Economic activity has picked up in the third quarter from its depressed second-quarter level when much of the economy was shut down to stem the spread of the virus. Household spending has recovered about three-fourths of its earlier decline, likely owing in part to federal stimulus payments and expanded unemployment benefits. The housing sector has rebounded, and business fixed investment has shown signs of improvement. In the labor market, roughly half of the 22 million payroll jobs that were lost in March and April have been regained as people return to work.
Both employment and overall economic activity, however, have remained well below their pre-pandemic levels, and the path ahead continues to be highly uncertain. The downturn has not fallen equally on all Americans; those least able to bear the burden have been the most affected. This reversal of economic fortune has upended many lives and created great uncertainty about the future.
While the economy has been on the mend, the return to normalcy has endured some downside risks. For starters, uncertainty surrounding the trajectory of COVID-19 has continued to loom large. The summer surge in COVID-19 cases across the southern half of the country appears to have subsided, but infections have now been on the rise. The concern is that cooler temperatures may intensify the spread of COVID-19 throughout the country as many stopgap measures such as outdoor dining and curbside pickup become less viable and people spend more time indoors.
The pace of improvement in recouping jobs lost to pandemic mitigation efforts has also slowed, as employers have rebalanced headcounts with new occupancy limitations and softer demand. Moreover, funding for expanded unemployment benefits (prolonged by executive order after expiring in July) has run dry. Absent another round of fiscal stimulus, a still-cautious consumer may go into spending hibernation later this winter. In short, the economy has continued to improve, but progress from this point forward will likely be more challenging.
The Shape of the Recovery: A two-track recovery has emerged from the country’s pandemic-driven economic contraction. Some workers, companies, and regions have shown signs of coming out fine or even stronger. The rest have been mired in a deep decline with an uncertain path ahead.
What has developed is like a K-shaped recovery. On the upper arm of the K are well-educated and well-off people, businesses tied to the digital economy or supplying domestic necessities, and regions such as tech-forward Western cities. By and large, all in this group are prospering.
On the bottom arm are lower-wage workers with fewer credentials, old-line businesses, and regions tied to tourism and public gatherings. This group can expect to bear years-long scars from the crisis.
The divergence has helped explain the striking disconnect of a stock market and household wealth near record highs, while lines stretch at food banks, and applications for jobless benefits have continued to grow.
Labor Market: The labor market recovery has continued to slow. In September, employers added less than half the number of jobs added in August. Further, while the unemployment rate dropped below 8.0%, twice as many people left the labor force than became employed. In short, the labor market has continued its recovery, but attention has already shifted to the tenuous outlook.
Several factors have hindered the rehiring of workers. First, the initial hiring rebound from businesses reopening eased as states lifted restrictions at a slower pace than earlier in the summer. Further, layoffs and the resulting claims for unemployment compensation have remained elevated compared with pre-pandemic peaks, though they are down from highs reached earlier in the crisis.
With the easy job gains due to re-opening largely in the rear-view mirror, the job market is expected to progress more slowly going forward. There remain about 11 million fewer jobs in the economy relative to February, and it is expected that it will be some time before those are all regained as the need for physical distancing restrains activity in several industries.
Housing Market: At a time when most sectors of the economy have continued to struggle under the weight of the pandemic, the housing market has remained a bright spot. U.S. existing home sales soared 9.4% to 6.54 million units (annualized) in September. With several factors such as low mortgage rates and a still-improving labor market continuing to offer support, resale activity is expected to move higher, but at a more moderate pace. A sharp acceleration in-home price growth, which has eroded affordability, and a record-low supply of housing have been elements that should limit homebuying to a more moderate pace ahead.
U.S. housing starts increased by 1.9% month-over-month to 1.42 million units (annualized) in September. This marked the fourth monthly increase in the last six months. Though the pace of growth has slowed markedly from the sharp rebound of earlier months, the turnaround in homebuilding activity has been supported by low mortgage rates and the growth in housing demand. However, skyrocketing input prices, e.g., lumber, have effectively added to construction costs. A fall resurgence in new COVID-19 cases as well as a labor market recovery that has lost steam are other factors that could weigh on housing demand in the coming months.
Energy Market: Oil prices in October slumped to their lowest level in more than two months under pressure from a stalling recovery in demand and planned production expansions by OPEC that have threatened to add to an existing glut of crude.
The pressure on prices is likely to build in the coming months. One reason is that OPEC and its allies are on track to ease the historic production cuts they imposed this spring. Another challenge facing the market: refiners are struggling to make money, prompting them to cut the amount of crude they buy to process into higher-value products.
A swift recovery in fuel consumption by U.S. drivers has petered out, posing new challenges to the oil market, economy, and global energy industry. After gasoline demand surged from mid-April to late June, consumption has stayed relatively flat in the past four months and remains well below its pre-pandemic levels.
The fizzling rebound has highlighted the lingering effects of coronavirus precautions and travel restrictions. Even as some states have advanced business reopening plans, rising cases in other parts of the country have fueled caution among consumers.
Combined with other data points showing that improvements in consumer spending and hiring are cooling, the slower increase in fuel demand has illustrated that the next phase of the economic recovery could be more difficult. The stalled demand rebound has helped keep U.S. crude-oil prices stuck in the low $40s per barrel, even with the OPEC and oil companies curbing supply in response to the industry turmoil. As a result, fuel prices also have remained flat recently, a boon for those consumers who can take advantage of the pump, but a threat to energy companies whose spending cuts and layoffs could add to the pressure on the economy. Unless demand picks up, more and more energy companies will be forced to file for bankruptcy or pursue mergers and acquisitions in the months ahead.
Fiscal Stimulus: Fiscal stimulus has been vital in shoring up lost income during the pandemic, providing households and businesses with a bridge to the other side of the crisis. But with this support fading, many have feared the rug would be pulled out from underneath the fledgling economic recovery. For households, the expiration of federal supplemental unemployment benefits at the end of July caused much handwringing regarding the looming hurdle for consumer spending and thereby possibly fall out for the economic rebound more generally. Such concerns are not off-base as millions of Americans have remained unemployed and continue to rely on benefits. As expected, personal incomes declined 2.7% in August, which was due almost entirely to the decline in unemployment benefits. It remains to be seen if consumers will meaningfully reduce spending, but even with millions not receiving the extra stimulus income in August, spending still rose 1.0%.
Global Economy: The global economy has bounced back strongly from the collapse it suffered in the spring. Fresh data has suggested the early gains from the lifting of coronavirus lockdowns are already exhausted, adding to evidence that the world economy could take many months, if not years, to heal.
A return to pre-coronavirus levels of output will be painfully slow in most of the wealthier parts of the world, as the coronavirus has deterred everything from travel to entertainment to office work. Strong economic growth in the third quarter will likely be followed by more modest expansion as companies, workers and governments adjust to what could be an extended period of uncertainty over the evolution of the pandemic and the availability of a vaccine.
If major economies do not need to get into generalized lockdown, the global economy should continue to mend, but cannot sustain the spectacular rebound seen upon reopening businesses a few months ago.
China: China has continued to lead the world in the containment of COVID as new confirmed cases are minimal. This apparent success can likely be attributed to early lockdown protocols, significant testing, and other healthcare procedures designed to mitigate the spread of COVID, allowing for the economy to re-open faster than expected. In addition to virus containment, aggressive monetary and fiscal stimulus have been implemented and have been key to the pick-up in economic activity. The combination of virus containment and fiscal stimulus has resulted in China leading the global economic recovery.
On a year-over-year basis, China’s economy has expanded 4.9% in Q3, greater than the 3.2% year-over-year expansion in Q2. The tertiary sector (i.e. wholesale and retail trade, financial sector, real estate, etc.) grew 4.3% year-over-year, while the secondary sector (i.e.: manufacturing, construction, etc.) expanded 6% year-over-year in Q3.
Despite their V-shaped recovery, vulnerabilities have still accumulated as China’s economy has been highly leveraged and stimulus measures have lost effectiveness. In a post-COVID world, “trend growth” could fall below the government’s 6% target as stimulus measures wind down to manage imbalances, and policy space diminishes.
Outlook: The economy is expected to expand through the fourth quarter, though more slowly, amid a pandemic still disrupting lives and commerce. The economy should end 2020 smaller than a year earlier but grow in 2021.
A full recovery is likely to come only when people have confidence that it is safe to re-engage in a broad range of activities. The path forward will depend on keeping the virus under control, and on policy actions taken at all levels of government.
The direction of the virus from here on out is still unknown, a fact that will likely stand in the way of further progress. Heading into the colder months, when flu season typically ramps up, a withdrawal in economic engagement seems more likely. Moreover, many industries are still absorbing the aftershocks of the COVID-19 induced collapse in economic activity, and now some rebalancing may be necessary. While the leisure & hospitality and retail sectors have been most directly hit initially, the contagion has spread into white-collar service industries which have generally been shielded from layoffs, thanks to the ability to work remotely. Furthermore, absent another round of fiscal stimulus, consumer spending could downshift in the coming months.
The path ahead for the economy is uncertain. First, it is not known how much employers can expand or cut back on layoffs in the absence of a coronavirus vaccine. Second, the effects of federal aid to households under the Cares Act has faded. If consumers cut spending in response to the reduction in their income, businesses could take a hit on sales, denting economic growth. Also, much of the spending in the summer may have reflected “pent-up demand”—purchases that households had put off in the spring. Now that many households are caught up on those purchases, spending may revert to more-normal levels this winter.
This Newsletter was produced for Middleburg Financial by Capital Market Consultants, Inc.
Sources: Department of Commerce, Department of Labor, Morningstar, Bloomberg, European Central Bank, China’s National Bureau of Statistics, Institute for Supply Management
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