Real GDP in the United States declined at an annualized rate of 4.8% in the first quarter of 2020, the steepest contraction since 2008. This reflected the early impact of widespread disruptions in the U.S. economy caused by business shutdowns, social distancing, and other initiatives aimed at containing the COVID-19. There were broad-based declines across most spending categories.
The slump in GDP in the first quarter was just a taste of what is to come in the second quarter. Real GDP could contract at an unprecedented annualized rate in excess of 20% in Q2.
Furthermore, the unemployment rate could surge to more than 15% in April or May.
But the federal government, along with the Federal Reserve, has put numerous support mechanisms in place. These programs should help to ensure that the economy does not completely collapse while stay-at-home orders are in place.As states slowly start to re-open in the coming weeks and months and assuming the COVID-19 outbreak does not re-emerge, the economy should start a process of gradual recovery towards the end of the year. However, social distancing in some form is likely to continue for many months to come, whether by individual choice or government edict. That means economic activity would be unlikely to rebound as quickly as it declined.
Labor Market: The coronavirus pandemic has driven 30 million people to file new claims for unemployment insurance in just six weeks. Business disruptions have driven millions of Americans to seek unemployment benefits, a pace, and scale of damage to the labor market unseen in decades. The hiring retrenchment has widened beyond the sectors initially hit—including restaurants, travel, and tourism—to white-collar industries. The job market could rebound more quickly than in previous downturns if businesses can reopen and bring workers back into their old jobs. But temporary layoffs could become permanent if the health and economic shock drag on. Will the job losses be lasting? Initial evidence suggests that companies are not looking to fundamentally restructure their businesses, as happened in some previous recessions. For now, at least, most companies appear to be looking to ride out the storm.
Unsure of how this crisis will play out, many of the firms that are hiring aggressively are doing so temporarily. Also, a growing share of job postings offers work-from-home opportunities. Companies will be more likely to hire for remote work and freelancers in the next six months.
Oil Market: Dysfunction in the oil market has intensified in recent weeks sending the most popularly traded U.S. oil benchmark at one point to its lowest level since at least 1986.The world has been awash with oil at a time when coronavirus lockdowns on driving, flying and industrial activity have all but eliminated the need for it. As social distancing and lockdown measures are likely to remain in place for the near-term, oil demand should remain subdued and the significant oversupply of oil should persist for at least the next few months. Despite an agreement from OPEC+ members to cut production, and even if there were additional production cuts, it is likely there would need to be a pickup in demand to bring the supply-demand dynamic into balance. Absent that change, oil prices should stay near current levels for some time.
Foreign Exchange: The prospect of a sharp, deep economic recession in 2020, the potential for further volatility in global equity markets, and a dramatic collapse in global commodity prices since the beginning of this year have affected foreign exchange markets.
So far this year the U.S. dollar has been a strong performer, with gains against most G10 and emerging currencies. In part that reflects a severe global U.S. dollar shortage when market stresses were at their peak. Also, the actions by the Federal Reserve have made dollar liquidity more readily available both in the United States and globally, which appears to have substantially alleviated those funding strains. Nonetheless, foreign exchange markets have remained somewhat unsettled in part because the policy outlook remains uncertain. In this environment, the U.S. dollar and Japanese yen are likely to outperform in the near-term.However, over the longer term, there is potential for the U.S. dollar to weaken, especially given the massive injection of U.S. dollar liquidity in recent weeks. Once the global economy and markets stabilize over the longer term, most emerging currencies should enjoy more sustained gains versus the U.S. dollar, while a more stable longer-term outlook should be helpful for many G10 currencies as well.
Federal Reserve: As the risks posed by the coronavirus have become increasingly apparent, the Federal Reserve has taken swift and decisive action to support the economy and stabilize financial markets. The Federal Open Market Committee (FOMC) quickly brought the target range for the federal funds rate to near zero. The FOMC also signaled that it expects to keep interest rates at this level indefinitely. The Federal Reserve has also made liquidity available to key intermediaries to support market functioning and to keep credit flowing.
These monetary policy actions have served two purposes. First, low-interest rates made it easier for households and businesses to meet their borrowing needs during this time of economic stress. Second, they fostered broader financial conditions that will help promote the rebound in spending and investment needed to return the economy to full strength.
These strong and timely actions averted a potential shutdown in the flow of credit and have provided funding and stability at a time of extraordinary volatility in markets. Although stresses in financial markets will not entirely abate until the pandemic has ended, there have been material improvements in measures of liquidity and market functioning in key parts of the U.S. financial system.
Fiscal Policy: Recognizing the strong demand for Payroll Protection Plan (PPP) loans, Congress has passed its fourth major relief package, including an additional $320 billion for the PPP, $75 billion for hospitals and $25 billion for COVID-19 testing. Demand for loans has remained voracious, and Congress will likely have to return to the negotiating table again. Assistance to state and local governments was noticeably absent from this package and has increasingly appeared to be a political sticking point.
Eurozone: In the Eurozone, economies are expected to suffer steep drops in gross domestic product this year because of the coronavirus and the lockdowns aimed at containing it. But the recoveries would differ markedly. Hard data pointing to a sharp contraction in economic activity have been limited so far, although a 60% year-over-year fall in March car registrations indicates what is to come. Meanwhile, confidence surveys have made it clear the downturn will be severe, especially in the service sector. After the Eurozone services PMI fell to a record low of 26.4 in March, it slumped to another record low of 11.7 in April and the economy-wide composite PMI also plunged to a record low of 13.5. Quarter-overquarter Q1 GDP declined by 3.8%, although there will be a much larger fall in Q2.
Most nations of Europe’s north are set to recover faster than those in the south, exacerbating a divergence of fortunes in the eurozone and feeding political tensions over how to pay for the fallout of the coronavirus pandemic. In the north, Germany and France had a lighter lockdown, more fiscal firepower, in better economic shape as they entered the pandemic. In the south, Italy and Spain had a deeper economic standstill and higher debts that deterred aggressive stimulus.
That widening economic divide poses a challenge to the long-term viability of the euro. It erodes support for the currency in southern Europe while making it harder for the European Central Bank to set interest rates that would be suitable for all members across the board.
China: China’s Q1 GDP slumped 9.8% quarter-over-quarter and 6.8% year-over-year, with the secondary sector (i.e., manufacturing) falling more sharply than the service sector. The collapse foreshadows the pain expected around the world as the coronavirus pandemic shuts borders, halts business activity, and cripples global supply chains.
The underlying picture has offered some signs of recovery after a nadir in February, though the numbers underscored the weakness of consumer spending. China’s urban jobless rate has remained at an elevated 5.9% at the end of March, after a record 6.2% reading in February.
Retail sales in March were off 16% from a year earlier. Industrial production for the month was down 1.1% from a year earlier. For the quarter, fixed-asset investment was off 16%, property investment was down 7.7%, and housing sales off 23%.
While the coronavirus has flattened economies around the world, China has been reckoning with it the longest, and recovery remains fragile. Many restrictions have been lifted but some new ones have been enacted, including tightened restrictions on international flights in a bid to prevent a second wave of infections from abroad.
Emerging Markets: Economic output in emerging markets is expected to fall at least 1.5% this year. Even if some developing nations manage to avoid catastrophic coronavirus infection rates, they have far fewer tools than rich ones to cushion economic blows. Their economies are less diversified, relying more on volatile commodities such as oil, remittances from workers abroad, and services like tourism. They have less money to spend to ease the burden on companies, and weaker social safety nets.
Cutting interest rates has often led to weaker currencies. The Mexican peso, Russian ruble, and South African rand have tumbled about 20% against the U.S. dollar in recent weeks, followed closely by the Brazilian real. The downturn has followed a difficult 2019 for many emerging markets hit by a wave of civil unrest and protests, including Algeria, Lebanon, Iraq, Ecuador, Chile, and Colombia.
A record $100 billion has been pulled from emerging markets since January. That will raise the costs of borrowing and may push debt-laden countries such as Ecuador and Argentina to default. Stocks in emerging markets have fallen 20% in the past six weeks, wiping out all gains since 2017. Many of these nations do not have the financial firepower they had during the 2008 global financial crisis when commodities, tourism, and remittances were booming.
Outlook: As the COVID-19 spread across the globe, governments have reacted to the spread of the virus by shutting down large portions of their economies, and in particular the service sector. It is almost certain the global economy has entered a recession, with figures for the first three months of the year pointing to a widespread fall in economic output.
In the U.S., the shutdown will induce the sharpest economic downturn and push the U.S. budget deficit to the highest levels since the 1940s. The economy is likely to shrink at an unprecedented annualized rate in excess of 20% in Q2. Furthermore, the unemployment rate is expected to surge to between 15%-20% in April.
The federal budget deficit is expected to reach about $4 trillion by the end of the fiscal year in September. Congress has authorized unprecedented deficit spending to offset the shutdown of vast swaths of the U.S. economy. As a proportion of gross domestic product, the deficit will end the fiscal year at almost 18%, its highest level since 1946. Federal debt held by the public is projected to hit 100% of gross domestic product by the end of the fiscal year, up from 79% at the end of fiscal 2019. The silver lining is that due to low-interest rates, the government’s net borrowing costs will decline even with the dramatic increase in borrowing.
As unnerving as the massive Q2 and Q3 GDP declines have been, conditions may begin to improve in Q4. Businesses are expected to gradually start reopening in June, resulting in a sharp snapback in consumer spending from very low levels. Business fixed investment may require an additional fiscal spark, however, and is not expected to turn the corner until later this year. Exports will take even longer to recover, as global growth comes back more slowly, resulting in larger trade deficits later this year and 2021. U.S. GDP is expected to contract about 6% in 2020 from last year and to grow 3% in 2021 as the economy begins to rebound.
One important source of downside risk has been state and local government finances, which have seen revenues evaporate at the same time expenses have skyrocketed. In the absence of increased federal aid to the tune of at least $400 billion, requirements for most states to balance operating budgets will likely lead to painful spending and employment cuts over the next several years. Direct state and local assistance are at the center of ongoing negotiations for the next round of fiscal relief.
Sources: Department of Labor, Department of Commerce, Morningstar, Bloomberg,
China National Bureau of Statistics, European Central Bank
|Index Performance as of: 4/30/2020|
|Index Performance as of:||1 Week 1 Month||QTD||3 Month||YTD||1 Year||3 Year||5 Year|
|Mid Cap Value||6.50||13.35||13.35||-21.05||-22.59||-16.71||-2.02||1.99|
|Mid Cap Growth||4.61||15.66||15.66||-8.38||-7.52||0.23||11.28||8.88|
|Dow Jones Industrial Avg.||3.53||11.22||11.22||-13.30||-14.07||-6.15||7.66||9.06|
|Wilshire 5000 (Full Cap)||4.53||13.50||13.50||-10.12||-10.15||-1.51||7.86||8.13|
|MSCI Frontier Markets||4.22||6.74||6.74||-21.60||-21.65||-13.62||-2.57||-2.30|
|MSCI ACWI Ex USA||3.68||7.58||7.58||-15.27||-17.55||-11.49||-0.25||-0.17|
|MSCI AC Asia Ex Japan||3.39||8.96||8.96||-6.93||-11.07||-7.43||3.25||1.66|
|Index Performance as of: 4/30/2020|
|Index Performance as of:||1 Week 1 Month||QTD||3 Month||YTD||1 Year||3 Year||5 Year|
|MSCI EM Latin America||4.76||6.30||6.30||-38.76||-42.19||-37.25||-11.18||-6.58|
|Barclays U.S. Aggregate||0.03||1.78||1.78||3.00||4.98||10.82||5.17||3.80|
|ICE BofAML US 3M Trsy Bill||0.00||0.01||0.01||0.45||0.58||2.07||1.81||1.19|
|Barclays U.S. Gov’t||-0.18||0.63||0.63||6.19||8.76||14.07||5.76||3.86|
|Barclays U.S. Credit||0.11||4.58||4.58||-1.03||1.29||9.35||5.40||4.33|
|Barclays High Yield Corp.||0.46||4.51||4.51||-8.78||-8.75||-4.10||1.87||3.44|
|Barclays Gbl Agg Ex USD||1.82||2.04||2.04||-1.44||-0.69||3.42||2.78||2.01|
|Barclays Global Aggregate||1.03||1.96||1.96||0.35||1.63||6.54||3.84||2.82|
|JPM EMBI Global Div||1.49||2.25||2.25||-12.76||-11.44||-4.96||0.67||2.94|
|FTSE NAREIT Equity REIT||7.18||8.30||8.30||-22.21||-21.27||-14.50||-0.57||2.40|
|S&P Global Natural Res.||4.61||13.82||13.82||-17.31||-23.60||-20.32||-2.11||-1.51|
|S&P N. Amer Natural Res.||7.91||26.94||26.94||-22.37||-28.78||-28.15||-10.33||-8.95|
This Newsletter was produced for Middleburg Financial by Capital Market Consultants, Inc.
Past performance quoted is past performance and is not a guarantee of future results. Portfolio diversification does not guarantee investment returns and does not eliminate the risk of loss. The opinions and estimates put forth constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The views and strategies described may not be suitable for all investors. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. References to future returns are not promises or even estimates of actual returns a client portfolio may achieve. Any forecasts contained herein are for illustrative purposes only and are not to be relied upon as advice or interpreted as a recommendation.
Securities are not insured by FDIC or any other government agency, are not bank guaranteed, are not deposits or a condition to any banking service or activity, are subject to risk and may lose value, including the possible loss of principal.