We believe recent shocks will cause the economic dominos to topple over, leading to a technical recession in 2020.
In January, we expected another year of modest economic growth riddled with uncertainty that would leave the dominos wobbling but not tumbling into a recession.
However, the new coronavirus and a simultaneous oil shock have increased the probability of a global recession. Our forecast for real U.S. gross domestic product quarter by quarter is as follows:
• 0.8% in Q1;
• (2.4%) in Q2;
• (0.4%) in Q3; and
• 1.8% in Q4.
For the calendar year, we anticipate GDP to be positive in the 0.4%-1% range.
The first two months of the year showed signs of economic improvement. Manufacturing was rebounding, the labor market was solid, and the stock market peaked on Feb. 19.
This recession will not be caused by the typical factors of economic imbalances, excess, inflation and increasing interest rates. It will be caused by Òblack swans,Ó or shocks. The 9/11 terrorist attack and the Japanese tsunami in 2011 were black swans that shut down economies. There is one material difference between then and now, however; during those events, consumers were encouraged to continue life as usual and spend. Today, the message is self-imposed quarantines.
Perhaps some good news is that recessions caused by external shocks have been shallow and short-lived. After 9/11, the U.S. experienced a 1.7% contraction in third quarter GDP. By Q4, GDP was up 1.1%.
Shock 1: COVID-19
The coronavirus is a black swan. There are so many unknowns at this time and an important, yet unanswerable, question is how long it'll last. Based on the virus' reproduction rate in China and Italy, the U.S. is in the early stages of the number of new cases. We do know the spread of the virus can be contained. China has taken draconian efforts to quarantine millions of people and close numerous businesses.
In the U.S., we are seeing self-imposed quarantines, events and gatherings canceled, and businesses suggesting employees work from home. The result of this will be that economic activity grinds to halt, corporate earnings evaporate and the stocks enter bear markets.
Shock 2: Oil
In early March, negotiations within the OPEC broke down, causing oil prices to sharply sell off as everyone is free to "pump at will" and increase supply while aggregate demand is waning.
We have seen shocks in the energy space before. From 2014 to 2016, oil prices declined by 60%. At the time, business spending declined significantly, impacting GDP. However, the consumer benefited, harvesting additional discretionary income, which grew consumption and boosted GDP. Today, the consumer will benefit from lower prices; however, they are not encouraged to spend.
The stock market is a leading indicator. Currently, it's down peak to trough well over 25%, indicating a bear market.
There is clearly some panic selling due to uncertainty. Typically, a 15% correction takes four months to play out. It took a mere 22 days for the S&P 500 to fall 26.7%.
The U.S. bond markets are treated as a safe harbor during periods of uncertainty. As the current drama has unfolded, investors stampeded into bond markets, driving interest rates dramatically lower at breakneck speeds.
Rates burst through previous all-time lows as investors prepared for the worst case. While the Federal Reserve jumped in on March 3 with an "emergency" cut to rates, the bond markets stampeded further ahead, and rates continued to plummet.
On Sunday, March 15, the Fed made a second decision and slashed fed fund rates by 1%, taking the rate back to its crisis-era target of 0.25%. In addition, the Fed will launch another quantitative easing, buying $500 billion of Treasury securities and $200 billion in mortgage-backed securities. The Fed cut the discount rate, the rate banks pay the Fed to borrow, to 0.25%. And finally, the Fed halved the cost of dollar liquidity swaps offered via other central banks.
Lower interest rates are one remedy for fading economic growth. But, we do not think the Fed action will prevent a technical recession.
Monetary policy may soften the recession blow; however, we do expect changes to fiscal policy. The overall stimulus package is incomplete - perhaps the stock market agrees as it continues to sell off. Changes in taxes or unemployment benefits may boost consumer confidence and spending. We are firm believers that the Fed cannot do it alone. Vast amounts of monetary and fiscal stimulus will be pumped into the economy, perhaps providing a launching pad for economic activity.
KC Mathews is chief investment officer at UMB Bank in Kansas City. The bank operates two Springfield branches and a private wealth management center.
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