Failure to launch

Inertia

Failure to Launch is a 2006 American Romcom ( the word makes me cringe) starring the comedically challenged Matthew McConaughey and the horsefaced Sarah Jessica Parker. The film focuses on a 35-year-old man living with his parents who shows no interest in leaving the comfortable life that they have made for him. The film was deservedly panned by critics with a 24% approval rating on Rotten Tomatoes.

See the connection with the pandemic in the US? No? Really?

Okay I’ll spell it out.

You see many United States-ians are so comfortable and fixed in their political, religious and lifestyle beliefs, so much so that they are extremely reluctant to change, such as wearing masks and social distancing. The result has been an avoidable failure to get the US economy back on its feet.

The Pandemic Returns

How things change!

I mean we jumped from historically low unemployment to historically high unemployment in a mere few weeks in March/April 2020 (seems like a lifetime ago). And back at the 10 June FOMC there were signs of life- increased mobility, fall in new virus cases and signs of economic stabilization.

But a lot has gone to Shitsville since 10 June:

·       A surge in corona virus cases have delayed reopening in many states. Florida reported a record one-day rise in deaths, and cases in Texas passed the 400,000-mark, stoking fears the United States was losing control of the outbreak.

·       The economic recovery has stalled. High frequency macro data are flashing red again. Credit card transactions are down. Restaurant reservations are waning. The rebound in air travel is leveling off. And foot traffic at stores is dwindling once again.

·       Another 1.4 million filed for first-time unemployment benefits recently -- the first increase in weekly claims since late March 2020.

·       On the vaccine front, healthcare execs are more cautious than Wall Street. 73% of healthcare industry leaders polled by Lazard estimate that a vaccine won't be widely available until at least the second half of 2021. Absent an accessible and widely distributed vaccine, there will be no complete economic recovery.

Forget V shaped. We are looking at a U or a W shaped recovery. I am not surprised; this was what I forecasted way back in April 2020.

What the Fed did

It was going to be absurdly hard for the Fed to surprise on the positive side on 29 July and it didn’t.

The Fed did nothing- rates are already near zero. It blandly acknowledged the deteriorating situation and paved the way for further action in September. Prior to the meeting it said its lending programs will be extended until the end of 2020.

Fiscal policy

What remains is for another fiscal stimulus to kick in because the Fed, as Powell succinctly stated, has lending powers but not spending powers.

US Republicans unveiled fiscal stimulus proposals, which cuts unemployment benefits from USD 2,400 per month to USD 800 per month and send out another USD 1,200 to most American adults.

There are two downsides of the proposed cuts. The unemployed will get less and the employed may experience an increase in fear of the consequences of unemployment. If fear does increase, the USD 1,200 is more likely to be saved rather than spent which doesn’t help the economy now.

Inflation

With the economy awash with so much liquidity, many have started getting up on their hind legs and barking about inflation as expected. In fact, one absurd poser to the Fed is when it will raise rates, given the inflation target of 2%.

There isn’t a snowball’s chance in hell Fed will raise rates anytime in the next 3 years because of inflation (Yellen started hikes in December 2015 to create the specter of inflation and because she wanted a buffer). 

Low inflation may remain for the next few years for some excellent reasons:

·       Look at recent history. Post GFC central bankers merrily pumped trillions into the economy in various rounds of quantitative easing. Inflation barely budged.

·       U.S. unemployment may decline to only 6.5% by the end of 2021. That means that monetary policy will still need to be super-duper easy

·       Even if unemployment drops below 4%, recent experience suggests inflation won’t surge. The ancient Philips curve has not just been “broken”, it’s been smashed into bits and scattered to the four winds.

·       American workers will continue compete with workers all over the world, even with “deglobalization”, leading to lower prices.

·       Institutional changes in the labor market have massively undercut workers’ ability to bargain for higher wages — things like decline of unions thanks to fall in the manufacturing sector and rise in services.

Negative yields

So, if inflation and higher rates belong to a distant world, should we worry about negative yields? After all we need something to worry about!

Well I’ve news for you. We are ALREADY in negative real yield territory.

For months now, the 10-year yield has been stuck around 0.6%. Inflation expectations reached 1.5% recently for the first time since February 2020. Hence the “real” 10-year U.S. yield last week fell to -0.93%.

The concept of negative interest rates has been confined mostly so far to Germany and Japan. Negative real yields in the U.S. are rare. Since the 2013 “taper tantrum,” the 10-year inflation-adjusted rate has only dipped below zero a few times, and never for too long.

Can it go lower and for longer? Although Powell declared on 15 March 2020 that it is unlikely, to echo Obama, yes it can. If investors keep greedily buying up treasury bills, notes and bonds, the minimal nominal yield will stay positive but will be so low that the real yield will slide even deeper. 

Negative yields are good for companies and stocks- lower borrowing costs and lower discount rates. But not so thrilling for anyone expecting fixed interest payments. 

Conclusion

The next gathering of the faithful is in September 2020, by when we should have more data on the pandemic, the economy and the effects of the stimuli.

But don’t expect miracles.

This crisis is biological, and the real solution is also biological i.e. a vaccine. So, the Fed and the Govt can huff and puff and wish but they can’t blow the pandemic away.