The last week’s market highlights:
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2020 Midyear Outlook:
- U.S. economy: Looking for a full recovery by late 2021, albeit with high unemployment.
- Global economy: More monetary and fiscal stimulus is needed to keep businesses afloat.
- Policy watch: No Fed interest rate hikes until well after the economy has healed.
- Fixed income: Lean into higher-risk assets to generate income.
- Equities: Focusing on quality across the board (and dividend payers, too).
- Asset allocation: Consider benefits of active management amid idiosyncratic opportunities.
Quote of the week:
“On the anvil of August, the city lay paralyzed, stunned into stupidity by the heat.”
― Janet Fitch, White Oleander
― Janet Fitch, White Oleander
The Fed keeps its foot on the gas…
As expected, the Federal Reserve made no major policy announcements at its July meeting last week, keeping the fed funds target rate at zero (0.00% - 0.25%), where it has been since the early days of the pandemic in March.
And that’s where rates will remain until officials are “confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals,” the Fed noted in its policy statement. That view reinforces Chair Jerome Powell’s oft-quoted line from his June press conference, when he said the Fed hasn’t even begun “thinking about thinking about raising rates.”
So when might the Fed actually begin to tighten? Not until at least 2022 under the best of circumstances, in our view. And that time frame assumes the development of a coronavirus vaccine.
Among the revisions in July’s policy statement compared to June’s was a notable, albeit brief, addition: “The path of the economy will depend significantly on the course of the virus.” Powell reiterated this point during last week’s Q&A, saying “It’s so fundamental, I think we cannot say it enough, it’s so important.”
While he avoided providing specifics in response to questions about the stimulus debate in Congress, Powell repeatedly emphasized the positive effects of the original CARES Act passed in March and professed a belief that more support will be needed. “Fiscal policy is essential here,” he stated. Several CARES Act provisions have already expired, including the $600/week supplement to unemployment benefits, which helped prop up incomes and consumer spending.
In addition, Powell briefly mentioned the Fed’s ongoing monetary policy framework review, which will likely be concluded before the next meeting in September. The Fed routinely undertakes a wholesale review of its approach to monetary policy, and we expect a few significant changes starting later this year.
First, the Fed is likely to consider its 2% inflation target in a more symmetrical manner. This would involve permitting inflation to exceed that threshold when the economy is operating at full capacity to offset unavoidably low inflation during downturns like the current one.
Second, the Fed’s forward guidance may become more specific and outcome-focused, employing words like “until” and “unless,” along with concrete economic targets that must be achieved before policy is modified. Current guidance could change to include explicit unemployment and inflation targets that must be hit before the Fed hikes rates.
…while the U.S. economy slams on the brakes
We now have a more or less complete picture of the global economy during the first half of 2020. Virtually every country in the world experienced a sharp contraction lasting two to three months and, to varying extents, began to recover by the end of the second quarter.
Such was the story in the U.S. Even May and June’s “V-shaped” recovery from the devastating effects of April’s economic shutdown wasn’t nearly enough to prevent a huge drop in growth for the quarter as a whole. In fact, the April-June period was the worst quarter on record for the U.S. economy: GDP shrank at a 32.9% annualized rate, or, more simply, by 9.5% from the first quarter, according to the government’s advance estimate released last week.4 The scope of this economic contraction, while massive, was largely in line with forecasts.
Not surprisingly, the primary drivers of the decline were consumption (-25.1%) and investment (-9.4%). In terms of consumption, the largest negative impacts came from sectors hit especially hard by the pandemic, including health care, recreation, restaurants and hotels. Within investment, the non-residential category exerted a bigger drag than home construction. Trade was a wash, as both imports and exports cratered. Federal government spending added 1.2%, while state and local government spending subtracted 0.4% — worrisome, considering schools are in dire need of more funding to help ensure the safety of teachers and students when they eventually return to class.
There were a few bright spots in the GDP report. Real disposable income, for example, rose by 9.7%, thanks to the CARES Act. The increase in income boosted the personal savings rate to 25.7%, versus 9.5% in the first quarter. An additional silver lining will be if the report shocks Congress into action to deliver another round of urgently needed fiscal stimulus.
Now that we’ve digested what’s almost certain to be the worst economic data of this crisis, we can focus on our outlook. Will the U.S. economy rally in the third quarter? And if it does, how big might the bounce be?
So far, the only “hard” data for July shows that both initial and continuing unemployment claims are gently rising after weeks of declines.5 Moreover, “soft” (survey-based) indicators reveal that U.S. consumers and businesses are somewhat less optimistic about the next few quarters.
Nonetheless, we expect July’s economic data to come in far stronger than April’s, and that alone should drive third-quarter GDP growth higher. Current consensus forecasts call for GDP to expand at an annualized rate of +18% for the third quarter.6 But to echo the words of the Fed’s July policy statement, the path of the economy will depend significantly on the course of the virus. And the possibility of further lockdowns — especially in large states where COVID-19 cases and fatalities are on the rise, like Florida, California and Texas — casts a cloud over recoveries in August and September.