Outlook and Market Review – Second Quarter 2020

The U. S. economy shrank 31.7% in the second quarter after a 4.96% decline in the first quarter, according to revised Bureau of Economic Analysis estimates. Almost all the damage occurred during March and April with a recovery beginning in May as the economy slowly began to open up. The unemployment rate reached 14.7% in April with over twenty million jobs lost. The most recent August report has the unemployment down to 8.4%, well below expectations. About half of the jobs lost in March and April have been recovered by August. The COVID recession has been the shortest and most severe in history.

While the recovery shows promising signs for the third quarter, there are potential stumbling blocks to include a potential resurgence of the virus in the fall. So far, the recovery has been aided by over a trillion dollars in fiscal stimulus to supplement unemployed workers. The stimulus will continue at a lower level in the third and fourth quarters unless there is a political deal for a higher level of spending. At some point, the private sector must be able to grow without artificial government support, but this is not likely until the shutdown is fully eliminated. Prospects for a vaccine by the end of the year are not clear but progress is being made on ways to cope with the severity and duration of the illness once contracted.

Monetary policy, both in the U.S. and globally, has been extremely accommodating. Interest rates are barely positive in most advanced economies. Pent up demand along with low interest rates and fiscal income supplements have stimulated housing and durable good purchases going into the third quarter. Debt burdens are growing at both the federal, state, and household levels due to borrowing needs to finance virus related costs and the enticement of using debt in the low interest rate environment. In the long run the economy must recover to service the higher debt levels and wean the markets off the combination of easy money and fiscal deficit spending.

Fears of deflation are easing somewhat but prices are growing well below the 2% target set by the Fed. Excess capacity, low demand, and low inflation all work to keep prices lower. The Fed has ample room for monetary easing without fears of approaching the 2% interest rate target. Banks tend to be flush with cash and government foreclosure policies have prevented the mortgage default rates seen in the last recession. In the long run, low interest rates need to stimulate investment in real assets and infrastructure to generate capital formation and growth.

Going into the third quarter, continued progress toward a recovery is expected with positive GDP growth of about 5% as the economy bounces off low levels of performance. Controlling the COVID virus is only one of many issues that could derail the recovery. Economic performance in 2021 also depends on potential changes in taxes, fiscal priorities, law enforcement reforms, global population migration, free but fair trade practices, a reversal of globalization, political polarization, and productive infrastructure investments.