As bond market professionals seek to divine the contours of a recovery likely to look very different from rebounds most Americans have seen in recent decades, a number of issues confound them. The strength of the economy and the inflation-versus-deflation debate top the list of many observers.
If modern history is any indicator, the economy’s comeback would be muted over the next year. That’s precisely what happened in 1991, 2001 and 2009.
But the circumstances today are quite different: The Covid recession was orchestrated by a government trying to control a public health crisis. The only downturn with a similar pathology was the 1981-1982 recession. It was engineered by the Federal Reserve in order to expunge inflation and accompanied by massive fiscal stimulus in the form of tax cuts and defense spending. Furthermore, the U.S. entered this recession without the egregious asset bubbles in housing or equities.
Heading into 2021, several fixed-income experts believe the easy, or V-shaped, phase of the recovery is already winding down. “We were surprised by the V we got [over the last four months], but we are getting to an inflection point,” says Michael Collins, managing director at PGIM Fixed Income.
Going forward, he anticipates a slow but steady recovery characterized by temporary mild, virus-related shutdowns, but “nothing like March.” America’s GDP is running at about 95% of its pre-recession pace. On a global level, the speed of the rebound varies. China alone has already regained more than 100% of its lost business activity.
Unfortunately, the other shoe is starting to drop, as temporary layoffs threaten to become permanent and small business delinquencies turn into defaults, Collins fears. If past experience repeats itself, white-collar workers in corporate America and high-wage earners in the strapped public sector could be vulnerable to layoffs.
Just because the next few quarters are likely to be challenging doesn’t mean the economy “has to slow to a crawl,” according to Erik Weisman, chief economist and portfolio manager at MFS.
But there are obstacles. The path to a coronavirus vaccine is the biggest unknown in the minds of many economists. And the presidential election aftermath could be almost as important as the vaccine approval, Weisman argues.
Financial markets usually favor divided government over one party controlling both the White House and Congress, since gridlock provides checks and balances. This time could be different. Weisman believes either a Biden victory and a Democratic Congress or a Trump re-election and a GOP Senate would create an environment where badly needed stimulus is more likely to pass. “If Biden wins and the Republicans keep control of the Senate, they are likely to give him [very] little,” he says.
A recovery that’s slower for longer may be a popular narrative, but it’s not a universally shared view. The financial crisis 12 years ago was marked by a blame game. Many Americans were furious at having to bail out Wall Street banks and there was scarce sympathy for borrowers who acquired houses more expensive than they could afford.
But this time around is different. It’s difficult to resent small business owners and their employees when they were forced to shut down by government mandate. Without all the finger-pointing, there could be a more constructive resolution for this most recent recession.
Consumers Are Stronger This Time
Consumers also entered the 2020 recession in much stronger financial shape than they did when the housing crisis struck. “Behavior has changed,” says Anwiti Bahuguna, senior portfolio manager at Columbia Threadneedle. “People are not willing to take on large amounts of debt.”
Housing is one of the few sectors that is booming, she notes, but people are taking out mortgages at record low interest rates. More than a few home buyers are moving to more rural areas where they often pay less for more space.
The savings rate was running at an annual clip of nearly 8% for several years before Covid-19 hit, and the lockdown temporarily sent it spiking to 19%. But Bahuguna claims this behavior was bifurcated: Some people were saving at rates resembling China’s, while unemployed, low-wage workers in industries like hospitality and retail were quickly burning through their savings and were forced to subsist on government aid. Still, at some point after a vaccine is widely available, she says the global economy should see a burst of pent-up demand.
Odds of a stronger-than-expected recovery are about 60%, according to JP Morgan Asset Management chief investment officer of global fixed income Bob Michele. That view incorporates the belief that there will be more fiscal stimulus regardless of who wins the election.