COVID-19 Recession Takes Hold

Real GDP growth fell at a 4.8% annual rate in the first quarter. The primary drag on growth was a contraction in consumer spending, which was affected by school and state closings in March. Across the country, schools closed on March 16 while shelter-in-place orders went into effect on a state-by-state basis starting with the shutdown of California on March 19. Spending on big-ticket items held up better than spending on clothing and services. Even health care spending fell as elective procedures were restricted.

Business investment fell precipitously in response to supply chain disruptions earlier in the quarter and weak global demand. By late April, more than 200 countries had reported outbreaks of COVID-19. Inventories plummeted but will fall further in the second quarter when the full effects of lockdowns appear and then the economy very slowly reopens.

The trade deficit narrowed but for the wrong reason. Imports fell more rapidly than exports. Imports from China, one of our most important trading partners, were especially hard-hit by a lockdown that started in Wuhan in January to attempt to contain what was only known then as the novel coronavirus. Inventories remained bloated in the first quarter as consumer spending ground to a halt. The exceptions: toilet paper, hand sanitizer and disinfectant wipes.

The only real additions to growth in the first quarter were residential investment and government spending. The housing market was on a tear and faltered only slightly when the crisis triggered lockdowns in mid-to-late March. In fact, the housing market is one of the few sectors poised to make a comeback and help drive the economy out of recession, but only if we can preserve the mortgage finance system.

The CARES Act passed on March 26 allows homeowners to defer mortgage payments at least six months without proving damage related to COVID-19. Only one million homeowners were expected to sign up. As we have already seen more than three million, the damage to mortgage servicers could be substantial. In response, credit conditions are tightening for borrowers. This could be a major glitch for the housing market on the other side of the crisis and potentially derail one of the few engines to pull us out of recession.

Government spending slowed in the first quarter, despite efforts to shore up the economy with the CARES act. The forecast for a rebound in growth in the second half of the year is heavily contingent upon transfers to the states, which have suffered the largest blow to revenues and boost to costs to counter the spread of COVID-19. Congress has yet to approve transfers to the states; the politics surrounding them are ugly.

Bottom Line
The COVID-19 recession that started in the first quarter is global in scope. The losses we have yet to endure are expected to eclipse anything in living memory. Other countries have stepped up much more than the U.S. to test, track and blunt losses associated with the virus. Wait-and-see is not an option for an economy hit by such an extraordinary external shock. Indeed, one of the few silver linings to this crisis is the foresight it has given us. We actually know what we need to confront instead of just reacting to losses after the fact.

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