Virus Suppression Policies Induce Global Recession While U.S. Politics Stalls Fiscal Stimulus As Fed Extends Market Support



Virus Suppression Policies Induce Global Recession While U.S. Politics Stalls Fiscal Stimulus As Fed Extends Market Support

William Lee
William Lee
Chief Economist, Milken Institute

We cannot avoid the first health-policy-induced recession in US history. A severe recession (especially a double-digit decline in Q2 GDP growth), is now “baked in.” Political jockeying has delayed much-needed US fiscal cash injections to (lower-than-median income) households and small-medium businesses, which will worsen the US downturn and postpone any rebound. The Fed’s shoring up of the credit markets will help companies finance their drop-in cash flow, even as short-term funding markets continue to seize globally and dollar shortages emerge. 

  • The Administration’s and state government admonitions for social distancing and economic shutdown efforts to date are not yet slowing the rise of virus caseloads in key hotspots (e.g., Tristate New York area).

  • With massive numbers of business shutdowns accelerating during late March, first-quarter GDP growth likely turned negative.  

  • Second-quarter GDP growth will certainly be severely negative (some forecasts project declines in the range of -10 to -25 percent (SAAR)). 

  • Most forecast trajectories assume shutdowns and social distancing will slow the rate of new infections to allow economic activity to rebound in 2020H2—but the recovery’s pace is highly uncertain. 

    - Bottoming of the growth freefall is likely to occur during the summer months as a precursor to
       a strong Q4 and Q1 GDP rebound (e.g., 4 and 3 percent, respectively). 

    - Remaining economic drag on Q3 growth will depend on the pace at which remaining social-
      distancing restrictions are removed.  

Funding for immediate cash injections to (lower-than-median income) households and small-medium-sized businesses will be critical for ensuring that businesses can avoid bankruptcy and retain employees. Even as political bickering stalls/delays needed funding legislation, administrative changes are required to channel funds to impaired businesses and distressed families.

  • Streamlining Small Business Administration (SBA) procedures to allow immediate bank lending may be too little done too late; supplemental funding may be sourced from a new instrument (e.g., SPV) to allow capital markets to supply liquidity for lockdown-stressed companies. 

  • The window for providing liquidity to lockdown-stressed businesses and to secure jobs for their workers is closing rapidly. Cascading layoffs will snowball soon to raise unemployment claims well above 2million (650 thousand is a threshold level of past recessions). 

  • Year-end expiration will help prevent legislated emergency financial injections from becoming entitlements that permanently balloon the US fiscal deficit and debt burden on future generations.

Aggressive Treasury backstopping must complement new Federal Reserve liquidity facilities to target funds where needed and to fortify market functioning to prevent the emerging recession from deteriorating into a depression. 

  • Commendable that Fed has set up liquidity facilities to bolster the commercial paper market, and to support money market funds and medium-sized businesses who do not qualify for SBA loans.

  • A new effort to buy corporate bonds in the secondary market via ETFs rightfully extends the Fed’s scope of market support. 

  • Continued (almost unlimited) asset market purchases will stabilize Treasury and mortgage-backed securities markets and keep open monetary policy transmission channels.

  • Despite the absence of fiscal support, the Fed's heroic efforts will ensure financial markets function properly and have sufficient liquidity for the economy’s rebound on the other side of this health crisis. 

  • The delay in Congressional funding belies oft-repeated concern for the welfare of laid-off workers and near-insolvent small business owners. 

  • We need to see “cash in hand” before the recession that is already in train becomes a full-blown depression not seen since the 1930s. 

  • Back then, political leaders stalled because they worried about ballooning fiscal deficits, just as some leaders today will not act unless they see climate standards met by auto manufacturers who receive federal support. 

Nevertheless, we can rest assured that the Fed has learned from its mistakes of the 1930s. Their latest policy initiatives will ensure that markets function properly and that there will be adequate liquidity to finance the expansion, once it gets started.

This article was originally published on LinkedIn, March 24, 2020.

Published March 25, 2020