Update on US economy-Morgan Stanley

Economic activity is contracting and we see GDP posting a significant drop in 2Q. Monetary and fiscal policy support have been provided, and more is coming; it is not yet enough to calm financial market unrest. We look for a tepid return to growth in 2H, but the outlook remains unusually uncertain

Greater disruptions to US economic activity from COVID-19 are likely to lead to a more material contraction in economic activity in 2Q20 and 2020 on the whole. We expect consumption to post its largest drop since 1980 in 2Q, and for the full year GDP growth barely keeps its head above water at 0.2% 4Q/4Q.

On the other side of peak coronavirus effects, we assume the normalization in consumer spending growth is tepid at first, and in our base case forecast rises just 1.5% in 3Q20, before accelerating in 2021. On the other hand, Capex will likely take somewhat longer to recover and in our forecast remains in contraction in 3Q20 before turning modestly positive in 4Q.
This sudden shock to growth, followed by a sluggish normalization that is accompanied by labor market disruptions—may end up going down in the books as the first US recession since 2009.

In our revised forecasts, nominal GDP ends 2020 roughly $360 billion dollars below our pre-virus baseline forecast, with some output permanently lost over the forecast horizon. In our bear scenario, nominal GDP falls more than $825 billion dollars below our pre-virus baseline. We present these numbers to give a sense of the scale of the potential fiscal package needed to stabilize aggregate demand.

While a significant monetary policy package has been delivered, Chair Powell was careful to indicate that the Fed still has tools left in its toolkit. We expect these include GFC-era programs such as the CPFF and TALF, to ease commercial paper lending and more directly channel credit outside financials.

The FOMC is now back at its lower bound 0-0.25% policy rate. The new inflation framework should guide the Fed to keep interest rates low until inflation dynamics have shown credible evidence that inflation is sustainably achieving the symmetric 2% goal. Consequently, we expect the Fed to keep rates at the zero lower bound through the end of 2021 (our forecast horizon).

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