Economy Shrinks at Fastest Pace in 70+ Years

Real GDP plunged at a 32.9% annual rate during the second quarter, after slipping 5% in the first quarter. The latest decline marked the fastest pace of contraction on a quarterly basis in the 70 years that the government has been reporting quarterly changes in growth. The previous record was a 10% decline during the first quarter of 1958.

The data is compounded at a seasonally adjusted, annualized pace. This process magnified the drop between the first and second quarter, the bulk of which occurred between March and April. The economy contracted by 9.5% before being annualized, which is still the worst quarterly contraction on record. April was the weakest month of the quarter. We saw a sharp rebound in employment, spending and production during the months of May and June.

The quarterly losses were broad-based. Consumers and businesses alike pulled back as fears of contagion and state-mandated lockdowns were implemented. Spending on services was hit hardest with a drop of more than 40% on an annualized basis. Business investment was halted even as inventories were depleted. Even the trade deficit, which usually narrows in recession, was a drag on growth; exports fell more than imports in response to COVID-triggered weakness abroad.

Government spending also fell, with sharp declines at the state and local levels more than offsetting an increase at the federal level. Employment at the state and local levels plummeted during the second quarter and will remain a headwind for the economy unless Congress includes transfers to the states in its next aid bill.

The only silver lining was the housing market, which posted a strong comeback in May and June in response to record-low mortgage rates and the pent-up demand triggered during lockdowns. That was not enough to lift residential investment out of the hole dug in April when home sales and construction cratered.

The housing market has come to embody the worst in inequality, which has been magnified and exacerbated by COVID-19. The rebound in home buying and building activity post-lockdown was accompanied by a sharp increase in delayed mortgage and rent payments.

Recent data suggest the problem worsened as we moved into the third quarter. More than one third of renters worry they will not be able to make rent payments on August 1, according to the weekly Household Pulse Survey by the U.S. Census Department. More than 15% of home owners were worried about making their next mortgage payments, up almost two percent from the same week in June. Black and Hispanic families have been especially hard hit. Barring an emergency extension to unemployment benefits and evictions, we could be facing the worst food insecurity and homelessness since the Great Depression.

This is all at the same time that high frequency data on everything from spending to employment went from plateau to reversal in recent weeks. Foot traffic at shopping malls is down along with credit card usage while job postings have slowed and remain at a small fraction of the previous peak. The worst news came in the weekly household survey, which shows a drop of four million jobs since mid-June.

Separately, the personal consumption expenditures (PCE) price index, which the Federal Reserve targets, dropped at a 1.9% annualized rate during the second quarter. A fall in energy and service sector prices led the decline. Fed Chairman Powell openly worried about the disinflationary effects that COVID-19 will have on the economy during his decidedly downbeat remarks following the Fed’s meeting on monetary policy this week.

Bottom Line
The economy contracted sharply during the second quarter. Our forecast shows a moderate rebound in the third quarter, but that is now being challenged by a resurgence of COVID-19 infections. Change the course of COVID: Change the course of the economy.

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