Letter from the Americas: the pandemic persists

While economic recovery is underway, the Americas are not yet “out of the woods” when it comes to the global coronavirus pandemic. New infection rates are rising again, exacerbating fears of a winter surge as cold weather makes outdoor social distancing difficult.

U.S. — A Global Financial Crisis-sized hole, the risk of resurgence and paused pandemic policy-making

The good news is that the recovery so far has been robust. Tracking estimates for third-quarter GDP growth continue to rise, and, encouragingly, the economy has recovered more than half of the ground lost during lock-down. However, there is still a hole in activity that resembles the height of the 2008 Global Financial Crisis (GFC). This emphasises the fact that there is still a long road ahead to full economic recovery. Furthermore, failure of Congress and the President to agree on the next phase of stimulus may make for a bumpier, longer ride.

Over the third quarter, a surge in consumer spending will, in our view, be the most powerful driver of growth. Household spending is tracking a remarkable increase of 38% quarter over quarter annualised. This leaves consumer spending down 3.9% from its pre-crisis peak. A large 7.6% shortfall in services spending accounts for the gap. Elsewhere, the durable goods report in August showed a strong rise in core capital good shipments and orders. This bodes well for a large gain in business equipment spending. The only negative has been a widening in the trade deficit over recent months, which will provide a drag on growth.

Per our estimates, this performance will leave overall activity in the third quarter around 3.6% below the pre-crisis peak at the end of 2019. On one hand, this would be a shallower shortfall than feared in the earlier days of the coronavirus crisis. On the other, it still shows activity running at depressed levels. In fact, a 3.6% shortfall is only 0.3 percentage points% smaller than from the 3.9% drop at the worst point of the GFC.

Chart 1: The U.S. economy has rebounded well, but still faces a GFC-sized hole (U.S. GDP, level)

 

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Source: ASI, Haver (as of October 2020)

The GFC-sized hole in the economy is something to worry about, but so is the lingering presence of Covid-19. New cases of coronavirus have increased thus far this Autumn, especially as some schools and colleges have opened. New daily infection rate at the time of writing is around 55,000 cases per day on average in the U.S, with states in the Midwest suffering the most over recent weeks.

After a surge at the beginning of the pandemic, the northeast U.S. enjoyed a period of low case numbers after implementing successful containment measures. However, in September these areas saw cases start to rise again. This suggests that colder weather, school and university re-openings and social-distancing fatigue may be important risk factors. Signs of further virus resurgence must be monitored, which may necessitate re-imposing at least some localised lockdown measures as we contemplate economic recovery.

The end of unemployment insurance payments and lack of stimulus checks may see household incomes drop by 20% annualised in the third quarter and further in the fourth. The near-term impact on spending will likely be dampened by the large savings buffers Americans have built up over recent months. However, even considering this, we have downgraded our expectations surrounding consumption and our aggregate GDP growth forecast for the fourth quarter is down to 1.8% quarter over quarter annualised.

If Congress cannot decide very soon, the onus of moving forward with stimulus and relief packages will fall on the next administration. In the event of a Democrat clean sweep, we expect a generous short-term support package to pass that would cost about $2.3 trillion. If Democratic candidate Joe Biden wins the presidency but the Senate is majority Republican, however, this would be difficult to enact. As would his manifesto for additional large increases in infrastructure and entitlement spending, only partly funded by higher taxes. If incumbent Republican President Trump wins re-election, we believe he is most likely going to be up against a split Congress. In this scenario, we expect the government to enact a smaller relief package of about $1.2 trillion.

Another key consideration when trying to predict the course of future economic recovery is monetary policy. Here there are fewer signs of any faltering in support. The U.S. Federal Reserve (Fed) has committed to keep interest rates between 0-0.25% until unemployment has fallen and inflation has reached its 2% target and this is on track to overshoot this benchmark There has been less guidance on how the Federal Open Market Committee (FOMC) plans to set its asset-purchase targets. September FOMC meeting minutes suggest that more guidance on this front will be forthcoming.

The FOMC September minutes also suggest that there is some dissent regarding the Fed’s promise to hold rates unchanged until inflation has increased markedly. Some regional bank representatives are concerned that this commitment could create risks to financial stability and reduce flexibility over future policy. One could interpret this as a curious backtracking of the Fed’s new inflation targeting framework, which requires continued accommodative policy until inflation starts to overshoot. However, FOMC minutes reflect all input during the meeting. The core of the FOMC is very much behind the new inflation strategy, even if some regional bank presidents are not. 

Canada — Will resurgence reverse recovery?

Canada’s labour market experienced an impressive recovery in September. Promisingly, employment rose, and 76% of the total jobs lost during lockdowns have now been recovered. However, increasing Covid-19 infection rates have cast doubts on the sustainability of this rise in employment. In our view, employment growth is likely to slow from here.

Some areas of Canada have re-imposed lockdown measures to try to curb the spread of coronavirus. These include Quebec and Ontario, the country’s two most populous provinces. Economic recovery rates may slow as the fall progresses and the bite of lockdowns worsens.

Fiscal policy is likely to remain supportive throughout the crisis. Canada’s recent Throne Speech announced several relief measures. These include, extending the national wage subsidy scheme through next summer, relaxing restrictions on unemployment insurance and making several green investments. There is, however, some political pressure to turn to austerity, as these measures will increase Canada’s deficit. But, for now, we don’t think such a turn is necessary. The government is likely to be able to rely on the support of the New Democrat party for various spending measures.

Chart 2: Federal budget blowing up through the Covid-19 shock (CAD million, 12 million total)

 

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Source: ASI, Haver (as of October 2020)

Mexico — the government may need to open up its wallet

The IMF has recommended that the Mexican government raise fiscal support up to 3% of GDP (from the current rate of 0.7%). It has also assured the government that moving toward more accommodative monetary policy would benefit the nation without risking financial stability. However, these recommendations have fallen on deaf ears. Relatively high rates of inflation — close to the top of The Bank of Mexico, or Banxico’s, target range — and inflation expectations appear to be tempering the outlook for significant interest-rate cuts in the near term. Mexico has maintained an austere policy response toward the global pandemic throughout its duration.

There are other policy levers in place to support the financial system, however. For example, Banxico has extended its liquidity and credit provisions. Additionally, the finance ministry and banking commission have announced measures to allow more restructuring. This should help ease repayment strains amid economic stress.

It is unclear how quickly Mexico will recover given the domestic policy backdrop and external environment. The macro data has been a bit mixed. For instance, the PMI data from the Instituto Mexicano de Ejecutivos de Finanzas (IMEF), a civil association of members of the Mexican financial sector, suggest decent progress. This contrasts the Markit manufacturing PMI, which notably lags other countries (Chart 3). Manufacturing exports are now close to pre-crisis levels, which has contributed to an improved trade balance. However, this also reflects import compression, as domestic consumption continues to struggle. Spillovers from a fiscal splurge under a Biden clean sweep in the U.S. election could, of course, give Mexico a significant boost. This would help mitigate headwinds from their own policy stance.

Chart 3: Mexico lagging Latam survey data

 

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Source: IHSM, DavIHSM, Haver Analytics, ASI, October 1, 2020.

Brazil — Supportive policies have helped — so far

Things seem to be looking up in Brazil, where new coronavirus infection numbers have been trending downward since early September. August data signaled continuing recovery in Brazil, although growth rates have slowed again. Industrial production (IP) increased 3.2% month over month, with consumer durables coming in strong. At the same time, retail sales were up 4.6% month over month (Chart 4).

Chart 4: Impressive bounce in Brazilian activity

 

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Source: ASI, Haver (as of October 2020)

PMIs for the month of September continued to signal further recovery. The manufacturing output index declined, however it remains in solid expansionary territory. The services PMI improved marginally during September. Overall, we expect the recovery in Brazil to continue, albeit at a slower pace as momentum from the reopening starts to fade.

The Brazilian government has been supportive in response to the pandemic. It has, for example, provided income support to poor households, which has aided economic recovery and boosted support for President Bolsonaro. The government has already extended its “corona-voucher” support system, which provided stimulus to help support self-employed or gig-economy-based workers, through the end of the year. Furthermore, the President wants to make income support longer lasting  under a new minimum-income scheme. This plan, “Renda Cidada,” would go into effect in 2021 — after the voucher support ends. This would replace the former welfare program, “Bolsa Familia,” which paid mothers a stipend on the condition that their children go to school. Many have credited Bolsa Familia with helping to reduce poverty in Brazil. Hopes are that the new plan, which would have a larger budget, would have a similar, if not more impactful, effect.

There may be some cause for concern with Brazil’s current plans due to their cost. Expenditure for the current year is not subject to Brazil’s spending cap rule. However, if the cap is to be adhered to next year, it will require the government to scale back its spending. With elections coming up in 2022 and the pandemic persisting, incentives for the government to breach the spending cap rule (for better or worse) are aplenty.

 

       

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