The deepest part of the covid-19 global recession occurred probably in April. It was in April that US, Europe and Australia recorded their weakest monthly economic readings at the same time as government and central bank support measures aimed at combatting the negative impact on economic activity of restrictions aimed at containing the spread of covid-19 were starting to kick in. In April, governments in the US, Europe and Australia were also beginning to ponder what restrictions could start to be lifted in May and June. China was at a similar stage two months earlier back in February when it suffered its worst monthly economic reports.
When the monthly economic data relating to May are released in June and July they are likely to show much less savage falls in activity than occurred in April and possibly even the odd monthly improvement that should become more common when June data are released in July and August. The first half of Q2 2020 is likely to be when most major economies hit rock bottom, but the precipitous fall will ensure that Q2 GDP reports are mostly deeply negative even with monthly economic reports showing the first signs of improvement later in Q2.
By Q3 monthly economic readings are likely to be rising. While economic conditions in a less restricted “covid-safe” world will not return quickly to conditions in the pre-covid world they will be much stronger than during the worst of the covid shut-down period (mostly between February and April). Q3 GDP reports in the US, Europe, much of Asia and Australia will almost certainly be much stronger than in Q2.
The only circumstance that might stop a Q3 GDP rebound is if the easing of covid-19 restrictions occurring currently stops and is thrown into reverse by a quick and large second-wave lift in covid-19 infections. Such a circumstance seems unlikely not because a second wave of infections is unlikely but rather that it seems the political will is changing to limiting economic damage rather than battening down infection rates at all costs.
Coming back a few months from what lies ahead to what happened in May the economic reports show the heavy cost of widespread economic shutdown, especially in the United States. The advance report of Q1 GDP showed an annualised fall of 4.8% led down by a 7.6% fall in consumer spending, previously the mainstay of growth through 2019. With many US States in covid-19 shutdown in April monthly reports plummeted. April non-farm payrolls fell 20,500,000 pushing the unemployment rate up to 14.7% from 4.4% in March. April retail sales fell 16.4% m-o-m; industrial production fell 11.2%; housing starts fell 30.2%; and existing home sales fell by 17.8%.
US business and household surveys conducted for May so far, although still weak, are better than in April. The May National Association of Homebuilders’ index rose to 37 from 30 in April; the preliminary May manufacturing purchasing managers’ index (PMI) rose to 39.8 in May from 36.1 in April; and the services sector PMI rose to 36.9 from 26.7 in April. The high covid-19 infection and mortality rate in the United declined sharply through May and restrictions have started to ease in most US States. It is highly likely that US economic activity will quicken noticeably in June and July, albeit off a very low April/May base.
During May, the US Federal Reserve reiterated concern about the weakness of economic activity and its willingness to expand its balance sheet and buy assets to reduce the risk of economic weakness triggering a financial crisis. The Fed remains reluctant to consider deploying negative interest rates that risk doing more harm than good to the banking sector. The US Federal Funds rate at 0-25 basis point range is unlikely to change over coming months but is anchoring US interest rates at a low enough level to reinforce other factors promoting the rebound of the US economy from the April/May low point.
In China, the economy showed signs of improvement in April economic readings from its February/March low point. Industrial production rose 3.9% y-o-y in April from –1.1% y-o-y in March. Fixed asset investment spending (-10.3% y-o-y from –16.1% in March) and retail sales (-7.5% y-o-y from –15.8% in March) were both less weak. The covid-19 infection rate reduced to minimal through May and the authorities have encouraged a rapid re-opening of businesses although retail spending is proving slower to revive than the authorities would like. The May National Congress meeting focused on initiatives to boost both investment spending and retail spending. The flow-on benefits of stronger Chinese economic activity to Australia through its major trading partner status may be limited by the less resource intensive nature of this round of spending initiatives as well as signs of deterioration in the trading relationship between Australia and China.
In Europe, preliminary Q1 GDP fell by 3.8% q-o-q and by 3.2% y-o-y. April is likely prove the weakest point for economic activity in Europe. Even the countries that were worst affected by covid-19 such as the United Kingdom, Italy, Spain and France the infection rates and mortality rates were declining in May and restrictions were starting to be lifted. While Q2 GDP is likely to fall at least as much again as occurred in Q1, a rebound is likely in Q3.
In Australia, Q1 GDP will be released the first Wednesday in June and is likely to be close to flat, or even show some growth. Several March readings were quirkily strong. March retail sales rose 8.5% m-o-m, its biggest monthly gain primed by panic supermarket purchases. More importantly Q1 real retail sales rose by 0.7% q-o-q. International trade was also unusually strong in March with exports up 15% m-o-m and imports down 4% m-o-m producing a record monthly trade surplus of $A10.6 billion up from $A4.4 billion in February. Net exports are likely to contribute strongly to Q1 GDP.
Q2 GDP, however, will fall sharply. The preliminary reading of April retail sales released last week showed a record monthly fall of 17.9% m-o-m. Even with basing retail sales in May and some recovery in June household consumption spending will detract considerably from Q2 GDP growth. Another detraction will come from net exports in Q2. The 15% lift in March exports will inevitably give way to poorer results in April and May especially with mounting friction in the Australian/Chinese international trade relationship.
Other developments in May point to some lift in GDP, beyond the sharp fall in Q2 GDP. Australia performed very well in May containing covid-19 infections and to the point where it became possible to announce plans to ease many restrictions by July. By late May progress on those plans was moving faster than expected. It also became apparent in May that the unemployment rate may not rise as much as feared earlier. In April, although job losses were very large, -594,300, the unemployment rate lifted less than expected to 6.2% from 5.2% in March. The unemployment rate is likely to lift further in May but beyond that the earlier-than-expected re-opening of large employing sectors such as retailing and restaurants, hotels and clubs should cap the unemployment rate in June and probably below 10%.
One issue beyond Q3 is the way the Government ends covid-19 income support programs for businesses and households. An abrupt end to support programs risks a new fall in GDP in Q4 2020. The key JobKeeper program is currently set to end in September but is due for review in June. The initial cost of the program was estimated at $A130 billion but mostly due to a clerical over-estimate of recipients is now estimated at $A70 billion. While the $A60 billion saving is not a windfall for the Government to spend it does provide flexibility for the Government to develop a taper process for JobKeeper allowing for some businesses to come off the program relatively early while others that are likely to take much longer to recover in a “covid-safe” economy and could receive WorkKeeper beyond September.
During May, the RBA, indicated that it expected a big reduction in GDP in the first half of 2020 but followed by a relatively pronounced lift in GDP later in 2020 and early 2021. On the RBA’s base forecasts GDP would take three years or more to recover to its pre-covid-19 forecast trajectory an indication that monetary policy will need to be growth-accommodating for a lengthy period ahead.