Morning Commentary: The Fundamentals of Supply and Demand

Foreign Exchange - Morning Commentary
The Fundamentals of Supply and Demand
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
The CARES Act’s supplemental unemployment payment of $600/week is set to officially expire today.  In reality, however, the supplemental payments actually stopped being paid last week due to how the law was written and how states pay out unemployment benefits. 

The supplemental payments have been one of the more controversial portions of the CARES Act as ~67% of recipients are estimated to have received more on unemployment than when they were employed.  Understandably, this led some to believe that workers lacked the incentive to look for new jobs.  Continuing this train of thought, some lawmakers are arguing that scaling back these benefits would speed up the recovery as it would incentivize people to return to work.  On a high level, this seems to be a pretty straight forward analysis, but interestingly enough, academic economists appear to disagree.    

The University of Chicago’s Booth Business School regularly surveys a panel of leading academics for their views on the economy and economic policy.  In a recent survey, the policy choice for unemployment benefits to remain unchanged or increased was given the highest probability, and by a large margin, of being the best policy for the US economy. 

The reason for this is that economists see job growth more constrained by a lack of demand than an unwillingness to work at prevailing wages.  If this is true, then reducing benefits not only won’t help with job growth but would also hurt the economy.  Cutting the ~$10 billion/week supplemental benefit would put a dent in consumer spending which could lead to more layoffs.  It should be noted that COVID-19 related layoffs are concentrated on low income workers that are more likely to spend the unemployment benefits rather than save them.

To be clear, the survey results aren’t arguing for supplemental benefits to continue indefinitely.  But if these academics are correct, it is the overall weakness in the economy that is the greater issue and not misaligned incentives.  Continuing with unemployment benefits will directly support the unemployed and indirectly support businesses.  This should allow for labor demand to recover quicker which makes it easier to reduce supplemental benefits without damaging the economy.     
  • The markets are a bit of a mixed bag today with treasury yields falling and equity markets mixed with Asian markets lower but European stocks higher.  In the US, markets opened higher on the session.  Rising infections around the world continue to be a story as illustrated by the UK reinstituting stricter lockdown measures in some areas of the country due to poor adherence to distancing measures.
  • News reports suggest that President Trump may be willing to strike a stimulus deal with the Democrats that excludes legislation that provides protection from virus-related lawsuits.
  • Euro area Q2 GDP contracted 12.1% QoQ, which is in line with expectations and is the biggest contraction on record.  Broadly speaking, Europe instituted more stringent lockdowns than the US, which led to a bigger hit to its economy.  However, these stringent conditions allowed Europe to gain better control of the virus, setting the stage for a bigger rebound relative to the US which continues to struggle with the virus.  Price action in the markets indicate growing expectations that Europe will outperform the US in Q3 and possibly Q4.     
  • Positive economic news has come out of Canada and China.  Canadian GDP grew 4.5% in May against expectations for a 3.5% print. In China, manufacturing PMI rose from 50.9 to 51.1, beating consensus.  Services PMI moved down from 54.4 to 54.2 but remains in expansionary territory.    
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