Fed Won’t Easily Declare “Mission Accomplished”

The Federal Reserve reaffirmed its commitment to support the U.S. economy through the crisis and during the subsequent recovery. Federal Reserve Chair Jerome Powell and his colleagues will not declare victory prematurely. They have yet to even consider the pull back from the extraordinary level of monetary accommodation they are providing. We are just nowhere near that outcome yet so there is no point in asking about it.

The day began with an unsurprisingly weak reading on the economy. The collapse in March was sufficient to drag first quarter GDP growth down to a recession-level contraction of 4.8%:

Note that this is an annualized pace, which is something to keep in mind when we see the unimaginably bad numbers for the second quarter. Consumer spending took the biggest hit, subtracting 5.26 percentage points from GDP growth:

Health care, transportation, recreation, and food services and accommodation all took particularly large hits. Health care may seem like a surprise but reflects the cancellation of elective procedures and services. The service side of consumer spending contributed to 4.99 percentage points of the drag on GDP. In recent years, the service-dependent nature of the U.S. economy increased its resilience to the traditional manufacturing shocks associated with recessions. That dependency is a liability this time around as Covid-19 strikes directly on service-type activities.

The Fed has an appropriately bearish view of the situation:

…The virus and the measures taken to protect public health are inducing sharp declines in economic activity and a surge in job losses. Weaker demand and significantly lower oil prices are holding down consumer price inflation. The disruptions to economic activity here and abroad have significantly affected financial conditions and have impaired the flow of credit to U.S. households and businesses.

The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term…

I think the important element of this outlook is the risks “over the medium term.” Powell explained those risks as related to the virus and possible future outbreaks, the damage to the supply side of the economy (loss of job skills, closure of firms), and the global drag. Powell is looking forward to a “square-root” shaped economy with a bounce later this year as restrictions ease but with a high-likelihood of slow growth thereafter.

Importantly, Powell emphasized that the Fed would not retreat from its current policy stance until he and his colleagues were confident that the recovery would be sufficient to meet their goals. In other words, they aren’t yet thinking about when to pull back from the lending programs, when to scale back the balance sheet, or when to raise interest rates. Powell is intent not to make the mistakes of the Bernanke Fed, which began talking about reversing QE almost as soon as it began (to be fair, the politics and experience were not in the Fed’s favor at the time). Stop asking about it. I am going to lose it the next time I hear a financial journalist asking Powell when the Fed is going to raise interest rates.

Powell also emphasized the need for ongoing fiscal policy to support the economy and while he retains concerns about the sustainability of the debt over the long-run, such concerns were irrelevant now. It was a clear message to Congress and the President: Don’t drag your feet on more economic support. In music to my ears, Powell added that the economy was fine before the virus and the downturn wasn’t anybody’s fault. In other words, he has some thoughts about your moral hazard concerns.

It is worth considering that this whole situation would likely have gone sideways six times over if Trump had gotten his apparent wish and ousted Powell in late 2018. And, I suspect, gone sideways ten times over with a Judy Sheldon as Chair.

Bottom Line: The Fed has pulled out all the stops to support the economy and will continue to use every tool at their disposal to minimize the tail risks to the outlook and support the recovery. Powell and his colleagues have not declared victory; they anticipate a long road ahead. Here’s the thing: Powell gets it. He understands the enormity of the situation. He isn’t going to stand by and let it all fall apart without a fight. And he isn’t going to walk away after the first round.

Still A Long Road Ahead

Like so many of us, I have found the events of the last several weeks overwhelming and difficult to process. Eight weeks ago I was literally bored with the economy, six weeks ago it was hard if not impossible to process the possibility of deliberately shutting down the economy because of the destruction that would surely follow, and now I am trying to sort through the wreckage of that economy.

The speed and size of the shock was truly from the far, far left-hand side of the distribution. The entirety of a “normal” downturn – the careful analysis of data, the debate over the business cycle implications, the anticipated monetary and fiscal policy responses – that would occur over the span of a year or years occurred in the span of only a few weeks.

No doubt this dramatic turn of events has left it difficult for me to write. I am not inclined to write simply to write. I am not inclined to write simply to attract attention to myself. I am not inclined to pretend I am an epidemiologist. I am not inclined to make bold predictions about how “everything in the future will be different.” And perhaps most importantly, I am not inclined to write when I don’t feel that I can add value.

Adding value when stumbling around in the dark is challenging. Or at least it is hard to for me to see what value is being added. That has, again at least for me, been particularly difficult because any analysis remains predicated on the evolution of the Covid-19 pandemic. And how that evolves is still a mystery. Yet, another challenge is managing your tone, especially if writing in the space between market participants and public policy. The information relevant to one audience might be anathema to the other.

That was a long preamble to highlight my uncertainty about the evolution of the economy over this cycle before I attempt to answer this question: Where are we now? Answering that means we need to move through a difficult conversation. Did the economy already hit bottom? It’s best to leave the room after asking that question. Throw the grenade and walk away.

To begin with, we have to assume something about the path of the pandemic. Although some states are experimenting with reopening now, most states will find such exuberance premature (although it will be an opportunity to learn what works and what doesn’t). As a baseline, it’s reasonable to think that most states edge toward reopening by the end of June.

By the very nature of this recession, it is fairly clear that some sectors have bottomed out. Undeniable, really. We can argue about whether or not zero is really the lower bound for interest rates, but zero is a lower bound for the leisure and hospitality industries. Same for non-emergency medical care. Same for hair stylists. You get the idea. We flipped the switch on large parts of the economy and those parts went dark. Nowhere to go but up.

Hence, we will see a bounce in some portions of the economy as restrictions are eased. Has to happen. It’s the only mathematical possibility. There will be some pent-up demand that will be released. Running through the numbers this way gets you to the forecasts for a Q3 jump in growth after a Q2 collapse.

Past experience tells me that people get very upset when you say things like this. Policy wonks rightly worry that a turning point in the economy will lessen pressure on Congress (I am not so much worried about the Fed right now). And then there is a non-trivial segment of the financial community that are only happy if everything is burning down.

I think somehow the idea of a bottom is often interpreted as announcing an “all’s clear” for the economy. That, however, is certainly not the case. The raw GDP numbers will not tell the whole story. The “bounce” is an artifact of GDP accounting. Behind the scenes will be a huge tug-of-war between opposing forces as the economy grinds out a new equilibrium. The second and third order effects of the initial shock will be passing through the economy even as the first order impact is partially reversed. As an end result, the economy might turn, but it is turning from an extremely low level and the rate of future growth is uncertain.

The lagging nature of the data flow will further complicate our understanding of when the economy reaches a bottom. There are really no leading indicators for this recession. We knew the economy was in recession before the confirming data began trickling in. We know it is already unimaginably bad. We know it will continue to be unimaginably bad even after the economy bottoms just as the incoming data remained strong even as the shutdowns began.

In effect, the compressed nature of the front end of this cycle heightens the traditional “level versus direction” conflicts. The initial claims data reveal this conflict. Claims have declined for three consecutive weeks, from “beyond apocalyptic” to just “apocalyptic.” Claims are terrible but less terrible and being less terrible seems important. Less terrible is a precursor to better.

“Better,” though, for much of the economy remains a long ways off. Reopening the economy will prove much less easy than shutting it down. Broadly speaking, there are three main impediments to a rapid recovery. First, we can’t open up the economy entirely; social-distancing measures will be reduced, not eliminated. Second, consumers will venture out only cautiously (ultimately, we decide when the economy reopens, not the government). Third, we still don’t yet know the full extent of the persistent damage caused by the shutdowns, which firms close, which employer and employee relationships are severed.

The amount of damage to the economy, as well as the magnitude of the second and third order impacts, depend on the effectiveness of federal fiscal support. That has been something of a mixed bag largely due to the timing of moving money out the door. But it’s coming, and it is nontrivial. The PPP loans are making their way into the economy and the pot has been refilled. Continuing unemployment claims rose to just shy of 16 million, but at roughly $1,000/week after the $600 federal boost we get to $16 billion/week or $64 billion per month. That’s real money supporting the economy.

Still, PPP and the enhanced UI will not be sufficient to entirely support the economy (it’s support, not stimulus). We still need expansive aid to states and local governments to cover severe budget shortfalls; such aid will help mitigate the second and third round impacts of the shutdowns. Republicans in Congress are reportedly balking at additional aid with claims that we need to worry about the deficit and complaints about the fiscal irresponsibility of states. Neither claim is relevant at this point. States and local governments should be held blameless just as individuals and firms: The goal is to provide a bridge to the other side of the shutdowns to minimize damage to the economy. I suspect Congress will eventually reach this conclusion, but the possibility that they don’t should be on our list of downside risks.

Most importantly, Congress needs to pivot to viewing this crisis as temporary to a situation that is likely to need to be managed on a long-term basis, both from public health and economic perspectives. We need to be thinking of how to handle the economic fallout for regional outbreaks in the future and creating a public health infrastructure to manage the virus. These are the sorts of actions that will enhance the resiliency of the economy until a treatment or vaccine emerges.

Bottom Line: The economy may bottom in a mathematical, GDP sort of way this quarter, with a subsequent pop in the third quarter. This should not be confused to a “bounceback” or a “V-shaped recovery.” We are past that point. That was an options for a two-week shutdown and rapid reboot. This is a months-long shut down with a slow reboot. The economy will need ongoing fiscal support through that process for it to be successful (monetary policy support too but I take that as a given). And even with that support, the recovery will be slow and choppy (see the challenges of recovery in Wuhan). I suspect what will be most different in the near future is not so much “what” we do but “how” we do it. Efforts will center on trying to resume as much of our past behavior as possible while learning to live with the virus.




It’s Ugly Out There

The data is catching up to reality and it is … unpleasant.

If you stop the economy, some activity is going to drop to zero, which will yield some pretty substantial monthly declines. And that means you are going to get some pretty crazy annualized changes. Like this for retail sales:

And this for industrial production:See also the Beige Book for some distressing anecdotal discussions of the economy. Also, as should have been expected, this wasn’t a classic supply shock that produced a jump of inflation. Instead, the demand side weakness dominated and dragged inflation down:Of course, we really shouldn’t have expected anything else. Once we made the decision to shut down large parts of the economy, the data and anecdotes are going to follow in a fairly predictable way. In fact, a failure of the data to collapse would indicate that the shutdown was not successful. The collapse in data is almost not a bug, but instead it’s a feature of the broader policy.

Yes, even if expected, it is still a bitter pill to swallow. Making it more bitter is that the policy response is looking shaky. Certainly, some of the shakiness of the policy response is more about the execution rather than the intention. The objective was correct; attempt to keep as many people as possible attached to their employers and provide a generous safety net to those who lost their paycheck. Getting the money out the door, however, has proved a bit more complicated.

The enhanced unemployment benefits scheme looked good on paper but fell victim to woefully unprepared state governments. Partly the lack of preparedness is understandable. Even well-prepared states might fall short of the mark if they built systems for the “worst case” scenario of the Great Recession. But the technological limitations speaks to a broad-based failure to modernize the programs. I suggest that states adopt a “presumption of benefits” standard and push out the money while the paperwork is still in the pipeline.

The Payroll Protection Program (or PPP, an acronym  I hate because I can’t read it without thinking “purchasing power parity”) also found itself under the constraints of an underpowered system that has delayed the release of money. Moreover, the money has now all been spoken for and Congress needs to boost the size of the program.

That said, the money is beginning to flow and will flow harder in the coming weeks. That’s good; it will help keep a floor under the economy. More though will still need to happen to support the economy through the shutdown. Congress will advance another support bill to extend the PPP. Congress should also deliver more aid to state and local governments. And there is still that thorny problem of completing the chain between renters and investors in the commercial real estate space.

If Congress wants to keep the economy afloat, it needs to keep shoveling the money. The Fed has implicitly given the green light to spend away, and Congress should take it up on that offer.

I think the short story is that, from a macro policy perspective, we are moving in the right direction but more needs to be done to hold the economy together. Still, the ultimate constraint on the economy is that it can’t begin recovery until we can start to loosen the extreme social distancing and stay-at-home orders that are dragging dragging down activity.

Eventually that time will come (but don’t rush it or all the work we just did will be in vain; I am hoping by the end of June if not the beginning), and we should anticipate the economic numbers to pop on the upside. Think of the same story in reverse. Even assuming that reopening the economy is like turning up a dimmer switch, there will still be pent up demand activated and some activity will be starting from a base of almost zero. There is little place to go but up.

Keep a pragmatic outlook. Don’t confuse that pop for a V-shaped recovery. It isn’t. There will be some lasting damage to the economy. Arguably, PPP should have come first and more forcefully and then perhaps fewer layoffs and furloughs would be working through the system. Moreover, more now PPP might be cold comfort to firms that have already folded. I think it is hard to fix that damage, which will in turn slow the eventual recovery.

Moreover, we will open the economy gradually. Social distancing restraints will ease but not disappear. No large gatherings, fewer seatings at restaurants, etc.  And I anticipate people will approach many activities only cautiously. Ultimately, we the public will decide when the economy reopens, not the government. Travel, leisure, hospitality will face a tough road in the year (or longer) ahead.

Still, on the theme of pragmatism, don’t dismiss the importance of that first pop of activity. It marks a turning point, a place to begin rebuilding the economy. The level won’t be where we want it to be and we will need to maintain pressure for ongoing policy support to foster the economy, but the economy will be moving in the right direction. Don’t become too enamored with either the pessimists or the optimists; the reality will fall somewhere in-between.

Bottom Line: Controlling Covid-19 requires drastically constricting economic activity; the proof that the plan is working is that the data collapses and we bend the infection curve. The former has definitely happened and it looks like the latter will as well – social distancing works. We still have a long way to go until we return to some semblance of normality, but expect people to begin working in that direction when the restrictions on activity ease. Most important now is to keep the pressure up on Congress to provide sustained support for the economy; that support should be open-ended, based on economic conditions not time or dollars.

It’s Not About Debt Or Stock Buybacks Or Whatever. It’s About The Virus

Time to take a step back.

Just over a month ago, the U.S. economy looked poised for a solid 2020. Not spectacular, but a lift from 2019. Job growth was holding steady despite earlier fears that the labor supply would run dry as the unemployment rate sank below 4%. Housing markets were on an upswing and both the manufacturing and larger services sectors were on an upswing.

To be sure, we still had economic problems, largely related to inequality, but the broad macroeconomic contours looked solid. And, almost amazingly, there was no obvious bubble in the U.S. economy, no sector that had become relatively outsized as we saw in the last two recessions.

Then the pandemic broadsided the economy. No U.S. firm or employee was to blame. Their decisions had no part in creating the Covid-19 virus. The virus is, rhetorically at least, an act of God.

Nor could any individual or firm reasonably be prepared for a shock of this magnitude. In early March, it was still difficult to imagine that we could shut down the entire U.S. economy as happened elsewhere. No firm’s action could have prepared it for an event where the revenue stream literally entirely dried up overnight. No one runs a business on the assumption that that business won’t be there tomorrow. Such an assumption is ludicrous. You just simply can’t operate if you think the tail risk is in the center of the distribution.

And the pandemic isn’t just tail risk. It is far, far, left hand side tail risk.

It wasn’t the airlines’ fault for doing stock buybacks. It wasn’t the bankers’ fault for making bad or levered loans. Indeed, the banking sector is the only sector that is stress tested for a severe scenario of an 8% drop in GDP. It wasn’t the borrower’s fault for buying a house they couldn’t afford. It wasn’t your fault. It wasn’t my fault.

Look, I understand, in the finance and economics world we are used to a crisis being about us. But, this time it isn’t about us, as least not directly. This was as pure a shock to the national and global economies as one could imagine. One little tiny thing – you can’t even see it! – blew it all up overnight.

Unlike the last two cycles, the shock did not originate in the financial sector and spill over into the real economy. It originated in the real economy and spilled over into the financial sector. Neither is built to accept this level of damage. Just like I can’t blame my iPhone for shattering if I drop it from the roof of a ten-story building, I can’t blame anyone for what is happening in the economy. The phone isn’t made for that, just as the economy isn’t made to not be put to work.

From a macroeconomic perspective, there is no moral imperative to assign blame. There is no moral imperative to root out bad actors. There is no moral imperative to “punish” someone in the pursuit of “creative destruction.” In this situation, there is simply no reason to think that the activities that of 150 million people – our friends and neighbors– were just six weeks ago seriously misaligned.

The only moral imperative is holding together the economy so that those 150 million can resume their lives as quickly as possible. The only moral imperative is working to prevent another 15 million people from losing their jobs.

For the macroeconomy, it’s really not that complicated. Stop looking for someone to blame because there is no one to blame.

Somehow, you knew of course, that this had to circle around to the Federal Reserve. Thursday Federal Reserve Chairman Jerome Powell and his colleagues  stepped up their efforts – yet again – to keep credit flowing in the economy. The Fed’s overall objective is blindingly simple: To not let the financial sector seize up and reverberate back into the real economy. To not repeat the mistakes of the Great Depression. To not let another 15 million people lose their jobs. To hold as much of the economy together as possible to let those newly unemployed return to work as quickly as possible.

To accomplish its objective, the Fed has been jumping over roadblocks in credit markets wherever they appear. They have in a matter of weeks rolled out every program and more that former Federal Reserve Chair Ben Bernanke worked years to develop. In this last iteration, they expanded their corporate credit facilities to accept the debt of “fallen angels,” firms that have been downgraded from investment status, and high yield ETFs. Essentially, the Fed is trying to ensure that a firm that was investment grade before the virus and it likely to be investment grade after the virus passes does not fail because they downgraded as a result of the virus. It’s about preventing a liquidity crisis from becoming a solvency crisis.

This has triggered the usual howls from the usual suspects (I won’t link to them, you know who they are and they need no more attention than they already get) complaining that the Fed just needs to let everything burn and if they don’t let everything burn then nothing is real anymore or whatever. It’s not going to happen and it shouldn’t happen. No matter how much you want this to be a story about bad debt or excessive lending or stock buybacks or whatever, it just isn’t about that. It’s about the virus.

I don’t know when, but at some point we will begin to reopen the economy. We will have to learn to live with the virus. We won’t and can’t live in the shadows forever. And when that happens, we will want as much of the pre-virus economy as possible to ramp back up. The Fed (along with fiscal policymakers of course) needs to do everything they can to make that happen. Then it will be the Fed that drops back into the shadows again. Or as Powell said today:

Our emergency measures are reserved for truly rare circumstances, such as those we face today. When the economy is well on its way back to recovery, and private markets and institutions are once again able to perform their vital functions of channeling credit and supporting economic growth, we will put these emergency tools away.

And once the panic has passed, if you think the Fed is going to save you from your bad debt decision, think again. The Fed will once again allow countless firms to fade away just as has happened over past decades. But they will come back again if needed to bail out the economy as a whole because they consequences of not doing so are so severe that you couldn’t possibly expect otherwise.

The Three “Ds” of Depression

The U.S unemployment report for March foreshadowed the ugly numbers to come as the economy’s sudden stop sidelines entire sectors. The prospect of double-digit unemployment rates raises the possibility that what is now the “Great Suppression” will become the next Great Depression. This raises an important question for market participants: What separates a depression from a recession? A starting place is to consider the three “Ds” of a depression: Depth, duration, and deflation.

Continued at Bloomberg Opinion….