Federal reserve officials reiterated their commitment to maintain an aggressive stance on supporting the economic recovery. The fed policy is thought to remain extremely accommodating given the uncertainty and some stalling in large parts of the US recovery. The current consensus is that the federal reserve officials remain skeptical on the usefulness of their control over the yield curve.
The target range for the federal funds rate is 0-0.25% to help bolster and support businesses through the pandemic. This, coupled with waves of increased government spending, is hoped to ease the negative impacts of the recession and help recovery efforts. Payment Protection Programs, stimulus, and direct deposit have significantly helped in some areas of the economy. It is forecasted that the interest rates may stay low, around current levels, throughout 2020 and throughout 2021.
GDP Before, Now, And Ahead
GDP took a historic downturn due to the recession brought on by COVID-19 quarantines and lock-downs. The inability to halt the increased spreading of COVID eventually impacted nearly all of the continental US and Americas, and planet, resulting in travel bans and difficulty performing normal daily routines for consumers. This type of crisis was unprecedented in the modern world economies, as no previous crisis halted businesses to a near standstill except essential workers. Because of this, the 2nd quarter GDP contraction results were an astounding -32.9% QoQ (estimates were roughly -34% QoQ). Before then, the economy was enjoying higher than normal GDP growth. Current forecasts place 3rd quarter estimates at a +15% QoQ recovery. This trend is expected to slowly return to normal through 2021 towards previous norms of about 2%. Current estimates put the total US economy shrinking by 6.5% in 2020.
While GDP remains low, there are signs of economic recovery in process. Unemployment levels have been actively watched since the recession was believed to be occurring at the beginning of the COVID outbreak. In April, Unemployment was recorded at 14.7%. However, in May, June and July, rates dropped to 13.3%, 11.1% and 10.2%, respectively. This represents a positive trend against the unemployment crisis. It is with this data we see indications that the economy is in recovery which could contribute to an uptick in consumer confidence in spending and corporate profits, increasing GDP over the near to long term. While it may be many months before unemployment returns to pre-COVID levels, the current trend contributes to our semi-positive outlook.
Consumer Price Index (CPI)
Another positive contributor to our outlook is Consumer Price Indexes. This statistic uses average prices of products or services consumer purchase for their household and can be a indicator for price equilibrium between supply and demand. Generally, prices drop in reflection to decreased demand then increase as demand also increases until they reach equilibrium. This contributes to our outlook as it may reflect a normalization of demand for common goods in urban areas. During 1Q of 2020, CPI began to drop in response to COVID fears, and by 2Q prices were nearing 2 year lows. By July, prices were increasing back to normal pre-COVID levels.
Inflation is another statistic of interest when looking at economics. Pre-COVID/recessionary inflation hovered around a healthy 1.9-2.1% range. During 1Q and 2Q of 2020, however, we can see a drastic drop during the recession with a slight rebound occurring May-July. This indicator is based on CPI and can also hint towards deflation of other goods. Further research will be necessary to see where consumer spending indicated both inflation and deflation of goods during the economic recovery to gauge purchasing power of certain products and services. While it is a positive indication that inflation has reversed from its lows of 0.1 in May, the upward trend could be pointing towards time lag between different recovery times of US markets.
Consumer Spending will be another uncertain indicator we will want to watch moving forward. Currently, consumer confidence is low, and spending reflects that. 1Q of 2020 reflects a slight decrease in consumer spending before a significant drop ending 2Q. While there are still time lags between now and consumer spending for 3Q, analysts project a low 3Q but a much sharper increase in 4Q, and steady normalization of spending in 2021.
While it is encouraging to see optimism in consumer spending, there are risks ahead that may hinder these projections. A second wave of COVID-19 requiring further closures and stalled business-as-usual. The federal government easing and then stopping of stimulus may also negatively impact spending. Currently, there are worries that eviction protections running out will lead to a housing crisis from renters and landlords, which could lead to volatility in discretionary spending. The time lag between the recovery of consumer spending will be especially important in the months ahead as they will indicate consumer confidence and a return to norms. Given the current trends in unemployment, inflation, CPI and consumer spending forecasts, we remain semi-positive in economic performance.
Our economic overview, accompanied by data gathered from the U.S. Bureau of Economic Analysis, points towards a uncertain but positive economic look based on the positive trend in unemployment, CPI, consumer spending and federal interest rates. Because of this, we believe that corporates show good opportunity for fixed income. Corporate bonds would benefit from a positive economic outlook with lower duration, higher yield, and lower credit rating (at or below investment grade, not junk). We would also recommend looking into Government-related bonds in both local authorities and sovereign. Securitized CMBS also appears attractive as all bond ideas listed before have high OAS (options adjusted spread). We also believe that EM (Emerging Markets) would be a potential play here, as many countries have stalled their business cycles and nearly lined up, making international trade beneficial in both imports and exports as country’s recover from their simultaneous recessions surrounding COVID.