FedViews: April 6, 2020


Sylvain Leduc

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April 2, 2020

Sylvain Leduc, executive vice president and director of research at the Federal Reserve Bank of San Francisco, stated his views on the current economy and the outlook as of April 2, 2020.

  • The human toll from the coronavirus disease (COVID-19) pandemic continues to
    rise around the world. As authorities implement social distancing
    restrictions to mitigate the spread of the coronavirus, the associated
    economic costs are becoming more apparent. How the economy will fare over
    the next several quarters remains highly uncertain, however. Much hinges on
    how the virus spreads and evolves over time, as well as on the effectiveness
    of social distancing and shelter-in-place measures. This uncertainty
    necessarily clouds the economic outlook.
  • The uncertainty about the coronavirus is spreading through financial markets
    as well. The Chicago Board Options Exchange Volatility Index, or VIX, is
    frequently used as a measure of uncertainty based on equity market
    volatility. This so-called fear index measures investors’ perceptions of the
    30-day-ahead volatility of the S&P 500. The VIX shot up recently to a level
    even higher than that experienced at the height of the 2008 financial
    crisis. While the VIX has declined from its recent peak, it remains elevated
    by historical standards.
  • This uncertainty has impeded the proper functioning of the financial system.
    Using its emergency powers, the Federal Reserve set up facilities to
    increase liquidity in several segments of the financial system, including
    money market mutual funds, the commercial paper market, and the corporate
    bonds markets, among others. The Fed also resumed buying Treasury securities
    and agency mortgage-backed securities and reduced the federal funds rate to
    near zero.
  • Equity prices have fallen sharply since the end of February and the market
    has remained very volatile. Still, the passage of the Coronavirus Aid,
    Relief, and Economic Security (CARES) Act has helped the stock market recoup
    some of its losses. The $2 trillion relief package, at roughly 9% of GDP,
    includes several measures targeted to alleviate the adverse economic impact
    on households, businesses, and workers. This assistance should provide some
    support to the economy in the months ahead.
  • Spreads on riskier assets, such as low-grade corporate bonds, have remained
    high. Substantially higher borrowing costs might pose challenges to highly
    indebted corporations. Rollover risk is somewhat limited in the near term,
    as only 2% of speculative-grade corporate bonds are expected to mature
    during the second quarter. However, corporations currently in need of
    funding are facing much direr financial conditions.
  • The current financial conditions are also extremely challenging for small-
    and medium-size businesses, particularly since roughly half of them only
    have enough cash on hand to cover operating expenses for about one month,
    according to a recent JPMorgan Chase Institute report. Payroll reductions at
    small and medium-size businesses could have a large impact on the labor
    market, as these businesses account for 47% of total employment.
  • With social distancing measures and shelter-in-place orders, firms have had
    to rapidly shed workers on an extraordinary scale. Payrolls contracted by
    roughly 700,000 in March and the unemployment rate rose from 3.5% to 4.4%.
    However, this captures only part of the worsening of labor market
    conditions, since the labor market surveys use the middle of the month as a
    reference point to compile the data. Thus, this snapshot for March occurs
    before most social distancing measures were widely implemented. Indeed,
    jobless claims surged to unprecedented levels in the last half of March,
    with more than 10 million workers filing new claims. Hence, the unemployment
    rate is likely to rise much more in the following months.
  • Consumer confidence also fell in March, as economic activity in several
    parts of the country stalled and the economic outlook darkened. Consumer
    confidence is likely to decline further in the months ahead as labor market
    conditions worsen.
  • The pandemic is also adversely affecting manufacturing activity around the
    world. While China’s purchasing managers index (PMI) rebounded last month as
    the country’s social distancing measures were eased, the PMIs in the United
    States, Japan, and the euro area fell sharply.
  • The uncertainty around the evolution of the pandemic heavily clouds the
    outlook. As a result of the necessary social distancing measures, the
    contraction in economic activity will be deep in the second quarter,
    accompanied by a steep rise in unemployment. How the economy evolves
    thereafter will largely depend on the effectiveness of social distancing
    measures and whether the virus weakens during the summertime or experiences
    a second burst in the fall. It will also depend on whether social
    interactions quickly resume once the virus abates. Given the rareness of
    similar events for comparison, our understanding of these issues is too
    imprecise to provide clear guidance about the evolution of the economy later
    this year and the next.
  • In the best scenario, the virus is sufficiently contained by the end of the
    second quarter that activity can quickly resume in the second half of the
    year. The strength of the rebound will depend on the effectiveness of
    monetary policy accommodation and the fiscal relief package in providing
    sufficient support to households and firms to avoid typical recessionary
  • However, if the social measures last substantially longer, more firms may go
    out of business and more workers may remain or become unemployed, reducing
    aggregate demand further and lengthening the downturn. The rebound in
    activity would be more muted in this case, as relationships between workers,
    firms, and banks would need to be reestablished.
  • All told, the steep decline in economic activity suggests that inflation is
    likely to decline this year and remain substantially below target in the
    near future.
Market uncertainty spiked

Equities recover slightly from recent low

Investors shy away from riskier bonds

Unprecedented rise in jobless claims

Consumer sentiment declines

Manufacturing activity falls further, recoups in China


The views expressed are those of the author, with input from the forecasting staff of the Federal Reserve Bank of San Francisco. They are not intended to represent the views of others within the Bank or within the Federal Reserve System. FedViews appears eight times a year, generally around the middle of the month. Please send editorial comments to Research Library.