Graph of the week

Extraordinary stimulus by both central banks and governments is intended to help the global economy and give it time to recover. With a gradual relaxation of lockdown measures, few signs as yet of a second virus wave and the global search for a Covid-19 vaccine, a recovery is likely. Yet, we must remain vigilant for risks that make the road to that recovery bumpier than markets currently seem to be pricing in. One of those risks is the US consumer.

In the past two months, 41 million Americans have filed new claims for unemployment benefits. And unemployment has surged to 14.7%. Moreover, this rate is for the month of April and doesn't yet reflect the new claims filed in May. Estimates vary greatly, but the rate could easily peak well above 20% in the coming months.

However you look at it, this isn't good news.

Jobless Americans are losing confidence and, unsurprisingly, spending less than working Americans. In recent months, US consumer confidence has plummeted – to its lowest point in six years. The collapse in consumer confidence in March and April was the biggest ever in such a short period of time.

Incidentally, before Covid-19 struck, consumer sentiment was at its most positive since the start of the millennium, driven by a very stable labor market and economic growth, in combination with historically low mortgage rates. So, thankfully, the decline began at a very high level.

The declining confidence is not only concentrated among jobless Americans. With millions of Americans still losing their jobs each week, the sudden stop of economic activity is heightening concerns among the entire population. This means that people are putting spending on the back burner. The percentage of disposable income that Americans are saving has shot up to 13.1%.

We have to go back as far as 1981 to find a similarly high savings rate. So, it’s not surprising that US retail sales tumbled more than 16% in April.

The above developments could lead to a ‘traditional’ vicious recession cycle, where the decline in employment opportunities results in lower spending and, ultimately, lower profits for companies. They, in turn, have to fire even more people, causing a further fall in confidence. And so on.

There is a chance, which should not be underestimated, that this vicious cycle will get in the way of a rapid economic recovery this time, too. What is more, the blow this time around is so big that it’s hard to imagine there not being any long-term damage.

The sharp decline in labor participation is a key indicator of this. A V-shaped recovery therefore seems almost impossible, but at present the markets don't seem willing to contemplate any other letters from the alphabet.

Nevertheless, there are a number of factors that lead me to believe that a traditional recession cycle may not materialize or, at least, won’t be so severe. The first is speed. As stated above, the actions taken by central banks and governments are extraordinary. Never before have stimulus packages been so substantial and implemented so swiftly, with job retention often being used as the reason for this. In addition, when the economy does pick up – somewhere in coming months – unemployment figures are expected to fall back by millions again each week.

Lastly, the average – with an emphasis on ‘average’ – household debt in the US has fallen sharply in the last ten years. While all of these are factors that could prevent the cycle, they certainly don’t eliminate the risk entirely.