Sharp U.S. Recession Ahead as Crisis-fighting Toolbox Reaches Limits

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The U.S. economy faces a historic crunch that's already close to exhausting the Federal Reserve's (Fed) arsenal and which could yet necessitate the most significant shake-up of the crisis-fighting toolbox in modern times.

President Donald Trump was reported Tuesday to be preparing an $800bn set of relief measures that would support companies and households to a tune of just over 4% of GDP, if it can get through a divided congress where Democratic Party officials proposed a package worth around $750 bn on Monday.

He also told a press conference the government isn't ruling out restricting the movement of Americans within the country and Treasury Secretary Steven Mnuchin said the government will be "sending cheques to Americans" within two weeks. This is the same day Canadian Prime Minister Justin Trudeau said the House of Commons is recalled to approve measures aimed at getting cash to citizens who've had incomes disrupted by the coronavirus. 

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"Policymakers are moving with increasing aggression on the bailout front – skipping quickly from talk of traditional stimulus to cash handouts for companies and individuals. France has led in Europe with French president Macron vowing to go to war on the virus and the government back EUR 300 billion in bank loans and announcing a few tens of billions in other measures, saying no business would be allowed to fail as the country looks set to become the new epicenter of the virus outbreak in Europe, together with Spain," says Steen Jakobsen, chief investment officer at Saxo Bank. "Ideas for giving every citizen in the US $1,000 are already circulating in US Congress." 

Confirmed coronavirus cases hit 1,714 in the U.S. Tuesday, up sharply from around 1,300 on Friday and just 148 the previous Friday. In short, the U.S. could now be on the verge of its own surge in infections, one which some analysts fear will leave America looking like “a larger version of Italy”. Already San Francisco has been placed into a draconian ‘lockdown’ while federal as well as local governments are now encouraging social distancing. Meanwhile, New York Mayor Bill de Blasio is reportedly also considering a 'shelter in place' order for a city that plays host to one of the world's largest financial centres.

The Fed cut rates to the ‘zero lower bound’ in a surprise announcement Sunday and formally relaunched its quantitative easing (QE) program, firing what many say was its last bullet in a panicky but ultimately failed bid to shore up market confidence. Risk assets had rebounded strongly Friday after President Trump declared an emergency that freed up $50bn in disaster relief funds but Spain and France then followed Italy in placing all citizens under ‘lockdown’ at the weekend, prompting risk assets to unravel Monday. 

The rub for President Trump, opposition lawmakers and the Fed is that even those amounts could be woefully inadequate in combating the crunch now seen ahead for the U.S. economy as it grapples with a coronavirus outbreak. 

The crisis-fighting toolbox of rate cuts and QE has reached its limits and some say the government now needs to spend a sizable chunk of GDP to combat the blow delivered to the economy by efforts to contain the viral pneumonia. Others say that with the economic and financial outlooks as they are, central bank “monetisation” of government deficits is needed rather than the small beer fiscal stimulus typically deployed to counter crises.

“We don't know yet whether Congress will spend, say, 2% of GDP or 10%. We hope for the latter, but given that the very modest first-stage House bill has not yet passed the Senate, it's hard to be wildly optimistic,” says Ian Shepherdson, chief economist at Pantheon Macroeconomics. ”We are becoming more pessimistic about the near-term economic outlook. Discretionary consumers' spending—that is, consumption excluding housing, healthcare, food and energy—accounts for some 39% of GDP, and some of the major components are set for massive second quarter meltdowns.” 

The Fed’s Sunday policy action is just one of many taken by central banks across the world in the last week as signs of coronavirus-induced pain began to manifest in falling footfall in retail outlets and in the restaurant trade. Retail sales were shown Tuesday to have already fallen by -0.5% in February, before coronavirus ever had an impact on the economy.

Shepherdson says plummeting restaurant reservations on OpenTable, where bookings were down -42% year-on-year at the weekend, and falling hotel occupancy rates are indicative of what’s yet to come for broad swathes of the remaining economy. He says consumer confidence and retail sales will “collapse” over the coming months and that this will deal a severe hit to the economy in the first and second quarters.

“We are pencilling-in a 20% plunge in discretionary consumers' spending in the second quarter, enough alone to subtract some eight percentage points from GDP growth. At the same time, we expect a steep drop in business capex as firms seek to preserve cash,” Shepherdson says. “We now guesstimate that second quarter GDP will drop at a 10% annualized rate, after a 2% fall in Q1. We look for a 6% rebound in the third quarter and 4% on the fourth, but that won't recover all the lost ground and we think GDP will fall by about 1% across the year as a whole. Congress needs now to step up, in real size.”

Shepherdson’s back-of-the-envelope estimates based on current and likely policy responses suggest the economy will face a double-digit contraction in the second quarter before rebounding strongly in the second half. Given the unprecedented nature of the crisis stemming from coronavirus and efforts to contain the virus, which is now in more than three quarters of the world's economies, forecasts can change within the blink of an eye. 

Pantheon assumes an annualised 6% growth rebound for the third quarter, toward the end of summer when it’s hoped the spread of coronavirus will have slowed, which is followed by an anticipated annualised growth rate of 4% in the final quarter. That leaves the overall 2020 contraction at -1%, although Shepherdson has emphasised that policymakers need to “step up.” Others say the effects of the crisis are so large that governments and central banks now need to consider "monetisation."

“We live in a world where there are far too many monetary claims after three decades of relentless ‘financialisation’. This makes us vulnerable whenever a deflationary shock threatens to trigger a domino effect that leads to a chain reaction of failures in the economy and a disorderly debt liquidation. Deep deflation would ensue, thereby threatening democracies,” warns Yves Bronzon, chief investment officer at Julius Baer. “The private sector, households and companies are being hurt by a major natural disaster, COVID-19. Losses must be offset by monetisation, otherwise a severe recession, followed by several years of chronic deflation, will ensue.” 

Monetisation would involve the printing of new money in order to finance ballooning government deficits, which would take the world a step closer to so-called modern monetary theory and risk seeing inflation return with vengeance. If such an approach is used to combat the economic fallout of coronavirus it would amount to the biggest shake up of the crisis fighting policy toolbox since the financial crisis and arguably be the most notable of modern history. Many economists, and especially the German ones, would be likely to object to it but Switzerland's Julius Baer says many now have little choice. 

Any second-half rebound would only come if economic activity was normalising, which might require the growth rate in coronavirus infections to have peaked. That could yet happen, especially with companies reverting to work-from-home arrangements while social distancing keeps consumers away from the shops and social haunts. Social distancing measures, not mention lockdowns, will hurt the economy severely but being taken in March they could yet be effective in heading off the spread of the virus. 

"As the coronavirus outbreak is hitting the economy, the concept of helicopter money is coming back into vogue again. The latest policy measures proposed by Western policymakers are not strictly speaking the implementation of helicopter money, but it looks a lot like it," says Christopher Dembik, head of macro analysis at Saxo Bank. "As the economic impact of the COVID-19 outbreak is likely to be more visible in coming weeks, the concept of helicopter money will certainly generate more and more support among policymakers."