News analysis

Why the outlook for the US economy just got worse

Traders work on the floor of the New York Stock Exchange on March 9, 2020. PHOTO: AFP

NEW YORK (NYTIMES) - There are rare moments when the world economy seems to be reconfiguring itself beneath our feet. These can be startlingly fast bursts, not obvious to people who are just going about their business, but glaringly so to those who interpret the moves of financial markets.

March 2020, it is now abundantly clear, is one of those moments.

Already, it appeared that chunks of the US economy would have to reduce operations or shut down entirely to try to slow the spread of the coronavirus, especially in travel-related businesses. Then over the weekend, Russia and Saudi Arabia began an oil price war that sent the price of crude to its biggest plunge in three decades - which could cause widespread bankruptcies in the American energy industry.

The exact scope of the economic damage the United States faces is still an open question, and there may yet prove to be significant disruptions without full-scale recession.

But Monday's markets, which recorded the steepest single-day drop since 2008, indicated that some very gloomy possibilities were becoming more likely.

Asian markets opened for the week with implausibly large moves in some of the world's most important measures of economic and financial conditions. The numbers that flashed on traders' screens in Asia, then eventually in Europe and the US, seemed to be evidence of a world economy realigning itself.

Ignore the steep sell-off in stocks - that is an effect, not a cause, of the disruptions remaking the global economic outlook. What matters now are bond yields and commodity prices, the two most vivid indicators of a shifting landscape.

These market prices are telling us that a recession is becoming more likely in the US this year, and that it will probably leave scars on the economy for years to come. Worse, it looks like predictions of a "V" shaped downturn with a quick, sharp rebound are probably off base.

"We've reached the tipping point where things are feeding off of each other," said Julia Coronado, president of MacroPolicy Perspectives. "We're going to lose a chunk of activity and then we'll grow out of it. That's the good news. But are we going to boom out of it or crawl out of it? Crawling is looking more likely."

President Donald Trump late on Monday endorsed a temporary cut in payroll taxes - after weeks in which his administration appeared largely resistant to large-scale fiscal stimulus. He said that he would announce other economic measures on Tuesday, and that "they'll be very major."

The Federal Reserve is likely to take further actions to contain the damage for the economy and financial markets. Not only do futures markets indicate the Fed will cut its short-term interest rate target more in the coming weeks, but the yield on 10-year US Treasury bonds also fell to a mere 0.54 per cent, and the 30-year bond now yields only 1 per cent. Those numbers strongly suggest investors expect the Fed to keep rates near zero - or conceivably below zero at some point - for a very long time.

The oil price rout - a barrel of West Texas Intermediate Crude was at US$31.13, down 25 per cent in a single day and around half its level at the start of the year - implies trouble to come in the American oil patch.

Cheaper oil will create benefits for US consumers and for oil-consuming industries. But as the shale gas industry has grown and the US has become a net energy exporter, the balance has changed in how cheaper energy affects the economy.

The pain of cheap oil will tend to be highly concentrated in oil-producing locations, and will have an outsize impact on capital spending. (Spending on energy is a major driver of demand for heavy industrial equipment.) A telling indicator: Shares of Halliburton, the leading maker of energy equipment, were down 38 per cent Monday, compared with about 7 per cent for the overall market.

The US has experienced something like this before, in late 2015 and early 2016, when a drop in commodity prices caused an economic slump that was most pronounced in the oil patch and in heavy industry.

In that episode, the overall US economy kept humming along because consumer spending and service industries were mostly unaffected. What makes the outlook for 2020 seem so different is that the oil price swoon is coming at the same time coronavirus appears likely to wallop those sectors.

The damage is still highly uncertain. But if large gatherings like conferences and concerts continue to be canceled, and more people decide they will not fly this summer and stay home more generally, it's likely to cripple the consumer-driven side of the economy.

That means that workers who serve those industries will be in danger of furloughs, lost hours or layoffs. "This is unusual in that it may prove faster acting than past downturns," said Jay Shambaugh, director of the Hamilton Project at the Brookings Institution. "The drop in oil prices and drop in financial markets alone, and when you add those to the impact of the virus and the hit to global demand, at some point that has spillovers to the US economy."

Companies affected by the coronavirus spending freeze would, like their counterparts in the energy business, be at risk of default.

Years of aggressive lending practices by businesses could come back to bite them, and a few high-profile bankruptcies could trigger a broader reassessment of risk among lenders that means even healthy businesses have trouble rolling over their loans.

The downside of the aggressive borrowing by corporate America in the last decade is that it makes companies more brittle - less able to withstand the occasional hiccup in demand, or a problem with supplies. It appears 2020 will be a test of their resilience and whether debt loads have truly become excessive.

In effect, plunging energy prices caused by geopolitical machinations are combining with coronavirus to put numerous major industries under pressure in ways that could bounce off one another - through financial markets, to the economy, and back again - in unpredictable ways.

The news isn't all bad. Lower oil prices really are good news for consumers; lower bond yields will translate into lower mortgage rates; and the big market moves on Monday will probably get the attention of policymakers and coax a more aggressive response.

"If the virus doesn't spread too widely in the United States, or if a natural peak were to occur in the infection rate, the economic damage could be contained," said Megan Greene, a senior fellow at Harvard Kennedy School. "A massive fiscal stimulus would be huge at this point."

In other words, avoiding some of the more dismal possibilities might take some mix of luck and a strong public policy response.

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