Here is my forecast from last Fall along with my summary of the Annual Forecasting Conference. You can see how well I am doing given my baseline economic assumption that recovery from Covid would be a halting period of fast and slower growth periods.
Going forward I will be submitting comments based on my contributions to the Chicago Fed’s Monthly Survey with a particular emphasis on autos and financial services. Comments and replies will be welcome.
Chicago Federal Reserve
Highlights 34th Forecasting Conference
December 4, 2020
This year’s Forecasting Conference was held virtually, so no time for personal interaction. However, I did submit a forecast and recorded the highlights from the speakers. In developing my 2020-2021 forecast, I went with the currently accepted science that a Covid-19 vaccine will not be widely distributed until the end of the second quarter of 2021. I also side with those forecasters that believe even then that consumers and workers will be cautious in returning to more normal patterns of behavior and so the economy will not really approach full recovery until the end of next year, 2021. In the Chicago Fed’s summary of submitted forecasts, this view seemed to emerge as the consensus and was noted as being broadly consistent with the forecast done by the FOMC [Federal Open Market Committee] as well.
The first speaker focused on the Sectors Hardest Hit by Covid-19 that resulted in Economic Growth being down 34% in the 2d quarter. Further while the economy rebounded 33% in the 3d quarter, it was important to note and not surprising that there was a direct link between those sectors that were successful in dealing with the virus and their economic recovery and growth. Therefore, sectors that continued to be adversely affected did not participate in the recovery. This is why the most pessimistic forecasters from last year won the various awards, with the caveat that no one was close to the actual results or predicted the pandemic.
The Chicago Fed’s Forecasting Consensus for 2021 is a 3.3% increase in real GDP in 2021 after a 2.7% decrease for 2020. This is why the economy will essentially just get back where it was at the end of 2019 by end the end of 2021, again close to the FOMC’s expectations. Unemployment will end 2020 at 6.9% (4th Quarter) and 2021 at 5.8% versus 5.5% for the FOMC. Longer-term the FOMC sees unemployment as settling around 4.1% with a slack economy until 2023.
As a note of caution, though, it was explained that the Chicago Fed’s Monthly Business Survey did not expect the full recovery until the first half 2022.
This economic forecast summary was followed by an explanation of the Fed’s new strategy statement compared to the prior statement in 2012. The new strategy sees the Long-run Fed Funds Rate as the current 2.5 % versus the prior 4.5%, which unfortunately means less response power to potential economic shocks. The Phillips Curve now views the natural rate of unemployment as 4%, a significant drop from the prior 5.5%. The strategy does note, however, that at this overall rate the unemployment level for black Americans remains stubbornly about twice as high as for white Americans. Therefore, the employment gap continues even though the difference is narrowing due to the overall drop in the natural rate.
In this new Economic Policy Environment, it was emphasized that even responding to a normal economic or financial shock could get rates to a zero-lower bound. This will then require more accommodation, such as greater quantitative easing, though the Fed does not currently see inflation as an issue when it is no longer clear when unemployment is too low. Rather the Fed’s approach will be to look at a more comprehensive set of data in setting Economic and Monetary Policy, including getting data from more diverse parts of the economy such as the disconnect between IT workers and those in depressed communities. It will continue, however, using 2% inflation as a key policy anchor and will assume the unemployment rate is not too low if inflation is below this bound. In this respect the Fed will be pursuing a pro-growth strategy, even with a very low unemployment rate unless there is a sustained move above the 2% inflation target. It will thus not “jump the gun” as it might have done in the past.
Under this economic scenario the current FOMC targets are 4% unemployment and 2% inflation based on a 5-year average. It currently expects this to occur around the end of 2023. However, given the present economic uncertainties, it would not be surprised if it was unable to fully claim victory with arrival at its goals until the middle of 2026. This recognizes that this year, 2020, has been like no other and whatever is ahead will be heavily influenced by the course of the pandemic. Given that consumption is such a large part of the economy, outstanding consumer issues will drive the recovery. Thus, it important whether even if stores are open consumers will come, and if they do not, will it make economic sense to be open? Further, even after a vaccine becomes available, we do not know when consumers will feel really comfortable returning to old habits such as leisure travel?
The first two quarters of 2021 especially will be driven by the course of the virus and consumer response. Current view is that even optimistically only 40-60% will get the vaccine by the end of the 1st quarter. In addition, the distribution will be very complex and there may be supply chain issues such as an adequate supply of needles combined with many hesitating to get the shot. Indeed, incentives may matter such as having access to restaurants, schools, travel, in-person work, and public events. Shutdowns and the recovery are linked especially as the prior stimulus runs down. The latest job figures show a declining labor force with 9 million not employed compared to last January. So just because the unemployment rate has declined, it is not good if one adds back those that have left the Labor Force. This situation has only gotten worse since the Conference with a spike in cases and new jobless claims rising as the stimulus has expired. This is despite the Holiday Season. Though Congress has passed a lower bound stimulus, it seems determined to put a lump of coal in the economy’s stocking going forward.
The bottom line is the economy will still need more stimulus in the first half of 2021. If this occurs then the prospects for a strong recovery improve dramatically, though the timing remains dependent on what happens with the virus and consumer behavior. Generally, the Conference was not concerned about the increase in short-term debt given the need for a better recovery. Also, US Central Bank assets relative to GDP (36%) are way below EU levels much less Japan’s. Further, the velocity of money is weak, and savings are high, which helps keep inflation under control, especially in the short term. However, there was concern regarding the situation facing state and local government that will create economic headwinds unless get some stimulus which is not in the December package. Therefore, political gridlock remains a real issue with respect to a robust recovery. The fact that Kentucky is one of the states that have been worst hit seems to matter very little.
Another potential negative is trade that has normally been a source of expansion over the last 10 years. This is because there is the clear potential for more restrictions between countries, plus a renewed corporate emphasis for onshoring, though the latter would offset or more than offset some of the negative growth from reduced trade flows. Climate is also an unpredictable growth factor as one cannot be sure if the costs of reducing the fossil fuel footprint will be offset or exceeded by the benefits of remedies or investments in renewables in the short-term. In the long-term, however, the benefits are quite apparent. Overall real US GPD growth for 2021 will be about 2.3% versus world growth of about 5.0%. Unemployment will still be over 6% at the end of 2021.
Things that need to be monitored as the year unfolds as potential or actual short and long-term problems and concerns in terms of economic recovery and growth are: Evictions; support for SMEs and State & Local governments; fact that while upper 20% have natural economic support from being able to work from home along with financial assets such as a rising stock portfolio, lower 50% have no savings and are more likely to be in-person workers; increases in long-term unemployment and lower labor force participation; fact if take out top 5 stock market performers then actual results become somewhat anemic. One bright spot is the housing market that never fully recovered from the 2008-2009 collapse, partly due to more stringent mortgage rates and lower building rates. Therefore, have lower supply and stock meeting increased demand due to ultra-low mortgage rates, more working from home, and increased family formation with attendant interest in schools and education.
With respect to individual sectors other than housing or finance, autos; energy; steel; transportation, including mass transit, airlines, and trucking; state and local governments; commercial real estate; and community-based organizations were on the Agenda.
Auto inventories and factory operations both of which fell initially in March and April given the reduction in overall demand bounced back in the 2d quarter. This favorable development was driven by moves to the suburbs plus higher demand for cars as a way to avoid mass transit. Further dealers are now rebuilding inventories. Fleet demand though is weak and will depend on more travel that will lead to more rental demand but right now that is a negative that has led to bankruptcies in the rental industry (Hertz).
The effect of shifts to more electric vehicles [EV] remains uncertain. The greater the shift the larger the negative effect on the demand for oil but this could help Natural Gas and Gas Turbines due to larger charging requirements. EV demand issues are the key to conversion progress since consumers do not want much change from their current vehicle use, which necessitates longer battery life and lower costs. The trend is there with a recent 20% reduction in costs plus range improvements. Further, Federal Government has indicated it will make fleet purchases combined with 500,000+ charging stations nationwide. In this regard, Toyota’s recent announcement of a 10-minute solid state battery with increased range represents a huge leap forwards.
The pandemic decisively reduced oil demand in the 2d Quarter with inventories jumping by 1 million barrels, forcing OPEC to make its largest actual cut in history while shale oil production has dropped a lot as well. But inventories still continued rising through summer. In September US inventories began dropping but remain far above normal. Overall, it is not expected that oil demand will get back to normal until 2022 and even this forecast involves several caveats and unknowns similar to those affecting autos, such as when people will feel more comfortable traveling, how much they will feel they should drive rather than take mass transit, the move to the suburbs, and the shift to EVs. Further shale production will act as an upper bound on prices since it depends completely on price versus cost, though the feeling is that shale faces real headwinds in terms of its recovery. This is because currently the scope for innovation compared with 2015-2016 is much more limited and it is having problems attracting financial sector support given that it is spending all its cashflow.
Other qualifiers are Libya and Iran as wild cards on the production side and on the demand side the fact it will take EVs time to have an impact given that 85% of world energy is still fossil-fuel based, which is constantly being depleted, and EV’s expected negative effect is less than the decline in the availability of fossil fuels annually. The impact of the new Administration’s emissions and leasing policies is expected to be modest.
The absolute decline in oil demand and production along with other factors had a large negative impact on steel at the beginning of the pandemic. Capacity utilization beginning with raw steel production took a beating in the Spring as capacity usage fell about 30% from 80% to 50%. However, with the recovery of autos and energy since May there has been a steady improvement with capacity utilization now about 70%, which has been reflected in downstream products such as steel sheet and pipe that feed the auto, appliance and energy sectors.
The Trump tariffs have helped too, but global overcapacity from China with its government support means a potential import surge is still an issue even though currently the slowly increasing domestic demand trend is holding. In April, 8 blast furnaces shut down, but four or five have now fired up again. The steel forecast thus expects capacity usage to be up about 6% next year with autos leading. Non-residential residential construction is worrisome, though, given the working from home trend and the excess office space while oil and gas also are problematic since the industry is expanding slowly. The recovery is thus in step with major customers. But trade issues remain at the top of the worry list because of the excess global capacity problem.
Other considerations are how much of the pandemic shock will continue and what are the other trends that should be monitored. Clearly there will be increasing demand for lighter and lighter steel at reduced costs in order to keep market share in the face of EVs and battery packs. This will advantage the technology leaders, though steel pricing issues keep anti-trust exposure in the rearview mirror.
Transportation has been one of the hardest hit sectors by the pandemic especially in terms of employment. But some subsectors have shown resilience such as freight. Chicago’s and other urban transit systems’ ridership is way down except for essential workers. But train and truck freight are back where they were plus there has been a 5% plus boost in air freight due to vaccines and immediate delivery demand. In addition, delivery is up 15-20%. In sum, services that increase mobility and work-at-home are benefitting from the pandemic and may continue to do so as consumer habits change.
NASBO or National Association of State Budget Offices has no such good news as it reviews the current period and forecasts forward for its members. Last year everything really looked quite positive for the states with robust revenue growth and fortunately many put the unexpected revenue bonus into reserves amounting to about $75 billion. However, this has now all changed. Yet, taking a longer-term perspective, it must be recognized the states were just recovering to levels before the Great Recession.
Comparing this year with 2019, there has been an actual 1% revenue decline. But since the states expected a 3% increase, there is generally a 4% gap between their 2020 budgets and the actual situation. Also, Federal support has been an important component of these 2020 numbers. Therefore, given Congressional reluctance to offer more support means the state and local budgets for 2021 are looking dire. Current forecasts are therefore tracking further declines in 2021 and 2022, making for a situation worse than the Great Recession. This is because besides the decline in revenues there will be increased expenditures due to the pandemic. There are, of course, wide differences between states and cities in terms of revenue declines versus growth as well as dependence on Federal aid. Still, it is currently very tough on budget officers, especially trying to accurately forecast revenues where income tax is important and where sales/hotel taxes depend on tourism.
Commercial real estate is similar to transport with certain areas really hard hit such as malls and office space and others that are relatively OK such as warehousing. This sector usually lags economy and so is hit later and will recover later, but next 6-9 months will be tenants’ market.
Community based organizations or the non-profit sector are important parts of the social safety net, and all have been negatively affected by the pandemic and economic downturn, losing both staff and revenue with donations down about 50%. The biggest drops, though, have hit arts and culture. However, all have been negatively affected by the decline in revenue for services from local governments while at the same time the demand for some services such as food banks are increasing.
Since the sector hires about 12 million people, the 3d largest in the US, but more importantly are the groups that connect most directly with those impacted by the pandemic, this is a very worrisome development. This is especially true for households of color with incomes below $50K that are the most likely to have lost income and thus have the biggest problem meeting normal household expenses. There is also the issue of whether the eviction moratorium that ends 12/31 will be extended, though the current bill waiting for the President’s signature seems to have some protection. SMEs in these areas of color are also seeing a deterioration in their neighborhoods despite benefiting from the PPE due to a lack of building maintenance, an area of concern as the country enters the winter months.
While some forecasters expect a quick recovery after Covid-19 many organizations may not survive through next six to nine months since there is a connection between the declining budgets for state and local governments and the non-profits needed to support these neighborhoods since the former often hire the latter to carry out certain support and outreach activities. Therefore, while Medicare and Medicaid have filled some gaps, a rationing of services is likely, and some tough choices will have to be made that will widen the gap between the better-off households and others that are in real need and are overwhelmingly communities of color.
This should lead to a discussion of equity as well as income and wealth inequality at several policy levels. Failure to address these concerns in turn will lead to an erosion of trust in democratic institutions and increased trust in state capitalism, especially in light of industrial change. Indeed, if state and local governments cut headcount and support to non-profits who then also reduce headcount, not only will the social safety-net suffer, office and space requirements will be reduced, negatively impacting the commercial real estate market even after people can return to the office. On the other hand demand for and access to broadband demand will continue to expand as local governments and non-profits shift more to a work from home format.
The moderator then closed the Conference wishing everyone a safe and happy holiday as do I!