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Q2 consumption recovered faster than we initially forecast. But the pandemic’s continuing spread will hold back growth in the coming months.
Our US Economic Forecast released in June was pessimistic. But it included a slightly optimistic note for the short term: We assumed that the year’s second quarter—which we knew would show a very sharp decline in GDP—would be followed by growth in the third quarter as governors and local officials relaxed their stay-at-home orders and mandated closures, and some economic activity could resume.
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In fact, consumption recovered much faster than our forecast assumed—May’s consumer spending was up 8.1%.1 And employment snapped back somewhat in May and June, especially in accommodation and food services, the hardest-hit industry in the pandemic. Second-quarter GDP therefore fell “only” 9.5% (33% at an annual rate), according to the initial report on July 30. That’s considerably better than our dire 16% estimate in June.
But if the economy declined less than we anticipated, it’s also not going to recover as swiftly. We expected the economy would register growth in Q3 and then experience another, milder decline in Q4 as the country began to experience a second wave of the pandemic. It looks as though the second wave—or, rather, the first wave in different parts of the country—arrived early. By mid-July, a number of states that had escaped the initial flood were experiencing explosive growth in infections. The number of cases in the country overall plateaued in late July at around 20 per 100,000 people—twice the level of the mid-April peak.2 And perhaps unsurprisingly, economic activity began to slow again. There is now quite clear research showing that people reacted to the pandemic’s onset by reducing spending significantly before any government stay-at-home orders were put in place.3 With cases and hospitalizations rising, it likely will not require stay-at-home orders for people to once again stay at home, although some states such as Texas, California, and Florida have, in fact, reversed some of their reopenings.4
Daily and weekly data clearly shows the slowing. Daily credit card spending, which by early April had declined 32% from the pre-COVID level, was up to just 4.7% below the pre-COVID level on June 22. But by July 19, it was falling, down 6.4%. Initial weekly claims for unemployment insurance stalled at 1.4 million—a huge number suggesting that job losses were continuing. And the Census Bureau’s weekly Household Pulse survey found more people unemployed in late July than at the beginning of the month.
On top of the resurgence of the pandemic, the economy faces a potential withdrawal of federal aid. June personal income was US$905 billion above the January level, despite a US$583 billion decline in compensation, a US$174 billion decline in proprietors’ income, and a US$125 billion decline in financial asset earnings. The difference: more than US$1.7 trillion in additional social benefits to individuals. Of this, US$1.3 billion was unemployment insurance payments, and much of the increase was because of the US$600 supplemental unemployment insurance Congress added in the CARES act. This expired as of the end of July, and if nothing replaces it quickly, personal income (and, likely, personal spending) will drop sharply.
One important detail in the initial Q2 report on GDP is the substantial decline in the GDP price deflator. The deflator was down half a percent for the quarter, or about 2.0% at an annual rate. The personal consumption (PCE) deflator was down about the same amount. That’s a hefty decline. Much of this was due to the drop in energy prices, but the PCE deflator less food and energy was down about 0.3%, reflecting severe discounting of new motor vehicles and other durable goods, and a sharp decline in clothing prices. It’s a fact: The Fed’s flooding the market with liquidity has not (so far) had an inflationary impact, and we don’t expect this any time in the near future. With an unemployment rate above 10%, the Fed taking extraordinary measures to keep banks lending, and most consumers continuing to avoid in-person dining and shopping, the prospect of too much demand seems pretty far from economic reality. Our forecast will continue to assume that inflation eventually moves back to the 1.5% to 2.0% level. In a world where, in addition to high unemployment, as many as 10% of the still-employed are accepting nominal wage cuts, an inflationary breakout seems highly unlikely.5
The Federal Open Market Committee inserted an important sentence into the statement it released after its July 28–29 meeting: “The path of the economy will depend significantly on the course of the virus.” Until there is widespread deployment of effective treatments and/or a vaccine, the Fed believes—as do we—that the economy will remain weak. The challenge to safely open schools epitomizes the struggle the economy faces to return to something like normality and full employment.
The next Deloitte US Economic Forecast, due to be published in September, is therefore likely to continue to show our expectations for continued high unemployment and subdued growth until at least the middle of 2021.