Stunning Blows in Service Sector-Induced Recession

Personal incomes dropped 2% in March, the second largest monthly drop on record. The Bureau of Economic Analysis (BEA) attempted to incorporate losses in income tied to the initial unemployment claims for the month to better capture the effects of the losses associated with COVID-19-driven layoffs. Income losses were driven by a sharp 3.7% drop in private wages and salaries. Government wages and salaries were essentially flat for the month. Employer contributions for employee pension and insurance funds and government social insurance (mostly social security) dropped a record-breaking 1.4%. Transfers for unemployment insurance more than doubled during the month but lagged the surge in job losses. Hence, the growing lines for food banks.

Consumer spending plummeted 7.6%, the largest drop on record. Spending on consumer services, which span the gamut from health care to travel and tourism, contracted at a 9.5% pace during the month, making this the first service-sector induced recession in history. The only monthly contraction that even approaches those losses occurred in September 2001 when the service sector contracted by 1.3% in the wake of the 9/11 terrorist attacks.

The slowdown in spending on health care may seem counterintuitive in a pandemic. Fear, school closures and shelter-in-place rules prompted people to stop going to their dentists, doctors and hospitals to avoid contracting COVID-19. Employment in the health care sector alone plummeted a record-breaking 42,500 in March, before schools and states were put into lockdown. The survey for the March employment report was taken during the week of March 12, which preceded school closures and state lockdowns.

Spending on services accounted for 70% of total spending in February, prior to the COVID-19 crisis. The contraction in services spending was stunning and expected to worsen as we move into April, when more of the country was in lockdown. The fear associated with infections is expected to persist; that will limit the pace at which we ramp up following state mandated closures. The fear factor has already shown up in China, which is much further along in its process of reopening than the U.S. In fact, the behavioral effect that epidemics and pandemics have on consumers has tended to extend the economic pain associated with mass closures.

The saving rate jumped to 13.1% in March from 8% in February. That is the highest saving rate since the 1981-82 recession and one of the highest saving rates in history. The saving rate briefly hit a peak of 17.3% in May 1975 as consumers were emerging from the 1974-75 recession. The saving rate had been moving up instead of down in the wake of the mortgage refinancing boom that started in July 2019. Baby boomers, who are near or in retirement, banked the saving that they received from refinancing their homes. This marks a sharp shift in the impact of mortgage restructuring on the economy. Boomers were the first to leverage home equity lines of credit to spend in the 1980s and decades that followed.

Baby boomers have recently proven much more sensitive to declines in the value of their 401(k) than they were in the past. Those shifts will further mute the rebound in consumer spending following the COVID-19 crisis.

Bottom Line
Consumers pulled back on spending more rapidly than they lost incomes in March, which pushed up the saving rate. That will provide little cushion, however, for a rebound in spending once the economy is reopened. Lingering concerns about contagion, a surge in job losses and concerns about retirement are all expected to mute the rebound when business resumes in fits and starts.

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