Morning Commentary: When Growth Isn’t Good

Foreign Exchange - Morning Commentary
When Growth Isn’t Good
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
Optimism around a sharp economic recovery in the US has created a pair of strange bedfellows.  In a recently published article, a former Obama economic advisor argues that COVID-19 will impact the economy in a similar fashion as a typical natural disaster.  There will initially be a sharp drop in activity in the initial quarter that is followed up by a sharp recovery in the following quarter.  This former aid goes on to conclude that “we are about to see the best economic data we’ve seen in the history of this country.”

Across the aisle, leading Republican economists agree.  President Trump’s chief economic advisor has said that he thinks that “Q3 may be the single best GDP quarter since regular data. 2nd half super big growth, transitioning to 4% or more in 2021.”

Certainly there are emerging signs of a recovery, but both of these economists gloss over two key points.  The first is simply math.  During periods when growth swings wildly, like the current period, growth rates do not provide an accurate measure of how the economy is doing.  For example, if activity drops by 50% in one period but recovers by 50% the next period, it is still down 25% overall.  A similar dynamic pertains to diffusion indexes such as purchasing manager indexes (PMI).  A drop from 50 to 20 and then back to 50 is not a “V” shaped recovery but rather an “L” shaped one.  It means that activity took a big drop and then stayed at that depressed level.  A “V” shaped recovery would require the rebound to be as big as the drop, so a 50 to 20 drop needs a rebound back to 80 for a “V” shaped recovery.

The bigger issue is that COVID is fundamentally different from a natural disaster.  Natural disasters such as an earthquake or hurricane come and go quickly.  Conversely, COVID will hang around until a vaccine is found.  This uncertainty/expectation for a second wave will reduce people’s willingness to rebuild on shaky ground.  Furthermore, experiences from other countries show that an effective testing, tracing and quarantine system helps to contain aftershocks and minimize their economic impact, but the US is still struggling to put up an effective system. 

Of course, given that it is an election year, the shape of the recovery has both market and political implications.  There is a wide range of studies that show it is the state of the economy during the year of the election and not during the full term of the incumbent that matters.  So while Democratic and Republican economists may be in agreement now, expect Republicans to point to a strong Q3 GDP growth rate while Democrats highlight still very high unemployment.  
  • President Trump is scheduled to hold a press conference to address the issues in China.  Based on recent developments, it is difficult to believe that Trump will take on a conciliatory tone.  Looking at USDCNY price action, it appears that markets are pricing in some risk for US tariff increases but the likelihood of non-tariff measures is much higher.  Should the US response be limited to targeted sanctions or visa bans, USDCNY could see some unwinding in the near term.  More aggressive actions such as tariff increases or cancelling the Phase 1 deal will see yuan much weaker.
  • Fed Chair Powell will speak as part of a discussion with former Fed Vice Chairman Blinder.  The discussion should touch on the range of tools left in the toolbox.  Despite the Fed’s strong push back against negative rates, futures market are still pricing a small chance of negative rates by mid-2021.  Expect Powell to push back on negative rates again as well as be asked about the possibility of yield-curve control. 
  • Canada’s Q1 GDP data came in better than expected at -8.2% versus expectations for a -10.0% decline.  Consumption was as bad as expected but investments did much better than expected. 
  • US personal income increased by 10.5% versus expectations for a decline of -5.9%.  A key factor behind the growth in personal income is the massive amounts of stimulus in the markets.
  • Speaking of stimulus, Germany is preparing another round of stimulus worth around EUR 50-100 billion.  Discussions are still ongoing but the new fund is expected to help municipalities, corporate investments and families with children.  Japan has also announced another fiscal package with overnight economic data out of Japan generally weaker than expected.
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