the potential for new waves of COVID-19, and looming fiscal cliffs, there is considerable anxiety about the path of the economy. Here are some of the key questions I’ve been asked recently and my answers.

Is the US economy healing?

To date, roughly half of the economic output and jobs lost during the early months of the pandemic have been recovered. In terms of economic activity, we have reached the depth of the downturn of the global financial crisis (GFC), from a level 2.5 times lower (Figure 1). My view remains that the economy is continuing to heal, albeit at a reduced pace. Following the initial V-shaped turn, I expect declining momentum going forward as the reopenings slow, but then an eventual leg up once a vaccine is widely available (the so-called “swoosh” recovery named after the Nike logo). Next year, I think we could see the economy recover fully as activity normalizes.

FIGURE 1

tracing the "v" of a swoosh recovery

Do you see a risk of a “double dip”?

Coming out of every big recession, it is normal to face a period in which the economy takes one step back for every two steps forward. This is due to the fragility of the underlying economy, as companies and consumers are displaced and forced to make budget right-sizing decisions. As growth slows from the torrid pace of the past several months, such decisions will become more prominent. Congress seems to have been unable to reach agreement on further aid, pushing the issue out until after the election and leaving the economy vulnerable in the short run. But when all is said and done, I believe next year will prove to be a good one for the US economy. Financial conditions are loose, with Congress and the Federal Reserve (Fed) having initially stepped in at a pace that was breathtaking. (I have baked in some tightening of conditions as we enter a period of uncertainty [e.g., related to the US election] that could last a few months.) Meanwhile, news on a vaccine and the virus should get better over time and the cash-flow position of companies and consumers in aggregate is healthy, even though the tails are fat (i.e., some highly levered consumers and companies may face a bleak outcome).

What’s next for the Fed?

The Fed offered new forward rate guidance in its September statement, with its forecasts suggesting steady interest rates through 2023. There were no changes in the generous quantitative easing stance, and I expect the central bank will step in with more support as needed. The intention in delaying action for now is to gauge how much fiscal support is ultimately provided. The policy path will be calibrated toward more support if Congress fails to provide any help and the virus and the economy take a turn for the worse. While it will never be acknowledged, the Fed is likely waiting to see the election result, given the potential impact on further fiscal support. For the next few months, it is possible that the central bank will end up being “the only game in town.” The Fed’s goal remains to heal the labor market as quickly as possible and to boost inflation. The new regime leaves the Fed tremendous flexibility in how it interprets the goals of maximum employment and 2% average inflation over time.

How worried are you about a fiscal cliff?

The likelihood of reduced fiscal support is part of the reason I expect slower growth moving forward. The aid under consideration has always been intended to continue through the end of the year, with both parties wanting to keep powder dry as they wait to see the makeup of Congress in 2021. Without more fiscal support, personal incomes gains, which are running at 8% now, will slow further in the coming months (Figure 2). Ultimately, the pace of reopenings will govern growth in the economy. Given the approach of the winter months, I have included a small sequential gain in my assumptions. Upside surprises could come if the President releases funds via executive action or we receive good news on the vaccination front. Further out, if Biden wins the election as polls currently suggest, additional fiscal measures could occur in the first quarter of 2021. The size and scope of these plans will depend on the path of the virus, the progress of the economy, and the makeup of Congress. (For more on election scenarios, see “The US election: Is there a blue wave coming?”)

FIGURE 2

can gains in personal income be sustained

What is your employment outlook?

My base case assumes a two-stage recovery — the first being rapid, like we typically see after a natural disaster, and the second being slower, like we would expect coming out of a recession. Unemployment is now in the middle of the 7% – 10% range that I had estimated for the first part of the recovery. The front-loaded fiscal stimulus provided many incentives for companies to choose furloughs over layoffs, and we’re now seeing workers rehired as the economy reopens. But there is scope for permanent layoffs to rise from the current total of two million. Small businesses and the leisure and hospitality industries remain vulnerable to additional cutbacks starting in October, with the expiration of clauses that prevented such cutbacks as a condition for government help. State and local governments, which have been hoping for more aid, remain vulnerable too. That said, there are some encouraging green shoots in the labor market. Temporary employment looks like it is starting to turn, there are signs of a recovery in job postings, and a few surveys suggest the intent to hire is gradually returning. With the right policies in place, the surprise of this recovery could be that the labor market rebounds faster than it did during the GFC.

What about the markets?

Given that markets have come up a long way and the near-term economic and policy outlook is cloudy, it is possible that equity returns will be choppier in the coming months. Historical analysis has also shown that equity market returns are often weaker in the months prior to elections in which the incumbent loses. These gyrations may provide opportunities to invest in the sectors that were hit hardest by the pandemic and that may benefit from the eventual arrival of a widespread vaccination program next year.

In terms of rates and currencies, my belief remains that the mix of policy and the lifting of uncertainty over time will gradually result in steeper curves and a weaker US dollar (this assumes there will be more policy support for the economy over time). On a related note, some have asked how much more weakening of the dollar we could see. In a medium-term context, I would note that the dollar is still expensive against many emerging market currencies, although it has already adjusted relative to the euro.

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