US policy makers fire the bazooka... but where will the shell land?

In spite of the impressive fiscal and monetary response to covid-19, the US will not avoid a recession. The question is how long and deep it will be.

Thomas Costerg, Senior US Economist

US policy makers fire the bazooka... but where will the shell land?

US policy makers have responded swiftly, strongly and creatively to the macro shock of the coronavirus and the associated ‘sudden stop’ in US economic activity.

Congress has voted an unprecedented USD2.2 trn fiscal package (10.7% of GDP), which includes the sending of USD1,200 cheques to all Americans earning less than USD75,000 per year, as well as stepped-up unemployment benefits to help support consumption when the economy re-opens.

The Federal Reserve’s (Fed) actions have been unprecedented too, with quantitative easing (QE) becoming ‘unlimited’, and the launching of various creative credit easing programmes, including the buying of select corporate bonds—a step not even taken during the Global Financial Crisis.

 In just two weeks, the Fed has bought USD455 bn in Treasury securities alone (2.2% of GDP), the equivalent of “putting its money where its mouth is”.

The Fed also aims to deploy a cash backstop for commercial banks in the form of the Main Street Business Lending Program (whose target size is USD 4 trn) so that they maintain the credit tap open to small businesses.

Recalling the memorable words of the White House health expert Dr Anthony Fauci (“You don’t make the timeline; the virus makes the timeline”), the real issue now is the ongoing spread of the virus and the uncertainty about the length of the economic shutdown.

The White House this weekend backpedalled on its earlier promise to reopen the economy by Easter, saying current federal guidelines on social distancing would persist until end-April (most states have taken measures that go beyond the federal guidelines, and these will be key to assessing the timeline for reopening).

We recently cut our 2020 US GDP growth forecast aggressively to -2.1%, but the possibility that the macro shutdown spills into May means there is a growing risk we might have to cut the forecast again. Each month of shutdown leads to an irremediable, i.e. net, decline of approx. 20% in our GDP estimates (the gross impact, which is recoverable later, is twice to three times as big).

Key is now the swift deployment of the various policy measures to help avoid the cash crunch spreading out from small businesses, leading to second-round effects on the economy. A second (and even third?) round of cheques may be needed if the shutdown spills into May.

The tightening in financial conditions (for instance seen in surging high-yield bond spreads) and the sharp drop in oil prices (which is hurting the important US shale oil sector) mean that the rebound in US activity later this year is likely to be shallow. In our central scenario, it will be Q2 22 before the US attains the same level of activity as in the final quarter of 2019.

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