Author: Mike Cagney | July 13, 2020
Every recession is different, and the one we’re navigating through now fits that bill. Brought on by a wave of self-imposed (albeit inconsistent) state and county shutdowns, the fall in output and rise in unemployment from Covid-19 have been unprecedented.
The federal government entered the onset of Covid-19 on our shores with the assumption the virus would be a short-lived affair. The government executed a strategy with the expectation that many businesses would need to furlough employees, only to bring them back months later. Efforts like the Payroll Protection Program provide 2 months of payroll coverage to businesses that hold employee count constant. The Cares act provides $600 a week in incremental unemployment benefits until August 1st. Policymakers felt this would end soon, and the government needed a bridge to get us to the other side of the Covid-19 pandemic.
Thus far, the government programs have been generally successful. In the case of the unemployment benefits, maybe even too successful. Pre Covid-19, the average national weekly unemployment check was around $300. Under the Cares Act, it’s $900. In nearly every state, the median worker is making more money unemployed than employed.
Unemployment Pays - For Now
This has resulted in the paradox of markedly higher household savings rates – something unseen in any other recession, but entirely understandable given the compounding effects of consumers earning more and not being able to go anywhere to spend their windfalls.
Personal Income Has Soared!
Another paradox in this market is the apparent disconnect between public markets and the real economy. The Nasdaq continues to clock new records, yet the Atlanta Fed is forecasting a 35% decline in Q2 GDP.
What’s behind this seemingly significant disconnect? Some of my peers blame the unemployment benefits. The thought is that $600 a week, times 18M unemployed people ($10.8B a week) makes its way to Robinhood accounts where naïve day traders drive markets to new highs. While this could be the case in certain stocks (like Hertz), it is unlikely that it is materially impacting the hundreds of billions a day that trade on the Nasdaq and NYSE. Rather, public markets are being driven by the Fed and the Treasury.
The Fed and Treasury have entered the markets in a way that makes their great recession efforts seem pedestrian in both speed and size. Using Treasury as a first loss to leverage the Fed balance sheet, the Fed has been on a ferocious run from backstopping corporate debt to TALF 2.0. Having only begun to work off the balance sheet expansion from the great recession, the Fed reversed course in February and added nearly $3 trillion through July.
The Fed Keeps Going
I often joke that everything we were taught about macroeconomics turned out to be wrong in the past decade. This is especially true for anyone who believed in the Austrian school of economic thought. Pundits of this philosophy believe that any time a central bank prints money - such as the $3 trillion the Fed printed this year - it will manifest through to inflation as consumers realize the central bank simply debased its currency. The Austrian’s ended up getting this partly right. While we haven’t seen central bank action in developed economies translate to inflation in goods and services, it has yielded asset inflation.
Stocks and bonds rise with easy monetary policy and low to negative interest rates. With consumption holding up (see card spending below), it’s not surprising to see markets higher. But Covid-19 is lasting longer than the government first thought, with much of the country re-entering lockdown. Was the bridge far enough?
Our biggest takeaway thus far is the old adage, don’t fight the Fed. We’re long the US market, and overweight the mega caps as they are bigger beneficiaries of Fed action. We are not in emerging markets (The BRIC looks sick! Well, not China...) outside of China, where the government has decided the market should go up, and it has (and will continue to), and zero weight on Japan and Europe as we’re skeptical of both markets. Given our US overweight, we are long the USD as we expect investment flows to more than offset a Covid-led shrinking current account deficit. We are nervous about benefits expiring in August and new lockdowns across the country, and will adopt a more defensive strategy if another stimulus deal isn’t struck. Central banks are driving markets again.
Some other takeaways from our work-from-anywhere moments of reflection:
There will need to be a massive reallocation of human capital. The staff for food and beverage and hospitality won’t come back - at least for awhile, especially in large cities. These people will need to find jobs somewhere - the question is where? The government should push for skills training across needed industries, and not let the for-profit private college ranks swell with more indebted students.
There is a significant Covid-19 bill that will need to be paid. Municipalities have lost massive tax revenue, and it’s unclear when that reverses. Expect a new wave of taxes at the state and county levels across the country. This is likely deflationary.
Commercial real estate will be under tremendous pressure. Companies have figured out that work-from-anywhere works. Why pay the costs, burden employees with commutes and limit human capital to one area? This is deflationary. Ironically, this would have been good for WeWork 2.0 if they weren’t already massively long commercial real estate.
Work from anywhere makes human capital more fungible. Globalization already impacted the wage power for workers, but at least there were still offices to go to. With remote work, companies will be able to extract geographic arbitrage for employee costs. This is also deflationary.
Despite the “money printing press”, deflation is still more likely than inflation. This will keep the Fed easy, but it also will exacerbate the growing wealth inequality. It seems likely to us that this - not bond vigilantes - will likely cause the Fed to alter course, but not for a while.