CFO Insights 2020 July

New research suggests that easing economic restrictions alone may not be enough to significantly boost economic activity.

New research using high-frequency economic data indicates that the sharp decline in U.S. economic activity in recent months was principally the result of consumer fears about contracting the virus, not government-imposed lockdowns. The study by University of Chicago economists found that only 7% of the change in U.S. consumer mobility in recent months can be explained by lockdowns, with the rest due to consumer aversion to social interaction because of the virus.

In other words, most people were going to avoid restaurants and theaters even if they were open. The study refutes arguments that once businesses reopen, consumers will quickly return to stores, restaurants, bars, movie theaters, bowling alleys, and airplanes.

Using high-frequency mobility data, the researchers compared the experiences of consumers in locations with severe lockdowns to those in locations with no or limited lockdowns. They found that there was not a big difference between the two. Indeed one can examine the recent history of consumer spending by state at www.tracktherecovery.org and note how similar the trend is among states that have followed very different policies.

This finding suggests two things: First, the lockdowns alone are not the primary reason for the very sharp decline in economic activity in April and May. And second, easing economic restrictions alone will not be enough to significantly boost economic activity. Rather, the only way to bring activity back to pre-crisis levels is to convince consumers that the virus is no longer a risk.

Jobs Report Doesn’t Account for Virus Surge

In this crisis, events have moved so quickly that economic data published by governments is often a mere snapshot of recent history rather than an indicator of where we are or where we are headed. That is certainly the case with the monthly jobs report for June (U.S. Bureau of Labor Statistics), which showed strong job growth and a decline in unemployment. The survey on which this data is based was completed in the first half of June.

Meanwhile, in the second half of June, the viral outbreak worsened significantly, leading state governments to reverse the easing of economic restrictions. Notably, a very large share of the jobs gained in June were in leisure and hospitality as well as retailing―the types of jobs likely to be negatively affected by recent decisions to reimpose restrictions on economic activity. Assuming that the re-lockdowns continue the next few weeks, many of the jobs gained in June will likely be lost in July.

Worsening U.S. Viral Outbreak Could Cause Economic Trouble

For some time now Deloitte’s baseline forecast(The Wall Street Journal) has called for moderate growth of the U.S. economy in the third quarter, largely due to the reopening of economic activity in May and June. Indeed, we did see a moderate but significant rise in consumer spending and mobility since the economy bottomed in March, although growth appeared to subside by late May.

However, with the third quarter underway, there are already indications that economic activity is starting to decline, likely because the virus is spiraling out of control in about half of the U.S. In many major cities, hospitals are becoming overloaded. Dr. Anthony Fauci, lead infectious disease specialist of the U.S. government, said, “I am very concerned because it could get very bad" (The NewYork Times).

In some states, reopening orders are being reversed(The NewYork Times), while others are halting re-openings. States that are renewing restrictions account for about 40% of the U.S. population. The latest actions by state governments to curtail the spread of the virus are also likely to curtail economic activities involving human-to-human contact. Moreover, high-frequency data on restaurant(Opentable) visits indicate that in the states currently experiencing a sharp outbreak, the number of visits has declined in the last two weeks after having increased substantially in previous weeks.

If the viral outbreak worsens further, lockdowns are renewed, and more people stay home, economic activity for the third quarter will likely either grow more slowly than expected or not at all. One unknown factor is whether Congress will extend enhanced unemployment insurance payments set to expire at the end of July. If not, there will be a sharp decline in consumer income in August, which will likely have a negative impact on consumer spending. That could lead to increased consumer defaults and bankruptcies, potentially creating financial market stress.

A Prolonged Downturn Risks Financial Crisis

During this crisis, the Federal Reserve has taken extraordinary measures meant to assure that credit markets stay open and available. These actions were successful in that measures of financial market stress quickly improved. A potential seizing up of credit markets was averted. However, James Bullard, president of the Federal Reserve Bank of St. Louis, said(BUSINESS INSIDER) that “Without more granular risk management on the part of the health policy, we could get a wave of substantial bankruptcies and that could feed into a financial crisis,” adding “I think it’s probably prudent to keep our lending facilities in place for now even though it’s true that liquidity has improved dramatically in financial markets.”

In response to complaints that by intervening in so many asset markets, the Fed is removing price-discovery from markets, potentially leading to misallocation of assets, Bullard said, “with all these programs the idea is to make sure the markets don’t freeze up entirely, because that’s what gets you into a financial crisis, when traders won’t trade the asset at any price. It’s not my base case, but it’s possible we could take a turn for the worse at some point in the future.”

NAFTA Replacement Could Disrupt North America’s Auto Market

The new, United States Mexico Canada Agreement (USMCA), which went into effect last week, replacing, the North American Free Trade Agreement (NAFTA), could hurt the U.S. automotive sector. The USMCA requires that, in order to be eligible for tariff-free trade within North America, at least 40% of the value of an automobile must be produced by workers earning more than $16 per hour. When the deal was signed, only 13.5% of the value of automobiles exported from Mexico to the U.S. met this requirement, mainly because of components imported from the U.S. and Canada. The U.S. administration expected that the 40% provision would lead auto companies to shift final assembly to the U.S., boosting auto employment in key Midwestern states. If companies fail the 40% test, their vehicles will be subject to a 2.5% tariff when crossing from Mexico to the U.S.

Major Japanese carmakers reportedly have no intention of shifting production(NIKKEI Asian Review) to the U.S. Rather, they will either triple wages in Mexico and/or will accept tariffs. Their calculation is that doing so will be cheaper than investing in a massive cross-border transfer of capacity. Carmakers expect to pass on their ensuing increased production costs to U.S. consumers.

The Center for Automotive Research estimates that, because of increased tariffs, the average price of cars sold in the U.S. will rise between $470 and $2,200 per vehicle, leading to a decline in units sold and U.S. automotive employment. Implementation of the agreement couldn’t happen at a worse time given the massive disruption already experienced from the virus, with car production and sales only just starting to recover.

Additional resources

• Global Economic Brief: Recovery at Risk as Virus Surges
• Space exploration: CFO considerations for strategically evaluating real estate