What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
Around the world, the COVID-19 crisis has led governments to impose lockdowns in order to keep people apart and, hopefully, suppress the spread of the virus. At the same time, many governments have dramatically expanded expenditures in order to protect people and businesses from large-scale disruption. Mature economies like the United States, Canada, the United Kingdom, and Japan can spend knowing full well that their central banks can fund the increased borrowing requirements of historically large expenditures. Yet in the Eurozone, the problem is more vexing. Countries, such as Italy and Spain, which must borrow heavily if only to make up lost revenue as economic activity collapses, cannot print their own money as they are part of the larger Eurozone. The European Central Bank (ECB) attempted to ease the stress faced by such countries by pledging to engage in massive purchases of member state government bonds. This pledge helped to suppress bond yields, but it did not solve the problem of how to fund additional expenditures without creating credit risk.
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To the rescue now comes the European Union (EU). Its leaders have agreed to spend EUR500 billion in the coming year to assist member states. This is actually a very big deal as it represents a sea change from past behavior. In the past, the northern European members of the EU, especially Germany, were reluctant to engage in fiscal integration with other member states—that is, they balked at the notion of a strong federal role for the EU, similar to the role that the United States plays with respect to the 50 US states. Germany’s reluctance stemmed from the fear that fiscal integration would entail transfers of resources from affluent and fiscally responsible Germany to perpetually indebted and poorer southern Europe. This would be similar to the intra-national transfers that currently take place in the United States. Southern European countries have long sought integration, fearful that the constraints of living within the Eurozone would prevent them from being able to address crises such as the current one through fiscal policy. French President Macron had called for the EU to spend EUR1 trillion to assist member states. A compromise has been reached whereby German Chancellor Merkel agreed to EUR500 billion. Notably, she agreed that the EU will directly issue bonds to be financed over time by member state contributions to the EU budget. The money will be granted—not loaned—to member states, thus enabling them to experience fiscal stimulus without a buildup of national debt.
Although the EU has borrowed in the past, it has always entailed relatively small amounts. This is on a new scale and is a historic leap, possibly setting a precedent that could lead to greater fiscal integration for the Eurozone. Chancellor Merkel said that, for Europe, “this is the gravest crisis in its history and such a crisis demands appropriate answers.” The normally cautious chancellor occasionally takes actions that are not cautious at all. Recall her agreement to allow one million Syrian refugees to resettle in Germany. This is such a time. That said, the agreement is not without its critics. The leaders of the Netherlands, Sweden, Austria, and Denmark all said that they prefer the program to involve loans rather than grants for member states. Yet that would simply result in added debt—not held by public investors—for countries in southern Europe. This conflict among members means that the agreement is not yet completed and that further negotiations are likely required. Still, the fact that Germany and France have reached such an accord is highly significant. As President Macron noted, “An agreement between Germany and France is not an agreement of the 27 [members of the EU], but there can be no agreement among the 27 if there is not already a Franco-German agreement.” German Finance Minister Olaf Scholz called this the EU’s “Hamilton moment.” He was referring to the first US Treasury Secretary Alexander Hamilton, who in 1790 had the new US government assume the debts of the states, thereby creating a strong Federal government. However, it is not clear which European leader will be the star of a future Broadway musical.
What might come next? There is still much work to do as details have not been determined. Still, if this deal takes place, it will set a precedent for the EU to act as a tool for fiscal transfers from stable to troubled countries within the EU. It will create a tool that might enable coordination of fiscal and monetary policy at a European level. And it will likely create pressure for Europe to potentially create a continent-wide system of generating revenue, perhaps by having the EU take a cut from member country value-added taxes. It might also create pressure for further financial integration, such as the creation of Europewide bank deposit insurance.
However, this deal might create a populist backlash, especially in northern Europe. Voters might recoil from a perceived obligation to assist other countries in the EU. They might object to political power being held by leaders who were not directly elected. Such a backlash could contribute to European disintegration. Either way, the latest announcement is likely a turning point for Europe. Finally, although the agreement is historic, it is not actually very big. The transfer of EUR500 billion will not be nearly as hefty or impactful as the US$3 trillion the US government intends to spend.
I have been scouring the latest data releases from governments and industry groups in order to get a sense of the state of the global economy. It is a depressing exercise given that most indicators in most countries are down substantially. However, the data presented here are for April, which was likely the worst month in most countries other than China. Now that economic restrictions are being lifted in many locations, it is likely that the data will improve. Still, we have considerable anecdotal evidence that, even as restrictions are lifted, activity in most industries does not suddenly bounce back to pre-crisis levels. This is especially true in industries where activity requires consumers to be in close proximity to other people. This would apply to such industries as restaurants, movie theatres, airlines, and many personal services. Concern about social distancing is, consequently, working against a full recovery in activity. Even in industries where social distancing is less of a concern, the fact that large numbers of people are unemployed or fearful about job security likely prevents a full recovery in spending. Indeed, it is likely that personal saving will remain elevated in affluent countries in the coming months. Here are a few examples of what is happening:
One of the interesting aspects of recent economic data in the United States is that there has been only a modest decline in personal income, but a massive decline in personal consumption expenditures. Why has income fallen only modestly even in the midst of a huge rise in unemployment? There are two reasons. First, a disproportionate share of job losses involved people with relatively low wages. Indeed, Fed Chairman Powell recently said that 40% of households earning less than US$40,000 per year have someone unemployed. Higher-wage workers have been more likely to retain their jobs. Second, many of those who lost jobs are currently receiving sizable unemployment insurance reimbursements from the government. Notably, spending has declined sharply, in part because lockdowns reduced the opportunity to spend. In addition, consumers are likely being cautious about returning to places where social distancing is a problem. Thus, spending on restaurants, movie theatres, airlines, trains, and non-food retail stores has weakened. The result is that consumers are saving a much larger share of their income. Moreover, it is likely that saving will remain relatively high for a prolonged period until people are comfortable returning to normal behavior. One study suggests that, private savings will pass 20% of GDP in 2020, which would be the highest since the 1940s. It has generally been below 10% for most of the past 30 years. Thus, even as the government borrows massively to fund transfers of funds to people and businesses, people are saving much of that money.
What are the implications of this surge in private saving? First, it means that the surge in government debt does not necessarily mean a surge in overall debt. Government dissaving will be offset by private saving. Second, households will accumulate increased wealth by saving. When they ultimately become confident that the coronavirus crisis is over, it is likely that they will be willing to accelerate spending. When that happens, it is possible that businesses will not be prepared for the surge in demand. This could result in a temporary rise in inflation. However, the fundamental factors that have driven very low inflation in recent years remain. Thus, any surge in inflation is likely to be temporary. Still, even a temporary increase in inflation might be welcome as it will cause the government’s debt/GDP ratio to decline. Moreover, if inflation becomes problematic, the Federal Reserve can take offsetting action. Meanwhile, as unemployment gradually declines in the next few years, relatively rapid growth of employment could boost GDP growth, also causing a decline in the government’s debt/GDP ratio.
For the first time since the start of the crisis, the daily number of new cases in emerging countries now exceeds those in developed countries. Thus, the virus appears to be spreading in poor countries even as it recedes in more affluent countries. It is reported that poor neighborhoods in densely populated cities in poor countries are rapidly becoming a hotbed of new cases. Russia now has the third highest number of confirmed cases after the United States and Spain. Brazil now has the sixth highest number of deaths after the United States, United Kingdom, Italy, Spain, and France. Although many poor countries have imposed lockdowns, they are not always well enforced, leading to more social interaction and a faster spread of the virus. The World Health Organization (WHO) says that there is also growing risk in Africa where, so far, there have been relatively few deaths. However, the WHO says that, if nothing is done to halt the spread of the virus, there could be 190,000 deaths in Africa in the next 12 months.
For emerging countries, there are several problems. First, population density is high in urban areas and even in some households. This makes it difficult to achieve social distancing. Second, spending on medical care as a share of GDP is low and medical infrastructure is often poor, thus making it difficult to properly treat people. Third, lockdowns have not been fully enforced and some emerging countries are even starting to ease economic restrictions due to the terrible economic cost of social distancing. Among the countries where lockdowns are being eased are Brazil, India, and Russia.
Fourth, the economies of most emerging countries have already started to buckle under the weight of social distancing and the spillover effect from economic collapse in rich countries. More than half of the world’s countries have sought assistance from the IMF as their currencies have depreciated sharply, thereby hurting their ability to service foreign currency debts and risking a surge in inflation. Plus, declining global demand and declining global commodity prices have hurt emerging country exports, also damaging debt repayment. There is risk of social unrest, growing hunger, and outbound migration. To counter these problems, the G20 have pledged some debt relief and the World Bank and IMF intend to provide substantial financial resources to emerging nations. If the pandemic spreads rapidly in poor countries, the disruption of economies and health care systems could lead to a surge of financial defaults, outbound migration, economic collapse, political turmoil, and a major threat to the stability of the global economy. On the positive side, many emerging countries have relatively youthful demographics. This is helpful given that the virus disproportionately attacks older people.
The economies of Europe have nearly collapsed under the weight of severe restrictions on economic activity meant to stifle the spread of the virus. There is, however, one noteworthy exception to the pattern of lockdowns. That is Sweden, which did not impose a lockdown at all. Schools remained open as did retail businesses and restaurants. The Swedish government took the novel view that the best approach is to let the virus run its course and thereby achieve herd immunity, although it did encourage people to maintain social distancing. This view was informed by a desire to avoid economic turmoil. The evidence suggests, however, that the economy was hurt anyway as individuals and businesses took action meant to achieve social distancing. Data indicates that people did stay at home more, avoid public transportation, and avoid restaurants and other popular venues. People attempted to avoid social interaction and, as a result, spent less money. Plus, Sweden is a small open economy that depends heavily on trade. It has been hurt by the economic collapse elsewhere. Thus, in the first quarter of this year, Sweden’s real GDP declined, although not as much as in the rest of Europe. Still, the European Commission forecasts a sharp 6.1% decline in real GDP for all of 2020 while Sweden’s central bank predicts a decline of between 7 and 10%.
Moreover, Sweden has paid a price in terms of deaths. This country of 10 million people has had three times as many COVID-19 deaths as neighboring Norway, Denmark, and Finland combined. Those three countries together have roughly 15 million people. On the other hand, Sweden has had a lower death rate than in Italy and Spain. Yet Sweden has some unique features including a larger number of single person households and fewer multigeneration households than in Southern Europe. This helps to avoid the spread of the virus. It is, therefore, too early to say whether Sweden’s experiment can be called a success or failure.
Retail sales in China were down 7.5% in March versus a year earlier, which was better than the 15.8% decline in the previous month and the 20.5% decline in January and February combined. Thus, the weakness of retail sales has abated. The change in sales varied by product category. Compared to a year ago, sales were down 18.5% for clothing, 12.1% for jewelry, 8.5% for home appliances, 5.4% for furniture, and 5.8% for building materials. Sales of automobiles were flat while sales of telecoms products were up 12.2%. Sales of personal care products were up 8.3%. Thus, certain categories have returned to pre-crisis levels while others continue to be suppressed. Meanwhile, it is reported that retail sales during the May 1 holiday were down 6.7% from a year earlier with spending on restaurants and hotels down about 30%.
Perhaps the most promising bit of data coming out of China is the modest increase in industrial production for April. Specifically, the government reports that industrial production was up 3.9% from a year earlier after having dropped sharply in the previous three months. The manufacturing component was up 5.0% from a year earlier. This suggests a V-shaped recovery in the industrial sector. However, it is too early to make such a determination given that, in the coming months, China’s manufacturers are likely to take a hit from weakened exports to Europe and North America. Early indications suggest the hit could be substantial. Plus, the continued weakness of the consumer sector mitigates against a V-shaped recovery for the economy overall.
Fixed asset investment in China was down 10.3% in the first four months of 2020 compared to a year earlier. The decline was much bigger for private sector investment than for the public sector. Investment fell especially sharply in the secondary sector which includes manufacturing. Indeed, investment in manufacturing was down 18.8%. It fell less in the primary sector (mainly agricultural and commodity producers) and in the tertiary sector (mainly services). Foreign direct investment (FDI) from overseas was up a strong 11.8% in April versus a year earlier with especially strong increases in information services and e-commerce. This suggests that the disruption of supply chains that took place in February did not deter foreign companies from investing in China. Some analysts had expected that the crisis would lead foreign companies to avoid China and invest elsewhere. Evidently, this did not happen.
Retail sales in the United States continued to fall sharply in April. First, sales fell 8.3% from February to March. Then sales fell 16.4% from March to April, bringing sales to a level 21.6% below a year earlier. The April decline is the biggest on record. Of particular interest is what happened within various retail categories. For the month, sales were down 58.7% at furniture stores, down 60.6% at electronics and appliance stores, and down 78.8% at clothing stores. Sales were also down 28.9% for the already troubled department store industry. Also, sales were down 29.5% at restaurants and bars after falling 29.7% in the previous month.
Last month there was a 28.6% increase in sales at grocery stores in March as consumers switched from restaurants and stocked up on staples. In April, however, sales at grocery stores fell 13.2% from the previous month as consumers scaled back their panic buying. Plus, with so many people having lost jobs, there was less money available for discretionary purchases. Besides, there is a widespread view that consumers are increasingly transitioning toward online shopping. Yet sales at nonstore retailers were up a relatively modest 8.4% from the month, not nearly enough to offset the sharp decline in store-based retailing. Interestingly, some of the sales reported by various retail sectors such as department stores or clothing stores did take place through the websites of those retailers. Thus, it is likely that the online component of retailing continues to rise rapidly.
Industrial production in the United States continued to decline in April. After declining 4.5% from February to March, output fell 11.2% from March to April, bringing it to a level 15.0% below a year earlier. The monthly decline was the worst in the 101-year history of the index. The last time it fell at a similarly catastrophic rate was in the months immediately following the Second World War when factories that had been producing weapons quickly shut down so that they could retool back toward consumer and capital goods.
In April, production of automotive products was down 61.9% from the previous month and down 70.8% from a year earlier. Other categories fell sharply but not as much as automotive. Production of clothing fell 25.4% for the month, appliances fell 17.8%, food and tobacco fell 7.2%, and chemicals fell 3.8%.
Of particular concern is the fact that production of business equipment fell 17.3 for the month and was down 25.9% from a year earlier. The transportation component of this was down 60.3% for the month as airlines stopped buying planes. Meanwhile, purchases of information processing equipment only fell 5.0% for the month and was down only 0.2% from a year earlier. This augurs for stabilization of business investment which, in turn, is moderately good news for business purchases of consulting services.
The manufacturing component of industrial production fell 13.7% from the prior month and was down 18.0% from a year earlier. Finally, capacity utilization in manufacturing fell from 75.0% in February to 70.8% in March and 61.1% in April.
Last week there were 2.981 million new claims for unemployment insurance in the United States, bringing the eight-week total to roughly 36 million. The number of people continuing to receive unemployment benefits was 22.8 million, up 456,000 from the previous week. Meanwhile, the government released the Job Openings and Labor Turnover Survey (JOLTS). The number of job openings fell from 7.0 million in February to 6.2 million in March. April data is not yet available but is likely to be much worse. In our own industry of professional services, job openings fell modestly from 1.357 million in February to 1.226 million in March.
Americans are starting to travel again—but just a little. The number of people passing through airport security checkpoints on May 14 in the United States was 234,928. This was the highest daily level since March 25. The number bottomed on April 14 at 87,534. Thus, the number of people traveling by air has nearly tripled since it bottomed. Still, the number of people passing through security checkpoints exactly one year ago was 2,611,324. Therefore, air travel is down more than 90%. There is a long way to go to get back to normal. How shall we interpret today’s data? An increase in mobility is welcome and suggests a modest rebound in economic activity even as the number of new infections and deaths in the United States has begun to decline. Also, the numbers remain catastrophically low for the airline industry. If the industry does not see a more substantial rebound soon, there could be substantial financial stress with the possibility of restructuring.
Inflation in the US declined dramatically in April, with overall prices falling the most since the global financial crisis of 2008 ̶ 09. This was largely due to a sharp drop in energy prices. Still, even when food and energy prices are excluded, core prices fell by the most since records began in 1957. Does this mean that we’re heading into a prolonged period of deflation? Probably not. Prices are likely to rebound again at some point in time. The bigger question is whether, once the crisis abates, prices rise modestly or there is a surge in inflation.
First, here is what we know. In April, consumer prices fell 0.8% from the previous month, the steepest decline since December 2008. This was the second consecutive month of declining prices. In addition, prices were up only 0.3% from a year earlier. The weakness of prices was due primarily to the sharp decline in energy prices. The gasoline component of the consumer price index (CPI) was down 20.6% from the previous month and down 32.0% from a year earlier. Excluding the impact of volatile food and energy prices, core prices were down 0.4% from the previous month, the biggest decline since records began in 1957. This was also the second consecutive month of declining core prices. In addition, core prices were up 1.4% from a year earlier. Among the other interesting aspects of the government’s inflation report were a 2.6% increase versus the previous month in the price of food at home, reflecting increased demand for groceries as consumers shun restaurants. Indeed, this was the biggest increase in the price of food at home since 1974. Also, there was a 4.7% decline in the price of apparel as retailers struggled to unload excess inventories. Finally, there was a 4.7% decline in the price of transportation services such as airlines, reflecting the extreme weakness of demand.
What can we expect going forward? It is likely that US economic activity will begin to rebound modestly in the next few months as states remove economic restrictions and some types of consumer spending recover. However, it is also likely that economic activity will remain muted for the remainder of this year. Moreover, economic activity could even decline in the fourth quarter if the reopening in some states leads to a rebound in the virus. That, in turn, could lead states to bring back restrictions. At the least, it could lead consumers to return to caution. Thus, a more robust recovery is not likely until at least 2021. In the interim, prices will probably remain stable, depressed by weak economic activity but helped modestly by expansive monetary and fiscal policy. When a fuller recovery comes, bottlenecks could lead to a temporary surge in inflation. However, a sustained period of much higher inflation is not likely. The expansive monetary policy of the Federal Reserve will likely be reversed. Moreover, it will not lead to a surge in inflation as it is meant to offset a catastrophic decline in economic activity and weakness in credit market activity. The factors that were driving low inflation prior to the crisis will remain in effect. My view is that neither deflation nor inflation are serious concerns. Moreover, many investors largely share this perspective. The so-called “breakeven” rate on 10-year bonds, which is a good proxy of investor expectations of 10-year inflation, is now about 1.1%, down from 2.0% a year ago. Evidently many investors see the current situation as boding for a sustained decline in inflation.
Finally, one factor that might cause a fear of higher inflation is the fact that, in April, real (inflation-adjusted) average hourly earnings were up 7.5% from a year earlier, the highest increase on record. Normally, a surge in wages would suggest imminent inflation. Yet in this case, the surge in wages is due primarily to a dramatic shift in the composition of the workforce. More than 20 million Americans have lost their jobs, largely in industries that pay relatively low wages such as restaurants, hotels, and retail stores. Those who have retained jobs tend to be better paid. Thus, the average pay for those working increased suddenly due to this shift. It is not a reflection of tightness in the job market which would create inflationary pressures.
Is a V-shaped recovery possible? Probably not. A V-shaped recovery would likely require that consumers and businesses be confident of the virus’s disappearance and act accordingly—and with abandon. That will only come about when a vaccine or cure is found, and neither seems likely in the short term. As long as the virus is known to be a threat, consumer and business behavior is likely to be cautious, thus generating either a U-shaped or a W-shaped recovery.
What are the factors that will determine which shape prevails? There are basically two factors—the characteristics of the virus (which remain largely unknown even now) and the policy response. As for the characteristics of the virus, we don’t yet know if becoming infected makes someone permanently or even temporarily immune. If immunity is absent, then a vaccine will likely not be effective. In that case, we could be permanently stuck with having to live with the virus until it mutates and goes away. That would imply a prolonged period of changed behavior, likely leading to slow economic growth until society can find a way to function under radically new rules.
If being infected does create immunity, but there is no vaccine or cure, then we could face a prolonged period of slow growth and high rates of infection until the so-called “herd immunity” is established, as happened a century ago after the three waves of the 1918 pandemic. This scenario suggests a long period of slow economic growth as consumers and businesses act to maintain social distancing. Plus, waiting for herd immunity means absorbing an unusually high level of medical expenditure and human suffering.
Then there is the issue of the policy response. If social distancing is adequately maintained, we could see the virus significantly suppressed, as appears to have happened in East Asia—at least for now. In that case, we would have a U-shaped recovery where there is initial caution, later followed by a faster rebound in growth once there is confidence that the virus is no longer a threat. That confidence could come about from mass testing and tracing, thus allowing authorities to engage in targeted suppression of the virus. This assumes that immunity is established when people become infected. We still don’t know if this is the case.
That said, if social distancing is relaxed before the virus is suppressed, or if restrictions are relaxed before testing capabilities are present, then a likely scenario is a W-shaped recovery. Under this scenario, economic activity rebounds while the virus remains a threat. Easing of social distancing causes the viral outbreak to worsen, leading consumers and businesses to implement social distancing, thereby reversing the economic rebound. This scenario might currently be a threat in the United States where many states are easing restrictions even while the number of cases has not been reduced.
For businesses, it makes sense to plan for several scenarios, thereby being prepared to act quickly once the new reality becomes apparent. It especially makes sense to plan for a future that will likely entail a prolonged period of living with this virus. That means a semi-permanent switch to working from home, less travel, more online interaction, and the need to deliver goods and services without direct interaction, whether the customer is an individual or a business. For some industries and segments, this could mean a prolonged disruption of traditional business models.
Last month, the European Central Bank (ECB) calmed financial markets when it committed to massive purchases of government bonds. Yet that program is now at risk after a German court threatened to prevent the ECB from purchasing German government bonds. The court said that any purchases must be proportional and that the impact of the bond purchasing program must be focused on monetary policy targets rather than “economic and fiscal policy effects.” Essentially, the court is concerned that the ECB is becoming involved in fiscal policy. The rules of the ECB forbid it from funding government deficits. Yet the recent decision to engage in unlimited bond purchases was likely meant to assure that governments can borrow an extraordinary amount without difficulty. After all, prior to the ECB action, Italy’s bond yields had begun to soar, especially after ECB President Lagarde suggested that it is not the job of the ECB to assist member countries. Then she changed her mind and announced massive bond purchases, after which Italian yields fell sharply. The German court said that the ECB has three months to demonstrate that its actions are consistent with the rules. If not, the ECB will be forbidden from directly purchasing German bonds. In response to the ruling, the spread between German and Italian bond yields increased sharply and the value of the euro fell against the US dollar.
However, after the German court ruling, ECB President Christine Lagarde stood her ground and defended the policy. Lagarde said that, under the current extraordinary circumstances, central banks “have to go beyond the normal tools to use exceptional measures to avoid a tightening [of financing costs] and to ensure our monetary policy is transmitted across the euro area. We are an independent institution, answerable to the European Parliament, and driven by our mandate. We will continue to do whatever is needed, whatever is necessary, to deliver on that mandate. Undeterred.” In fact, several ECB officials have suggested that the ECB not even reply to the German court. To reply would acknowledge the standing of that court in this case and might encourage other member country courts to act on ECB issues. Moreover, it has been pointed out that the German court, in making its rulings, was implicitly rebuking a 2018 ruling by the European Court of Justice that approved of ECB bond buying. It is possible that a resolution of this issue will require intervention by German Chancellor Merkel. On a practical level, although the German court ruled against Germany selling bonds directly to the ECB, it cannot stop the ECB from purchasing such bonds in the secondary market. Consequently, the ruling might not have much practical effect. Indeed, bond yields did not move dramatically in response to the ruling, suggesting that investors may not actually be worried that the ruling will have practical consequences. Italian yields rose moderately after the ruling but fell modestly after Lagarde’s remarks.
The US government’s employment reports for April were released last week and, not surprisingly, the numbers were record-breaking and historic. The government releases two reports, one based on a survey of establishments, the other on a survey of households. Let’s examine both.
First, the establishment survey tells us that, from March to April, the number of employed fell by 20.5 million. This was, by far, the largest decline in history, bringing the number of jobs down to a level last seen in 2011. By industry, the biggest decline was in leisure and hospitality, with 7.6 million jobs lost. But there were big decreases in most other industries as well. For example, there was a decline of 975,000 in construction, 1.3 million in manufacturing, 2.1 million in retailing, 2.1 million in professional and business services, and 2.1 million in health care. The drop in health care jobs might seem counterintuitive given that the virus has boosted the demand for medical services. But the reality is that most non-COVID and non-emergency medical services have been put on hold. People are not visiting doctor’s offices and not undertaking non-essential procedures. Interestingly, average hourly earnings were up sharply, rising by 7.9 percent from a year earlier—a number not seen since the 1970s. Yet this does not mean that peoples’ wages went up. Rather, it reflects the fact that a disproportionate share of people who lost their jobs earned relatively low wages. Higher-paid people, especially office professionals who shifted to working at home, mostly retained their jobs. Thus, the average wage of those still working increased sharply.
The separate households survey, which reflects people working at establishments as well as those who are self-employed, indicates that the number of employed people fell by 22.4 million. Moreover, the survey found that the number of people participating in the labor force, which is the number of people either employed or actively seeking work, fell by 6.4 million. As a result, the participation rate (the share of the above-16 population participating in the labor market) fell from 62.7 in March to 60.2 in April. The survey also reports that the unemployment rate rose from 4.4 percent in March to 14.7 percent in April, the highest level since the Great Depression in the early 1930s. Moreover, given the huge decline in participation, the true unemployment rate is probably much higher. The government also reported a big disparity in unemployment depending on level of education. The unemployment rate for those with a high school diploma and no college is 17.3 percent while the rate for those with a college degree is 8.4 percent.
Finally, equity prices were up after news of the jobs report. Investors were not surprised. Rather, they appear to be increasingly optimistic about the future path of the economy. Late last week, it was reported that the number of coronavirus deaths in New York fell to the lowest since late March, indicating that the crisis is likely abating at the heart of the US outbreak. This bodes well for a return of economic activity. However, although deaths and infections are declining in New York, they continue to rise in much of the rest of the country. The result is that the number of deaths nationwide has been steady in recent days. Yet some state governments are reducing economic restrictions, raising the prospect of a rebound in the virus.
The downturn in economic activity around the world has been especially harsh for the services sector. This encompasses retailing, restaurants, hospitality, entertainment, transportation and distribution, finance, telecoms, professional services, education, and health care. Some of these industries have been required to nearly shut down because of government restrictions and some have seen a dramatic decline in demand as consumers have avoided businesses where social distancing is a challenge. The result has been a sharp decline in demand and activity in these industries—much more so than in manufacturing. We know this from observing the purchasing managers’ indices (PMIs) for services in multiple countries. IHS Markit, the company that produces the PMIs, released the services PMIs for April last week and the numbers are breathtaking. The PMIs are forward-looking indicators meant to signal the direction of activity in the broad services arena. They are based on surveys of purchasing managers of service enterprises and reflect information on output, new orders, export orders, employment, pricing, pipelines, and sentiment. A reading above 50 indicates growing activity; the higher the number, the faster the growth. A reading below 50 indicates a contraction of activity; the lower the number, the faster the contraction.
Markit produces a global services PMI that encompasses information from the 45 countries. The services PMI fell from 36.8 in March to 24.0 in April, a record low by far. The PMIs for consumer, business, and financial service industries all fell by roughly the same amount. Most sub-indices were down sharply. The only sub-index that was not in catastrophic territory was the one that assesses sentiment about the future. It fell more modestly, indicating that many businesses expect that activity will rebound quickly.
The April PMIs for Europe were especially bad. The overall services PMI for the Eurozone fell from 26.4 in March to 12.0 in April. Not surprisingly, the decline was most severe in those countries with the greatest outbreak of the virus. Thus, the PMI fell to 9.2 in Spain, 10.9 in Italy, 11.1 in France, and 17.4 in Germany. These numbers mean that services activity in Europe effectively collapsed in April as most countries were largely shut down. Markit suggested that the decline in both services and manufacturing activity in April was consistent with a quarterly decline in real GDP of 7.5 percent. However, it offered some positive thoughts, stating that “with coronavirus curves flattening and governments making moves to ease lockdown restrictions, many sectors should start to see output and demand pick up. The process will be only very gradual, however, as governments juggle between reviving economies and preventing a second wave of infections. Most companies will inevitably need to work at levels well below full capacity and sectors such as retail, travel, tourism and recreation—already the hardest hit—will continue to be badly affected by social distancing.”
The services PMI in the United States fell from 39.8 in March to 26.7 in April, a record low. The fact that the US PMI was higher than in much of Europe is likely a reflection of the fragmented and less severe nature of the lockdowns taking place in the United States. Services enterprises experienced a sharp decline in output, new orders, employment, and even output pricing. Many businesses chose to dramatically cut prices in order to attract customers at a time of weakened demand. Markit commented that “while manufacturing may see a rebound in production as increasing numbers of factories are allowed to re-open, prospects look bleaker for many parts of the services economy, especially where businesses rely on travel, social gatherings or close contact with customers. Businesses, such as airlines, bars, restaurants, cinemas, sports arenas and other recreational activities, will likely be at the back of the line in terms of being able to re-open to anything like previous capacity levels, meaning the recovery will be long and slow.”
Like Europe and North America, many emerging market economies also faced a sharp decline in activity in the services sector, especially due to the closure of businesses and other government-imposed restrictions. But no country saw a bigger decline in services activity than India. There, the services PMI fell from 49.3 in March to 5.4 in April, a catastrophic decline signaling a near complete shutdown of the services sector. This is especially alarming given that services entail more than 50 percent of India’s economic output. All sub-indices fell including output, new orders, employment, and export orders. The cancellation of orders meant that there was a sharp reduction in backlogs.
US exports to the rest of the world declined sharply in March. Exports of goods were down 8.9 percent from a year earlier while exports of services were down 14.8 percent. With respect to services, exports of transportation services fell 39.9 percent from a year earlier as foreign travel to the United States declined. Nonetheless, exports of telecom and computer services were up 11.8 percent. While exports of financial services were down 4.4 percent from a year earlier, exports of other business services (including professional services) were up 9.6 percent. Thus, it is clear that a shift is taking place in how American service-related businesses are generating income from overseas. Meanwhile, although overall exports were down 10.9 percent in March versus a year earlier, exports to China were down 23.5 percent. For the first quarter of 2020, US exports to China were down 14.7 percent. Thus, exports evidently decelerated as the quarter progressed. This will be troubling news for Chinese authorities who have promised to boost imports from the United States by 82 percent in 2020 as part of the so-called “phase one” trade agreement with the United States that was signed in January. President Trump recently said that if China fails to meet its targets, the United States will walk away from the agreement, which had involved averting significant increases in US tariffs on Chinese goods in exchange for increased Chinese purchases of US goods. Meanwhile, the data shows that US imports from China fell 30.1 percent in the first quarter versus a year earlier. The decline in bilateral trade is a result of the sharp decline in demand in both countries following implementation of lockdowns meant to suppress the coronavirus.
While US trade with the rest of the world has declined, including with China, it was reported that China’s exports to the rest of the world are increasing. Specifically, after declining 6.6 percent in March versus a year earlier, China’s total exports were up 3.5 percent in April versus a year earlier, the first such increase since December. The increase, which was largely unexpected, might have been due to the shipment of goods that had previously been ordered but delayed due to supply-chain disruptions. It likely also reflects a surge in exports of medical equipment meant to deal with the virus. Moreover, the sub-index for export orders in the latest purchasing manager’s index for Chinese manufacturing was down sharply, hinting at a further decline in Chinese exports in the months to come. This is due to weak demand in the United States and Europe as those economies collapse under the weight of coronavirus-related economic restrictions. Meanwhile, Chinese imports were down 14.2 percent in April versus a year earlier, due to weak domestic demand and declining commodity prices.
During this crisis, many major central banks have dramatically boosted the size of their balance sheets, pumping liquidity into the market at a pace never before seen. In part, central banks are helping to fund the dramatic expansion in government spending taking place, especially in the United States, the Eurozone, and Japan. This has led some observers to wonder if we are setting the stage for a period of much higher inflation in the not-too-distant future. That is a legitimate concern—after all, there have been plenty of episodes in the last century in which monetary financing of government budget deficits led to hyperinflation. Think Venezuela, Zimbabwe, Argentina, and even Weimar Republic (or the German state) in the early 1920s. However, many investors don’t seem to be concerned. The so-called “breakeven” rate, which is a good proxy for investors’ inflation expectations, has declined in the United States and Germany, suggesting that investors actually expect a relatively low rate of inflation in coming years. Even the 10-year breakeven rate has declined, indicating inflation pessimism over the longer term. Thus, investors are clearly not betting that, when this crisis ends, there will be a surge in inflation.
Why aren’t they concerned about the potential impact of monetary policy? The answer is the well-worn phrase: this time is different. The reality is that central banks are boosting their balance sheets in order to offset the shrinkage of economic and credit market activity. It is similar to what happened during the global financial crisis in 2008-09. At that time, central banks flooded markets with liquidity, driving up their balance sheets dramatically. Yet measures of money supply grew slowly as central banks offset a decline in bank lending. Inflation remained tame. The same is likely to happen again. Moreover, although businesses have shut down, demand has fallen sharply as well. Thus, there are no significant shortages. When the economy recovers from this disaster, it is likely to initially be slow as consumers and businesses remain cautious in the face of an ever-present virus. Thus, it is not likely that there will be pressure on prices due to excess demand. Moreover, once the crisis ultimately ends (perhaps after a vaccine is found), central banks will be able to reverse what they have done. They did so after the last crisis. The temporary expansion of government spending will potentially be reversed, thus reducing the need for central bank finance.
If anything, there is actually a risk of deflation. Already we have seen a dramatic decline in the prices of oil and other commodities. Mass unemployment will likely mean downward pressure on wages. And although there have lately been shortages of some consumer staples (toilet paper, for example), early data indicates that inflation has decelerated. Even when recovery comes, the deflationary trend will likely be reversed only gradually. Thus, my view is that investors are correct in betting on low inflation. Moreover, they have a good track record. Back in 2008 when some political and business leaders warned of coming inflation, the breakeven rate remained suppressed—and rightly so. Inflation in the decade that followed was historically low.
One question that might be asked is whether the coronavirus crisis will undermine globalization. The answer is that this has already happened. Many countries have already engaged in protectionist action related to the crisis. Several have imposed restrictions on exports of medical supplies, drugs, and food. These include the United Kingdom, Brazil, India, Turkey, South Korea, and Russia. The intention of such policies is to assure adequate supplies, but the reality is that such action usually results in shortages. Restrictions by one group of countries could drive up global prices, compel other countries to follow suit, and thereby result in shortages. Of course, one could argue that this is merely a short-term effect of a temporary problem. Yet we have already seen political and business leaders argue that the pandemic has exposed the fragility of global supply chains. The inference is that supply chains ought to be brought home to ensure against disruption. In addition, the shutdown of factories in Europe and the United States will mean that when demand revives, it will likely be initially filled by imported goods from Asia that have been waiting to be shipped. The asynchronous nature of the revival of supply chains could spur protectionist sentiment.
Meanwhile, some of the challenges to globalization that preceded the coronavirus crisis remain. These include the continuing high level of US tariffs on Chinese goods, continued US tariffs on steel and aluminum, continued US threats of protectionist action against the European Union, and US refusal to allow the appointment of new members of the Appellate Body of the World Trade Organization. The coronavirus crisis could provide the US administration with added support for these policies. Even if President Trump is succeeded by former Vice President Biden next year, Biden (who is more of an internationalist) will likely face significant pressure within his own party to be tough on China and other trading partners.
In the early days of the global financial crisis in 2008-09, the leaders of the G20 issued a statement indicating that they intended not to resort to protectionism in the midst of the greatest economic crisis since the Great Depression. Their view was informed by the experience of the Great Depression when countries engaged in beggar-thy-neighbor trade policies that exacerbated the downturn. The G20 countries largely adhered to the sentiment expressed in their statement, thereby avoiding a worse crisis. In the current crisis, however, there has been no such statement and countries have already imposed restrictions on trade and migration. Supply chains have been disrupted. Global cooperation has largely been absent. In part, this reflects the requirement that each country shut down its economy and isolate its people in order to suppress the virus. The danger now, however, is that this could become a longer-term problem of limiting global economic integration, thereby likely slowing economic growth.
Kate Hardin, Deloitte’s Executive Director for Energy and Industrials Research, and Anshu Mittal, Senior Manager and leader of Oil, Gas & Chemicals Research, analyze events and risks in the energy sector.
In late April, WTI crude oil futures prices for the May delivery contract fell below US$0/bbl and even reached –US$37/bbl as traders squared off their contract positions to avoid taking delivery of the oil. The perfect storm of demand decline, oversupply, and storage shortage contributed to this price collapse. Firstly, the pandemic-related decline in economic activity reduced global oil demand by about 30 million barrels per day (MMbbl/d) in April. Secondly, the OPEC+ agreement on supply cuts of 9.7 MMbbl/d was not enough to offset the decline and would become effective only after May 1. Thirdly, US crude exports have fell amid high inventories, high levels of floating storage, and increasing freight rates. Together, the three factors contributed to full storage facilities at Cushing, Oklahoma, in April, sparking the sell-off of contracts for physical delivery at Cushing. Although WTI prices have marginally recovered and are currently trading above US$10/bbl, the factors that led to this price drop are still in play and may affect prices ahead of May 19 when June delivery contracts are due.
The storage scarcity will not be resolved quickly—with about 160 million barrels of oil already held in floating storage, there is a possibility of negative prices repeating in June unless global lockdowns ease and production shut-ins happen. The US Energy Information Administration’s oil storage utilization rate of 76 percent indicates that some capacity is still available, but some of this may have already been leased or committed, limiting the storage available for financial contract holders. In fact, there is some concern that the storage shortage could also affect Brent futures—the highest crude price marker—inflicting significant derivative losses for traders worldwide. For example, South Korea, which has the fourth-largest commercial storage capacity of 30 million barrels in the Asia Pacific region, has already run out of storage space.
Production levels are expected to fall in May, which may help avoid another precipitous price drop. Saudi Arabia’s planned output cut of 3.5 MMbbl/d will eventually ease some pressure on global storage, and all eyes will be on the compliance rate of other OPEC nations. Based on recent announcements, upstream oil and gas companies have lowered their 2020 capex guidance by over 25 percent, amounting to about US$80 billion. In the United States, production is already slowing as reflected in the US rotary rig count, which has fallen by over 40 percent to 465 rigs since March. Based on initial announcements, US tight oil production is expected to drop by more than 300 kbd in May, with a few companies completely halting their drilling and production.
The third area to watch is global oil demand that remains depressed by COVID-19-related lockdowns and stay-at-home mandates. The pandemic has so far defied oil’s usual demand growth inelasticity of only 1-3 percent annually. A longer-term question is how enduring the “new normal” of remote work will prove—will many commuters opt to continue working from home, depressing refined product demand? Will commercial flights serve far fewer holiday and business travelers given widespread caution about travel and exposure?
The interplay of weak demand, oversupply, and storage shortage suggests an implied global oil stock buildup of 14.4 M/bbld in May compared to the 2019 average of 0.5 MM/bbld. This explains why WTI crude futures over the next three months remain below US$25/bbl. This continued price weakness could significantly challenge the economic viability of many oil and gas companies, especially independent US shale operators. We believe the widening gap between their fair and book values could trigger significant impairments and technical bankruptcies, perhaps even higher than the 2015 levels. So far, the international oil companies (IOCs) are faring better due to their strong financial position and a few IOCs even plan to maintain their dividends despite the downturn.
By contrast, the oilfield services segment is feeling intense pressure. Already faced with cost compression of 37 percent in the 2015-2016 downturn, the ongoing fall in drilling activity and rising cancelations of onshore and offshore projects have reduced the size of the US oilfield services industry by more than 50 percent since the COVID-19/OPEC+ era started. Contract cancellations and lower transportation fees due to production shut-ins are also affecting pipeline operators, whose debt is trading at distressed levels. Refiners are feeling the pinch as well in the form of a significant impact on capacity utilization and working capital. Refiners may report considerable inventory losses in Q2 2020 due to the reduced value of purchased crude oil and stored petroleum products.
The situation is bleak across the entire oil and gas value chain, and the unique price-plus-demand downturn has pressured the industry into the survival mode. The three areas to watch remain production cuts from key producing regions, supply response in economies tentatively reopening in the coming weeks, and the impact of high storage.
The US economy contracted at an annualized rate of 4.8 percent in the first quarter, the sharpest decline since the global financial crisis more than a decade ago. The degree of decline for the entire quarter masks what happened at the end of the quarter. It is likely that the economy grew at a healthy rate in January, perhaps less so in February due to the impact of the disruption of Chinese supply chains, and then contracted sharply in March—but mostly in the second half of March. Moreover, much of the data gathered by the government in March came in the first half. A helpful comparison might come from examining data from neighboring Canada, where the economy often tends to mirror that of the United States. Unlike the United States, Canada compiles monthly GDP data. The latest report indicates that real GDP fell 9.0 percent from February to March. Thus, we can reasonably infer that the decline in US GDP for the first quarter largely reflected what happened in March. Moreover, the number probably underestimates what happened because the lion’s share of the US decline took place near the end of March, when many state governments ordered lockdowns. As such, it remains reasonable to expect a catastrophic decline in US GDP in the second quarter.
Let’s take a look at the details of the US GDP report. First, consumer spending fell at an annualized rate of 7.6 percent, the worst since 1989. This included a 16.1 percent decline in durables that mostly reflected a very sharp drop in spending on automobiles. However, there was a 6.9 percent increase in spending on non-durables and reflects the anticipatory hoarding of consumer staples that took place early in the crisis. Consumer spending on services fell 10.2 percent, largely reflecting a decline in spending on medical care. Households avoided doctor’s visits and discretionary medical procedures. In addition, there were big declines in spending on restaurants, transportation services (air travel), and recreation services (movie theatres, amusement parks, etc.).
Regarding investment, there was an 8.6 percent decline in non-residential business investment, including a sharp drop in spending on business equipment, especially transportation equipment. Surprisingly, there was a very big 21.0 percent increase in spending on residential investment. It is likely that this number was compiled before the second half of March. We do know, however, that there has been an abrupt drop in housing market activity that is likely to show up in the Q2 numbers.
As for trade, both exports and imports declined in the first quarter. However, there was an especially sharp 21.5 percent decline in exports of services. This reflects a decline in tourist revenue from overseas travelers involving air travel and hotels. Exports of goods fell only modestly. Imports of services fell at a rate of 29.8 percent, in part indicating that Americans were not traveling to other countries.
The European Union (EU) reported record-breaking Q1 GDP numbers. For the EU overall, real GDP fell 3.5 percent from the previous quarter, or at an annualized rate of 13.3 percent. In the 19-member Eurozone, real GDP fell 3.8 percent, or at an annualized rate of 14.4 percent. Thus, Europe’s economy shrank three times as fast as that of the United States (which was down 4.8 percent annualized in Q1), reflecting an earlier effort to suppress social interaction to stifle the spread of the virus.
The European numbers are the worst since the EU started compiling such data in 1995. In addition, three major European economies reported their growth figures. In France, real GDP fell 5.8 percent, or at an annualized rate of 21.3 percent, the sharpest decline in the French economy since 1949. It was driven by a stunning 17.9 percent decline in consumer spending, or an annualized rate of 54.6 percent. In Spain, GDP fell 5.2 percent, or at an annualized rate of 19.2 percent. And in Italy, GDP fell 4.7 percent, or at an annualized rate of 17.5 percent. Germany has not yet report GDP numbers for the first quarter, but did report that, in March, retail sales fell 5.6 percent from February. Given that the decline in GDP in France, Spain, and Italy was worse than in Europe as a whole, it can be inferred that the decline in Germany and other Northern European countries was not as bad. This makes sense given that the worst outbreak and the earliest lockdowns took place in Southern Europe.
Michael Wolf, a global economist at Deloitte, provides an analysis of Japan’s response to the COVID-19 crisis.
The rate of COVID-19 infection in Japan is slowing after the country issued a state of emergency earlier in April. Even at its peak, the number of new cases relative to the size of the population in Japan was less than half the peak number South Korea saw more than a month earlier. As of April 30, the number of daily new cases was running below 2 per million, far below 74.5 per million in the United States and 15.6 per million in Germany. Still, Japan’s Prime Minister Shinzo Abe is planning to extend the state of emergency to at least the end of May, perhaps slightly longer.
Extending the emergency declaration may seem like an abundance of caution given that places with far higher rates of infection like the United States and Germany are already beginning to loosen their respective lockdowns. However, higher rates of infection in Japan could prove especially disastrous. An unchecked virus that is particularly fatal for older populations is likely the number one concern for the second-oldest nation in the world. Even with relatively low rates of infection, some of Tokyo’s hospitals are already overwhelmed. These low rates of infection have also allowed Japan to target clusters of transmission rather than implementing widespread testing and tracing methods seen elsewhere. This method of virus containment might prove less effective should higher rates of infection emerge, perhaps during a second wave.
Japan has also struggled to keep workers home. Just 18 percent of Japanese respondents to a YouGov poll said they didn’t have to commute to school or work despite 80 percent of them expressing fear of contracting the virus. Traditional business operating practices are partly to blame. Japanese companies rely more heavily on hard copies of documents, are more likely to use fax machines, and use hanko, a stamped seal that serves as a signature. Less-defined job roles in Japan relative to some other countries like the United States may encourage more frequent communication that can be difficult when workers are not in the same physical space. Government officials are working to reduce these barriers to telework, with Prime Minister Abe now having practices like using hanko reviewed to encourage more remote work.
Japan’s heavy reliance on cash transactions is also creating challenges to keep consumers at home. Just 20 percent of payments in Japan are cashless. By comparison, nearly all payments are cashless in South Korea and about two-thirds are cashless in China. Reliance on cash payments, which Japan’s elderly population strongly prefers, requires consumers to either risk infection while shopping or forego discretionary spending altogether. In the near term, this could have negative consequences for both health and economic outcomes in Japan. However, the crisis also presents an opportunity to hasten Japan’s efforts to dramatically raise its cashless payments. Indeed, Japan wanted to double the cashless ratio by 2025 and had implemented incentives like rebates at the end of last year. A move toward a more cashless society could raise productivity in some sectors and spur more data-driven marketing and sales.