• The path of COVID-19 remains the predominant driver of economic outlooks, and July was not a positive month on that front
  • Q2 GDP was expectedly bad on a historic level, but Q3 began with positive momentum on multiple fronts, but continued progress will likely require improved COVID data and additional fiscal aid
  • The July FOMC meeting offered no major surprises, but Fed Chair Powell did hint that the long-awaited changes to the Fed’s policy framework could be announced in the “near future”

Heightened COVID-19 concerns this summer have poured cold water on the optimism that surfaced in May and early June amid easing of economic lockdowns in parts of the country. We have been once again reminded that the virus remains the dominant driver of the economic outlook, but other doubts have emerged as well regarding the sustainability of the United States as the preeminent global economic power. The steady decline in the U.S. dollar index during the month of July and corresponding record highs in gold and silver prices sparked some speculation of burgeoning cracks in the U.S. outlook. The combination of the rising COVID death toll, the perceived mismanagement of the crisis at all levels, prolonged economic stagnation, and corresponding federal debt explosion are some of the apparent sources of concern in global markets, and the worsening political climate hasn’t helped, whether considering the current Congressional stalemate over a new fiscal aid bill or the upcoming election.

Despite these concerns, Treasury yields ended the month of July at or near record lows across the curve. In other words, global investors are not shying away from U.S. credit amid the dollar sell-off.  It’s quite the opposite.  To be clear, the U.S. Treasury market remains one of, if not the, deepest most liquid fixed income markets in the world, and Treasury yields, while at historic lows, remain positive. That cannot be said for much of the developed world, with the level of sovereign debt trading at negative yields now approaching a record high. July pessimism culminated with the release of the Q2 GDP report (first estimate) on the 30th.  While fairly close to expectations (Bloomberg median survey), a 33% quarterly decline (annualized) in output is startling nonetheless, and it shattered the previous post-WW2 record of -10% (Q1 1958).

Personal consumption plunged 35% in Q2, but it coincided with a massive 45% rise in disposable income (fiscal aid) and a huge increase in the savings rate to 26%, up from 10% in Q1. There was some positive momentum in consumer spending in the second half of Q2, and this, along with the firming of other economic metrics, sets the stage for a solid, but partial, rebound in Q3.  However, there are still many question marks related to the virus and additional aid from Congress. The recent resurgence of the virus in heavily populated states like California, Florida, and Texas pushed state and local leaders to reinstitute some restrictions that had been eased in May and June.  Consequently, we saw continuing jobless claims rise to more than 17 million for the week ended July 17, the first increase since late May, and market participants were more focused on this metric when released last Thursday than the Q2 GDP report given that it is a more current look at the economy. This increases the probability that we may see another decline in payrolls in the monthly jobs report in the next month or two.

As jobless claims are rising, Congress remains divided on a new round of fiscal aid, and the $600 per week federal subsidy to unemployment benefits expired at the end of July. Failure to extend this benefit in some form would be positive for the current budget deficit (long view), but it would also be negative for consumption and the near-term recovery from an unprecedented economic collapse. Fed Chair Powell has made clear what side of the debate he is on in recent weeks/months, stating that “fiscal policy is essential here” following the July 29 FOMC meeting. To reiterate, the path of the virus is the most dominant driver of the current economic outlook, and the sooner we can get the outbreak under control, the faster we can get our economy back running. This is where everyone can contribute in either a positive or negative manner. Powell said it well in his press conference last week. “The two things that are not in conflict, social distancing measures and fast reopening of the economy actually go together,” said Powell. “They’re not in competition with each other.”  That said, the development of a viable vaccine would go a long way to healing consumer psyche.

Fed Still Dovish
The July 29 FOMC meeting offered no major revelations (none were expected), but that’s not to say there wasn’t any new useful information provided. The clear message from the Fed is that monetary policy accommodation will remain easy for the foreseeable future. As Powell put it (again), “we’re not even thinking about raising rates.”

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