When I last wrote about the US economy on Friday, I wrote that the jobs numbers “support my baseline view that the rollover in US GDP growth has been mild so far. The threat to that outlook comes in the form of policy and the anticipated business bankruptcy wave that will hit after the summer.”
Those threats are now crystallizing. There will be no budget deal any time soon, despite what Wall Street seems to be banking on. And that fact will likely mean a sharp deterioration in US economic prospects for the end of Q3 and for Q4. I will explain below.
The economic situation for US households
In thinking about an economic shock – which the fiscal cliff will be – the question is about the stock as much as the flow. By that I mean, the existing precarious situation for US consumers as much as the loss of income through future income loss.
I have been focusing on the diminution in initial jobless claims as the most important stabilizing force for the US economy. But, tens of millions of Americans are worse off financially now than before the pandemic. And any flow-shock to their financial outlook will tip the US into deep retrenchment territory. A fiscal cliff will act as that shock just as much as increased initial claims would have done.
Axios has a provocatively titled article today, “Death spiral for consumers“, which outlines the situation. Read the full piece. But, here are the points to focus on:
- Joblessness remains “alarmingly high,” as one NYT article describes it.
- Food pantries are overwhelmed. (Feeding America, which runs 200 food banks, says average demand is up nearly 60% and one in six Americans could face hunger as a result of the pandemic.)
- A massive wave of homelessness is starting to swell. (“Eviction cairns” are cropping up in New Orleans, where piles of people’s belongings are being thrown out on the street.)
People are even surrendering pets because they can’t afford to take care of them.How it works: Personal finance experts say the good-news indicators mask the true face of America’s predicament.
- A lot of people were getting by on the extra $600 in their unemployment checks and $1,200 one-time relief checks.
- Now that those have expired — along with many eviction moratoriums — we’re likely to feel the full force of the recession that started in February (just before the coronavirus pandemic hit).
The loss of $600 per week in pandemic unemployment assistance has hit 30 million people. Over a full economic quarter, that adds up to $234 billion in lost income support for those with the greatest marginal propensity to spend, the unemployed.
The fiscal cliff will be a personal economic tragedy for millions of households. Collectively, it will also mean a gaping hole in US economic consumption.
Why the US went over the fiscal cliff
All of the preceding on household finances was known well in advance of the pandemic. For example, a January poll from Bankrate found that only “41% of Americans would be able to cover a $1,000 emergency with savings“. So, it’s been abundantly clear for some time that the US economy cannot survive a shock like the coronavirus pandemic without tremendous and enduring fiscal support.
Why did that support end?
In a word: Meadows – specifically new White House Chief of Staff Mark Meadows. He is a former conservative House Freedom Caucus member who was brought in to the negotiations to keep Treasury Secretary Mnuchin from giving too much away to the Democrats.
Here’s how the Washington Post describes the Meadows-Mnuchin nexus with congressional Democrats:
In private, Pelosi began to refer to Meadows as “the Enforcer,” the implication being he was there to ensure Mnuchin didn’t make a deal with the Democrats.
Unlike in previous rounds, when Pelosi held out for a better deal for Democrats and ultimately forced major concessions from Republicans, this time administration officials, led by Meadows, walked away. Now, Democrats are facing questions about their tactics and whether playing hardball will continue to work when someone like Meadows is intimately involved.
White House officials believe President Trump gained leverage Saturday when he signed four measures that he alleges will provide some economic relief through new unemployment aid and changes to payroll tax rules. Meadows played a central role in pushing Trump toward these executive actions, which aim to strip away some tax and spending powers from Congress. It is unclear whether the measures will work, though, and state leaders and business executives were confused about timing and implementation.
[…]
Meadows, 61, was never a legislative guru during his seven years on Capitol Hill — a tenure that was marked more by his willingness to wage ideological internecine warfare against other Republicans and, later, become one of Trump’s fiercest defenders in Congress.
For me, this highlights the political limits to deficit spending. Fiscal conservatives in Congress are happy with Meadows’ approach. They do not want to pass a $3 trillion coronavirus relief bill. And so, the failure of the talks is welcome if that is the alternative.
It also makes sense for Trump to have done the executive orders, even if they are ineffective or unlikely to be implemented. The goal is to put as much of the blame onto Democrats as onto the President and Republicans for the collapse in negotiation. Whether this political ploy works remains to be seen. But we are unlikely to see a deal for weeks. And the US economy will go into freefall during that time.
No fiscal relief is coming
Lawmakers have left town and Trump aides don’t expect new stimulus talks anytime soon. That leaves the U.S. economy without much of the government aid that had been propping it up.
That means we won’t get a Congressionally-approved fiscal package for weeks to come.
Meanwhile, there is a lot of doubt that that the President’s Executive Orders will be meaningful economically. Putting aside the constitutional issues of the President directing the power of the purse, the question here is implementation.
For example, one Executive Order depends on $100 per week assistance to the unemployed from US states, which are getting hammered by tax revenue shortfalls. That’s unlikely to work given the precarious state of state finances. The State of Missouri even tweeted it is waiting for more guidance before it does anything.
Businesses are also unlikely to implement a rollback in payroll taxes from another Executive Order. The rollback is not permanent unless future legislation makes it so. Therefore, it is effectively a tax deferment that adds to uncertainty for both businesses as individuals. Many businesses have stated they do not plan to change withholding as a result.
And remember, even were the payroll tax deferments to be withheld, it would do nothing for the unemployed. And nothing Trump has done helps cash-strapped states or small and medium-sized businesses.
US bankruptcies are now on track for a 10-year high, with more than 100 consumer companies already filing, according to S&P Global Market Intelligence. I believe the pace of bankruptcies will accelerate as consumption demand hits a wall due to the fiscal cliff. At a minimum, this will create a ripple of fear that could impact the yields on lower grade bonds.
My view
I have been saying for some time now that I thought the second wave of coronavirus infections has had a muted impact on the economy and jobs relative to worst-case outcomes. There has not been a spike in initial claims outside of the one initial week.
So, for me, the biggest wildcard had been policy. And, unfortunately, what we are now seeing on that front verges on a reasonable worst case outcome as we head into a volatile period in politics and markets. The fiscal cliff will mean a big hit to the economy and earnings in my view. And Wall Street has not re-rated risk assets to take that reality on yet.
As for the just initiated re-weighting of risk assets toward value over growth, with the Dow Jones Industrial Average advancing while the Nasdaq sells off, is that move sustainable? I doubt it. Irrespective, there are a lot of moving parts here. So, I think an increase in market volatility is the likely outcome even if the overall directional move to the market is up. I have a thesis on this I am working out. More on that later though