The policy response and continued accommodation on the policy front is going to be essential to keep the economy online and on track until a vaccine becomes available.
Listen to On the Minds of Investors
Last week’s GDP report showed that the U.S. economy contracted at a real, annualized rate of -32.9% in 2Q20. Against this backdrop, the unemployment rate rose to a level of 14.7% in April, before declining to a level of 11.1% in June as the economy came back online. The July employment report, due out on Friday, will provide another look at the state of the labor market, with consensus estimates pointing to another gain in payroll jobs and decline in the unemployment rate. Furthermore, although high frequency economic indicators flat lined as case growth has accelerated in recent weeks, the idea that we will see a v-shaped recovery seems firmly priced in equity markets.
That said, we are hesitant to get overly excited about the trajectory of the economy during the coming quarters. To start, this downturn has been very unique in the sense that it is concentrated in services, rather than manufacturing. The chart below decomposes and compares the current downturn to what was observed during the Global Financial Crisis (GFC). During the first half of the year, we estimate that 23.8% of the downturn was driven by manufacturing, while the remaining 76.2% was driven by services – this stands in sharp contrast to what was seen back in 2008 and early 2009, when the contributions were essentially reversed.
Importantly, this dynamic informs our thinking about the shape of the recovery, as it seems unlikely that service sector activity will be able to rebound sharply given social distancing measures look set to remain in place. In a traditional recovery, pent-up demand for durable goods tends to be realized as the economy comes back online, but the same is not true for services – in other words, if you didn’t go out to dinner because the restaurants were closed, you are not going to order two meals at a time when they re-open.
All of this has implications for employment. In February of this year, services accounted for 83.6% of total private employment; with such a large share of employment in service sectors, a muted economic growth backdrop may translate into a more moderate pace of labor market improvement in the coming months.
Historically, after hitting a cycle high, the unemployment rate has declined at a pace of around 0.85%-pts per year, and on average it has taken around 56 months to get to the subsequent trough. Before taking into account additional headwinds stemming from the services-oriented nature of this downturn, and assuming that consensus estimates for July are correct, the unemployment rate may not fall below 6% until the end of 2025. While we hope things turn out better than expected, continued accommodation on the policy front will be required to keep the economy on track until a vaccine becomes available, but there will be limits to how much of an offset fiscal and monetary stimulus can provide.
Contribution to changes in U.S. GDP
Share of total change in GDP