Have We Hit Event Horizon?
In astrophysics, the event horizon is a theoretical threshold of a black hole linked to an object’s escape velocity. That is to say, the closer an object is to this threshold, the greater the speed needed to escape the black hole’s gravitational pull.
This threshold’s escape velocity exceeds the speed of light, and since nothing travels faster than the speed of light, according to the theory of special relativity, once an object passes through the threshold, it has reached the point of no return.
That may be hyperbole, but the data is anything but V-shaped. Not only was Q1-20 GDP an utter surprise for most, down 4.8 percent, but the Atlanta Fed’s GDPNow tracker went from -17 to -34 percent GDP in Q2-20 just last week.
In “Don’t Say the V-, L- U or Swoosh Word,” we said [4.7.20]:
“The worst-case scenario probably looks something like below. In this case, real GDP drops by 10% in Q1 2020, 34% in Q2 2020, and another 12% in Q3 2020, after which the economy recovers at a 6% pace in Q4 2020 and 10% in Q1 2021. Total lost output over this period: $4.3 trillion.”
Yes, we were ahead of the game again. April’s consumer price data today showed that not even $5 trillion in stimulus could spur any price reflation.
Our forecast for headline and core CPI were 25 and 125 bps, respectively. We were a mere 5 and 15 bps bps off the 30 and 140 bps print. This was lower than consensus estimates of 40 and 170 bps.
It’s not just the U.S. that’s in trouble.
In the European Union, annualized GDP growth dropped by 3.8% in Q1-20, while in the growth in China dropped by a massive 9.8%. All indications through April and the first half of May are that second quarter GDP will be even worse. The global economy basically died in the last half of March through April and through the first two weeks of May.
With economies now beginning to open, three overhanging questions should be top of the list.
- First, how big of a hole will there be to dig out of?
- Second, will the hole act as a black hole – a force so strong that nothing will be able to escape (there’s a chorus with this mindset, wanting to keep the economy from advancing (it’s easy to hear the sucking sound)).
- Third, will the velocity coming out of the deep hole be fast enough to keep the intense social unrest at bay? The shape and speed of the expansion will need to be white hot to avoid real, prolonged problems.
This Part 1 addresses the first question.
How much of a hole is there for GDP? Let’s assume it’s not as bad as we forecast and annualized GDP drops by 30% in Europe, 35% in China, and 25% in the U.S., then the hole is $16.2 trillion. Making up the drop is -$4.5 trillion from Europe, -$5.8 trillion from China, and -$5.9 trillion from the U.S.
To put this in perspective, the $5.9 trillion drop in the U.S. takes GDP back to 2011. Nine years of GDP growth to make up in the last two quarters of 2020. At least it is not as bad as the jobs market, where the economy has more than 20 years to make up. If this recession turns out to be a black hole as opposed to just a big ditch, real hatred and fierce moral battles await.
Due up on Friday are retail sales. How big of a hole is there? To date, retail sales in the U.S. are down 6.2% over the prior year (through March), while retail sales in Europe are down 9.2% and down 15.8% in China. Retail sales out of China have been negative for three consecutive months (-20.5% in January and February and -15.8% in March).
In absolute figures, how much is this? The answer is, as with GDP, massive. In the U.S., if a 6.2% drop were to hold throughout the entire year, retail sales would be down around $1 trillion from their baseline projections of $6.6 trillion. (As a note, the figure is lower than what one would think based upon the GDP drop, the reason being that the retail sales data is based upon a survey of mostly large retail companies.)
In Europe, a prolonged 9.2% drop creates a hole of $400 billion. In China, a hole of $100 billion at current exchange rates.
On a side note, the money is there. Personal savings in the U.S. exploded by $800 billion in March, well-above any previous all-time high. As consumers become laid off or their confidence in their economic future become warn, consumers are going to opt to pay off their debt or save for a rainier day opposed to spending it on discretionary items (bullish staples, bearish discretionary?).
Revolving credit (i.e. credit cards) declined massively in March, falling 10.25 percent SAAR, or 31 percent YoY.
Consumer credit fell $12B MoM while expectations were $14.9B. This was a dramatic turnaround from February’s massive $19.9B increase. The MoM decline was the largest on record.
It seems odd, but one can reasonably ask how big the inflation hole is. What would inflation be like but for the COVID-19 lockdown? In February, inflation in Europe was 1.2% (y/y), 2.3% in the U.S., and 5.2% in China.
Inflation dropped across all three areas in March. In Europe, down to 0.7%. In the U.S., down to 1.5%. And in China, down to 4.3%.
How low can inflation go? Could deflation be on the horizon? The answer to the latter depends on how long it takes to get out of the hole for economies around the world.
The answer to the former is possibly to zero or lower. If inflation drops to zero in Europe, China, and the U.S., then the total amount of missing price increases sum to $2.6 trillion on output (assumes output is about twice as much as GDP). Certainly, there will be pressure on price increases.
Personal Consumption Expenditures
The hole for personal consumption expenditures? Using GDP figures as the guide, consumer spending has a colossal hole to work its way out of. In the U.S, the consumer spending hole is approximately $4.1 trillion. In Europe and China, the holes are around $3.4 trillion and $3.5 trillion, respectively.
There are many uncertainties surrounding the global economy even as limited economic openings have occurred in the U.S. and around the world. It is certain that giving the protests that dot the globe, people are tired of the lockdowns.
The willingness for both businesses and consumers to spend going forward in a COVID world with no vaccine or reliable therapeutics is declining with each passing day; and the data from states that have opened some non-essential businesses have seen the most modest of upticks.
But when you hit rock bottom, you can only go up.