This week we head toward an unfathomably bad employment report as we process a grim reality: This is simply no easy way to reopen the economy and an effort to do so before resolving the underlying public health situation may push us back to square one

The current situation differs from the past in that we deliberately closed large portions of the economy in an effort to contain the spread of Covid-19. The incoming data should thus be fairly predictable. To be sure, it hasn’t disappointed. Initial unemployment claims were without a doubt the harbinger of the data flow to come. While we look to be on the downside of the initial claims surge, that is kind of the definition of “cold comfort” when the level is ridiculously high:

If you can’t leave the house, you can’t spend. You can’t spend, the consumption numbers collapse:

I thought it was such a clever idea to annualize all of my charts to better connect the monthly changes to the annual changes. Of course, at the time I would not have anticipated an event that make it seem as if consumption had fallen by more than 50%. Annualized numbers aren’t much help here as in the short-run as they overstate what is already a bad enough situation; the 5% year-over-year decline is recessionary all on its own.

The saving rate jumped in March as should have been expected:

The spending collapse outweighed the decline in income. This should not be taken on face value of evidence that a massive surge of pent-up demand awaits us. The saving rate as calculated here is simply a residual of income minus consumption; the surge in the saving rate is an artifact of the income and consumption patterns, not a deliberate choice on the part of consumers. In subsequent months, we will see incomes collapse which will drive the saving rate back down. Yes, there will be pent up demand that is unleashed when the social-distancing restrictions ease, but it will be far more modest than suggested by this number.

Likewise, manufacturing activity took a hit:

Beware that a declining speed of supplier deliveries boosted the headline number. Typically, slower deliveries indicate tight demand. Now it reflects supply chain disruptions. There was a touch of deflation in core-prices:

Last week, Federal Reserve Chair Jerome Powell expressed confidence that deflation would be kept at bay:

I would say, as long as inflation expectations remain anchored, then we shouldn’t see deflation.

I am somewhat less confident, while there is a resurgence of inflation fears among some segments of the finance community. Hard for me to see that outcome given the demand shock ripping through the economy.

OK, the current situation is bad. Very bad. Still, eventually we need to move forward, right? Yes, but what will “forward” look like? It is becoming increasingly evident that “forward” will be slow and choppy. Restarting the economy looks increasingly difficult with each passing day

We are getting a glimpse of that reality as states trying to reopen are quickly learning that it isn’t about flipping a light switch. From the Wall Street Journal:

The early experience in South Carolina and other states is a sobering portent for the country as a whole, suggesting it will take more than lifting lockdowns for economic activity to rebound.

It also illustrates the limits of policy makers’ influence when residents’ and businesses’ behavior depends on their own perceptions of risk. In many places, activity shut down long before governors issued their stay-at-home proclamations. The data so far suggest it will take a while after orders are lifted for the economy to pick up again.

You can lead a horse to water, but you can’t make it drink.

Ultimately, I decide when and under what conditions I begin to normalize my behavior. I shut down before Oregon’s Governor Kate Brown ordered it, and I would stay shut down if she reversed those orders anytime soon. The parts of the economy that survive on low margins and high volume – think leisure and hospitality – simply can’t stay up and running if any sizable fraction of people remain unwilling to resume their pre-virus activities. Sure, you can let a restaurant open at 50% capacity, but how many can survive at 50% capacity? Not a lot.

Effectively, the economy is contracting to a new equilibrium that incorporates the threats posed by the virus. We can’t get back to the old equilibrium until we manage those threats. Managing those threats requires a strong, coordinated public health response. The public health policy is the economic policy.

Unfortunately, the U.S. lacks a coordinated, national response. The response is piecemeal, state-by-state. Some states, such as South Carolina above, are learning the hard way that you can’t restart the economy simply by waiving a magic wand. Moreover, such states also risk a resurgence of the virus by reopening prematurely; this would like result in a new round of closures. The first round of closures would become a completely wasted effort.

 The lack of a sufficient public health response also means that the Federal aid to support the economy will prove to be insufficient. The intention was correct, but the execution flawed. We see this most clearly in the unemployment insurance situation. The state systems where not capable of handling the influx of applicants and the enhanced benefits will end too soon if the economy is unable to rebound.

The SBA lending program similarly suffered from an overwhelming number of applicants. Moreover, firms are finding it difficult to spend the money due to the requirement that 75% of loans must be used for payroll within 8 weeks: see the Wall Street Journal here. If the economy remains weak, then firms will find they need to fire the rehired workers, so why pull your employees off of unemployment now? The loans will prove most beneficial to firms that didn’t lay off people in the early stages of the shutdowns and could limp along without the loans to begin with. For other firms, the loans can’t compensate for a lack of customers.

What to do? We need a coordinated public health effort sufficient to mitigate the risks of the virus enough to provide a reasonable degree of confidence among the general public, extended aid for workers and firms that is less restrictive and phase out on the basis of economic outcomes not time, and aid for state and local governments. The longer we delay these actions, the less robust will be the recovery.

Bottom Line: The public health response is the most important economic policy. The economy will be stuck at a lower equilibrium until the public is confident in their ability to manage the personal safety. Until that point, we limp along at sub-optimal levels.

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.

Federal Reserve Vice Chair Richard Clarida expressed confidence earlier this month that the U.S. could avoid an outbreak of deflation. I have become increasingly less confident that we can avoid such an outcome as rising anecdotal evidence of wage cuts reveals the magnitude of the negative demand shock that has slammed through the U.S. economy.

Continued at Bloomberg Opinion….

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.

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.

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 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….

A few items for you consideration this morning:

1.) My column at Bloomberg from last week:

The Federal Reserve has taken unprecedented steps in recent weeks to cushion the U.S. economy from the effects of the expanding coronavirus pandemic, including slashing its benchmark interest rate back to zero and eliciting the usual cries that the central bank is “out of ammunition.” Nothing could be further from the truth.

Continued here…

2.) Consumer confidence tumbled in March, but remained within its recent range:

Expect further declines in April as the unemployment rate climbs higher.

3.) Speaking of unemployment, last week the CARES (Coronavirus Aid, Relief, and Economic Security) Act was signed into law. The act provides for enhanced unemployment benefits of $600/week for up to 4 months on top of state benefits and includes the expansion of benefits to “gig workers.” The additional benefits will push the average replacement income for eligible workers in many states above 100%:

This is very substantial support for unemployed workers and should help cushion the economy during this “sudden stop” of economic activity.  For more information of state-by-state comparisons, see this report from the University of Wisconsin (source of above chart).

4.) The CARES Act also provides support for small- and medium-sized firms. Of particular importance is the Paycheck Protection Program which provides forgivable loans to cover payroll costs (excluding costs for any compensation above $100,000 annually), mortgage interest, rent payments and utility payments. The loans do not require a personal guarantee or collateral. The hope is to have these loans available as early as this week. Like enhanced unemployment insurance, this is the type of program that, if utilized quickly, can help firms stay afloat and preserve the basic structure of the economy. More more information, see this from the U.S. Chamber of Commerce.

5.) For helping to plan when we might see the other side of this crisis, see this helpful report from the American Enterprise Institute: National coronavirus response: A road map to reopening.

6.) On the academic side, see this report from the New York Federal Reserve on the benefits of early and aggressive action to contain pandemics:

Our paper yields two main insights. First, we find that areas that were more severely affected by the 1918 Flu Pandemic saw a sharp and persistent decline in real economic activity. Second, we find that cities that implemented early and extensive NPIs suffered no adverse economic effects over the medium term. On the contrary, cities that intervened earlier and more aggressively experienced a relative increase in real economic activity after the pandemic subsided. Altogether, our findings suggest that pandemics can have substantial economic costs, and NPIs can lead to both better economic outcomes and lower mortality rates.

7.) Finally, please stay safe! We are seeing distressing reports that the deaths attributable to the novel coronavirus in China may be far higher than originally reported. From Bloomberg:

The long lines and stacks of ash urns greeting family members of the dead at funeral homes in Wuhan are spurring questions about the true scale of coronavirus casualties at the epicenter of the outbreak, renewing pressure on a Chinese government struggling to control its containment narrative.

We are still nowhere near the end of this crisis.

As I write tonight, futures markets have limited down again, setting the stage for another ugly Monday morning. A reported factor in the decline is the failure of the Senate to move forward an economic stimulus bill. That may change tomorrow, but even so it must also pass the House where Speaker Nancy Pelosi can advance her own bill. The politics make it difficult to hammer out legislation quickly this week.

That said, perhaps I am being too pessimistic. Legislators have a strong incentive to get the job done given that coronavirus now strikes a little too close to home. Two U.S. House of Representative members have already tested positive and today we learned that Senator Rand Paul has also tested positive. Senators Mitt Romney and Mike Lee self-quarantined on that news, having had close contact with Paul.

Paul apparently made the curious decision to exercise at the Senate gym while awaiting his test results. Which raises the interesting question of why the Senate gym remains open in the first place? Rather than dwelling on those issues, we should instead consider that we don’t seem to find one case in isolation; others inevitably pop up soon thereafter. So one would think that members of Congress, and in particular the older members of Congress like say Mitch McConnell (78 years old), would be eager to wrap this up and maybe engage in a little social distancing.

The delay will hamper the Federal Reserve’s efforts to fight the turmoil in financial markets. Via Bloomberg, the legislation reportedly included funding for the

…Treasury to use $425 billion of the $500 billion “to make loans, loan guarantees, and other investments in support of programs or facilities established by the Board of Governors of the Federal Reserve System for the purpose of providing liquidity to the financial system that supports lending to eligible businesses, states or municipalities.”

This would apparently (unfortunately I don’t have a copy of the proposed legislation) expand the Fed’s ability to create lending facilities to support corporate and municipal debt or even buy such debt outright as they do mortgage backed securities. This would put some considerable firepower behind the Fed’s efforts to unstick financial markets. The sooner the Fed can be more creative, the better.

To be sure, please do not interpret this as criticism of the Federal Reserve. Chair Jerome Powell and his colleagues brought out tools over a two-week span that took years to develop during the last crisis. The Fed has acted with truly impressive speed and I expect it will expand its efforts further. The Fed is not out of ammunition.

That said, the Fed can’t do this job alone and needs the support of fiscal policy. I fear that while we may be temporarily appeased by the initial round of fiscal efforts, Congress and the administration have yet to come to grips with the evolving economic situation. The sudden stop of the U.S. economy is sending unemployment soaring. Initial claims may exceed 2 million this week after state and local governments around the nation began ordering shutdowns of everything except essential services.

My concern is that the fiscal package recommended by the Senate is both too small and too reliant on existing tools to alleviate the damage to household finances and stave off a wave of business closures that would threaten the ability of the economy to bounce back later this year. Other nations are moving much quicker to keep workers on payrolls for an extended period of time. See, for example, the U.K. plan, which pays grants to firms of 80% of salary of employees if companies keep them on the payroll. Moreover, the initial three-month phase would provide some longer-run certainty for firms and employees.

The goal is to keep firms solvent and connected with employees such that the economy can ramp back up after we have some measure of control over the virus (as has happened in China and South Korea, for example). The risk for market participants is the permanent damage to the economy that will occur with insufficient federal support for jobs during this crisis. This is not just another recession; we need bigger and newer tools to mitigate the damage. I am eagerly awaiting the House stimulus plan to see if it moves further than the Senate proposal.

Bottom Line: This week the data will start to catch up to reality and it’s going to be ugly. And beyond that, the coronavirus case load and death count will climb higher; we have only just begun to learn the extent of the spread. We still can’t see to the other side of this, and we can’t yet rely on fiscal policy to support us until we get there. I don’t think this is pessimistic as much as realistic. I have yet to see reason to expect financial markets will stabilize anytime soon.

In an effort to keep financial markets from spiraling out of control, the Federal Reserve came out with the big guns Sunday afternoon.This will not prevent the economic downturn that is already upon us. It will, however, create more accommodative financial conditions that will help support the eventual recovery. In the near term, however, the Fed’s action will – hopefully – support smooth functioning in financial markets and ensure that the problems on Wall Street do not feed back onto Main Street. The Federal Reserve has now passed the ball to fiscal policy makers, at least for the time being. This doesn’t mean the Fed is done; Powell & Co. have more ammunition if needed later.

Quick summary of the Fed’s actions today:

1. Cut policy rates to 0%-0.25%. Back to the zero bound all at once. It was the Fed’s only choice.
2. Forward guidance. The Fed committed to holding rates near zero “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”
3. Quantitative easing. Federal Reserve Chair Powell didn’t call it quantitative easing, saying instead the label doesn’t matter as long as it gets the job done. Fed will be buying $500 billion of Treasuries (presumably across the curve as the New York Fed signaled last week) and $200 billion of mortgage backed securities.
4. Discount rate cut to 0.25%. This is kind of a big deal, basically drops the discount rate to the overnight rate to take the stigma out of using the discount window (they really want this stigma gone). Plus, banks can borrow from the window for up to 90 days.
5. Intraday Credit. Fed wants banks to use its intraday credit programs.
6. Loan guidance. Fed signals that banks should use their liquidity and capital buffers to lend to household and firms. The Fed is telling banks this is the time to use those buffers.
7. Reserve requirements. Fed eliminates reserve requirements, which were pretty much irrelevant in a system of ample reserves.

Powell made very clear in the press conference that the Fed’s objective is to support the smooth functioning of financial markets. In particular, the Fed is reacting to the liquidity problems that crept up in the Treasury and MBS markets last week. Powell explained that the Treasury market is the foundation of the global economic financial system and keeping it functioning was the Fed’s primary objective. The MBS market is critical to keep credit flowing to households.

Powell said he expected the second quarter to be very weak but had little confidence in forecasts beyond that. It depends on how the virus evolves. He rightly noted that the rate cuts would not have an immediate impact on the economy, but will support the rebound in activity on the other side. He highlighted the role of fiscal policy in moving targeted aid to individuals and firms directly impacted by social distancing measures. To my ears, he wasn’t yet convinced of the need for a bigger fiscal stimulus, though I think this was because he wasn’t yet confident the downturn would last more than a quarter.

With regards to his own health, he has not been tested for the virus, he feels healthy, and he is doing some teleworking.

The will not be meeting again this week as originally planned. There will not be a Summary of Economic Projections. Powell said the forecasts would be pretty useless right now. And thankfully we then aren’t faced with the prospect of any “hawkish” dots in the 2021 rate forecasts.

Inexplicably, Cleveland Federal Reserve President Loretta Mester dissented against the rate cut, preferring instead just a 50 basis point cut. I await her explanation; I hope it isn’t about “saving ammunition,” which would be pointless argument now. I don’t see much percentage in trying to emulate a Richard Fisher or Thomas Hoenig in this crisis.

The Fed shot a lot of bullets today, but they are not yet out of ammunition. Most of today’s policy moves were designed to support market functioning, not the economy directly. They can do more on both fronts. For example, regarding market functioning, they can expand the size of asset purchases or, if needed, develop 13(3) emergency lending programs. Note that the asset purchases were of a fixed amount. The Fed could switch back to an opened commitment and link it via forward guidance to explicit economic objectives. They can follow up with yield curve control. Then there is the possibility of regime change toward average inflation targeting, etc. That said, in the near term we really need fiscal stimulus. The Fed has paved the way, but they can’t make Congress and President follow their lead.

Financial markets did not exactly cheer the Fed’s move; equity futures limited down, setting the stage for another difficult day on Wall Street.This should not be unexpected. I don’t see the possibility of any near-term stabilization in financial markets until we get more clarity on the challenges we face. This week reality will be settling in as much of the economy is going to be shut down. Testing will expand and the confirmed cases will grow. So too will the number of deaths. I don’t see where the Fed can do much more than keep financial markets functioning in this environment. This is important to sustaining the free flow of credit; crippled credit markets would only make the downside worse. But until we get enough testing, mitigation, and containment to bend the curve, market action will retain that distinctly bearish mood.

Bottom Line: The Fed realized this was a “go big or go home” moment, and it rightly decided to “go big.” The Fed basically signaled as clear as it could that it was ready to backstop the financial markets. I am thinking Powell is not going to let another Lehman Brothers happen on his watch. The Fed can’t, however, keep the economy from diving into a hole in the second quarter. Market sentiment now is probably going be driven by the prospects for fiscal stimulus.