Overview

In some respects, the US economy can be considered a proxy for how the global economy will respond over the next couple of years to a series of significant economic problems. 

Virtually all forecasting groups acknowledge that the US and global economies are in a perilous situation. 

And in many respects the rather weak and volatile equity markets still do not fully recognize the seriousness of the current economic downturn, and the likely consequences of a slow and uneven economic recovery. 

What we do know is that the covid-19 lockdowns which savaged the US job market and household spending, and which triggered a massive economic downturn, will soon morph into an extremely weak economic recovery. 

There is no way that the comfortable US economic status quo which existed in February of 2020 can be restored even before the end of 2021. Indeed, the evidence is extremely compelling that the US is moving into a long and painful period of slow growth, low inflation, and high unemployment.

Nonetheless what we can anticipate with a fair degree of assurance is that the US Federal Reserve will maintain near zero interest rates and massive liquidity purchases at least through to the end of 2021.

Indeed, the other large central banks which will be dealing with similar sluggish economic recoveries will follow the same lead in terms of providing liquidity and financing their huge government deficits.  

We can also anticipate that at some time next year the US government and Congress may try to limit the budget spending side, even if Democrats are in the White House.

Finally, as to the general state of markets, it is important to underscore that the Federal Reserve has openly committed to keeping the economic revival going no matter how long it takes. 

Since over the next couple of years money market interest rates will remain unusually low (very close to zero), as with wage and price inflation virtually absent, the extremely volatile equity markets will continue to seem to be the only real investment option for retail and institutional investors. 

The US Economy

We have known for some time now that the US GDP contracted at a massive 5% annual rate in the first quarter of 2020.

Bear in mind that the coronavirus impact on the economy was only starting to be felt in March, so the Q1 figure does not fully represent the bottoming of the US economy. 

Nonetheless, as the chart below indicates, the 5% annualized drop in GDP in Q1 was the sharpest contraction since the 8.4% GDP decline in the fourth quarter of 2008. Recall that the 2008-09 recession was associated with the worst economic and financial meltdown since the 1930s. The current economic decline obviously has come much more rapidly. 

Given the timing of the lockdowns and the responses to the virus, the second quarter decline in US GDP must be much steeper than the decline in Q1. 

Nonetheless, it is reasonable to expect that the US economy will rebound in the second half of the year as the lockdowns eases back. 

The consensus and even the financial markets fully expect a rebound in the US economy in the second half of 2020.

 For example, the Congressional Budget Office is predicting a 21.5% real GDP growth rate in the third quarter (July through September), followed by a 10.4% gain in the fourth quarter.

How rapid the rebound will be over the next couple of quarters, and its long-lasting nature, is the subject of incredible uncertainty. 

Larry Kudlow, the president’s chief economics adviser, is convinced, or so he says, that it will be a sharp v shaped economic rebound followed by a quick return to normalcy.

This thinking is clearly wrong and is based on unrealistic expectations both on the discovery of a credible virus and the ability of the US economy to recover quickly and easily from its economic trauma. 

Clearly the shape of the recovery depends on the success or lack of success that the US has in curbing the virus. 

And even with the current massive injection of federal funds to support the economy, there is no way that government funding can compensate for the fall off in spending in the private and household sectors. Moreover, confidence in both the corporate and household sectors will be hard to recover. 

The latest IMF projections paint a more realistic picture of the outlook. The IMF expects the US economy to shrink 8% this year and to rebound 4.8% in 2021. This projection is neither rosy, nor a soft landing, though it is also consistent with seeming rapid economic rebounds in Q3 and Q4. 

In other words, do not be misled by the seemingly steep US economic growth rates in Q3 and Q4. The reality is that the US economy will remain in a very weakened state next year. 

Equity markets, which are incredibly volatile, seem to this writer as being too strong given the uncertainty and the weakness associated with the future economic recovery.

Equity markets are responding to zero interest rates and low inflation, not to a strong economic rebound.