COVID-19: Research Update II


Will McIntosh, Ph.D
Global Head of Research

John Kirk, CAIA, CCIM
Senior Director, Research

Mark Fitzgerald, CFA, CAIA
Executive Director, Research

Karen Martinus
Senior Associate, Research

Chenchao Zang
Senior Associate, Research

Jane Zheng
Associate, Research

April 13th, 2020

As the economic and market dislocation caused by the Coronavirus continues to evolve, we have increasingly focused our attention on several key questions:

What is the best measure of current economic conditions?

The deteriorating labor market provides the most transparent picture of what is occurring in the broader economy.  The latest jobless claims report topped 6.6 million for the week ending April 4th. In total, more than 16 million people have filed for unemployment insurance in the last three weeks. By our estimates, that puts the unemployment rate at around 16%, decidedly higher than the 10% peak during the Global Financial Crisis (GFC), and the highest on record since the BLS started tracking this data in 1948. The following comparison will help put the gravity of this situation in perspective.  The U.S. economy created approximately 21 million jobs from 2009-2019. After next week’s jobless claims report, the economy will have lost as many jobs in one month as it gained over the last decade. Yet, an even more significant concern is on the horizon. With stay-at-home orders now impacting 85% of the country through at least the month of April, if not longer, the unemployment rate could approach 30% by the time this pandemic has run its course.

Shouldn’t the CARES Act help slow the job losses?

Ultimately, the unprecedented $2 trillion stimulus package will eventually help stabilize the economy, possibly adding up to 10 percentage points to second-quarter GDP. However, it is going to take time for this funding to be distributed widely among the vast number of individuals and businesses that need support. For example, the Small Business Administration’s Paycheck Protection Program – a vital part of the economic stimulus bill that allocates $349 billion for small businesses struggling due to the Coronavirus – has been met with an overwhelming response. According to a recent report from the National Federation of Independent Business, more than 70% of the nation’s small business owners, roughly 21 million companies, have applied for an emergency loan. So far, only 550,000 loans worth $141 billion have been approved, according to the Wall Street Journal. Not only has the rollout been bumpy, but the program will require significantly more funding to meet the needs of small businesses. In the meantime, job losses will continue to mount as federal officials sort out the program’s administrative issues.

Will the unprecedented level of stimulus lead to higher inflation?

In the short term, we believe that deflation poses a much more significant risk to the overall economy than inflation. With consumer spending muted and the collapse in energy prices, inflation will likely fall below zero in the coming months. Eventually, the Fed’s massive balance sheet (potentially approaching $10 trillion or 50% of GDP) and the ballooning Federal debt may spark higher inflation. However, it is instructive to note that the extraordinary stimulus, or Quantitative Easing, deployed during the GFC did not result in higher consumer inflation. The CPI struggled to sustain 2% over the last decade while short-term interest rates remained near zero until 2015, or six years after the recession ended. Suffice to say; we expect to be in a low inflation, low interest rate environment for many years to come.

Will U.S. interest rates turn negative?

The Fed has been on record as saying that they will not intentionally join the world’s $10 trillion in negative-yielding debt, but it could still happen. As many of you are aware, the Fed controls the federal funds rate (the interest rate target at which banks borrow and lend excess reserves from one another on an overnight basis). Still, they have much less ability to influence the longer end of the yield curve.  For example, the 10-year yield, at 0.59%, recently closed at its lowest level ever. If the increased demand for bonds leads to high enough prices, the 10-year Treasury yield could turn negative even though the federal funds rate is zero. Such a situation is more likely to occur initially on the shorter end of the curve. For instance, in late March, the 1-, 2-, and 3-month T-bill traded at zero percent due to the high demand for short-term liquidity.

How long will the recession last?

According to the National Bureau of Economic Research, the U.S. economy has officially had 11 recessions since 1945, and the disruption from COVID-19 seems certain to cause the 12th downturn. On average, these recessions lasted 11 months, starting at the peak of the business cycle and ending at the trough. The most prolonged recession occurred during the GFC (18 months), while the shortest recession was just six months in 1980. If the virus is contained over the next 4-8 weeks, the consensus is that GDP will start to rebound in the third quarter of 2020. If so, the coming recession could be one of the shortest on record, while also being one of the deepest since the Great Depression.

After the virus is contained, then what?

The behavior of the U.S. consumer will dictate the pace of recovery, keeping in mind that consumer spending accounts for two-thirds of GDP.  Not only have consumers been physically restricted in their ability to spend (with “non-essential” shops having been forced to close), but millions of them have also suffered a reduction in discretionary income. Consumers will eventually be at least partially restored to financial health, but what is not clear is if they will have experienced a psychological blow like those who lived through the Great Depression, leading to reduced spending over the long term.

Will the current environment create distressed opportunities?  

It’s too early to know the extent to which opportunities will present themselves, but history suggests there will eventually be properties offered for sale at distressed pricing. Commercial real estate prices fell by 35% between August 2008 and June 2010, according to Real Capital Analytics, creating a buying opportunity for many investors. However, several factors will influence the extent of the opportunities available in the coming months, not the least of which is the amount of dry powder available to investors. According to Preqin, there was over $330 billion of dry powder held by global real estate funds as of EOY 2019, nearly double the amount on hand in 2007. This dynamic suggests that there will be more capital chasing distressed deals than in the previous downturn, which could limit how far asset prices fall, particularly in markets with strong demographics.

Notable Property Sector Updates

Hotels:  Health officials have turned to the hotel industry for Coronavirus caregivers and patients. The U.S. has roughly 924,100 hospital beds, and about two-thirds of those were typically full before the pandemic arrived, according to the American Hospital Association. Consequently, there is a widespread need for hotels to augment hospital rooms.  In San Francisco, 30 hotels are competing to house an increasing number of patients. Chicago is planning to secure at least 1,000 hotel rooms, and the U.S. Army Corps of Engineers is looking at more than 10,000 hotel rooms across New York City. Similarly, Houston and Austin have negotiated agreements with local hotels, while California has procured 6,867 rooms and intends to secure a total of 15,000 in the coming weeks. Notably, China took a similar approach, using vacant hotels to help quarantine those impacted by Coronavirus.

Concluding Thoughts

For the first time in modern history, medical scientists (and their epidemiological projections) are driving economic conditions, and they will primarily be determining the path of an eventual recovery. Therefore, we thought it fitting to end this week’s update on some of the recent health-related news that may ultimately influence economic forecasts in the coming weeks and months:

  • Peak Week: According to the IHME’s COVID-19 model, which is often cited by government officials, the peak for daily deaths and hospitalization rates likely occurred over the Easter weekend. The model currently projects between 31,000 and 127,000 people dying in the U.S. as a result of the virus, which is down materially from earlier estimates.  By comparison, the CDC estimates that 24,000-62,000 deaths were caused by the influenza virus, or flu, during the 2019-2020 flu season.  Again, the COVID-19 projections are evolving rapidly, but they do indicate a gradual slowing in the spread of the virus.
  • Stay-at-Home Evidence: We have more evidence that stay-at-home orders have been impactful. California was one of the first states to impose strict shelter-in-place rules in mid-March and currently has about 489 cases per 1 million people.  In comparison, New York state has about 8,152 cases per 1 million people. Although New York was slower to impose strict stay-at-home orders, the recent aggressive lockdown imposed by government officials seems to have been effective. New York health officials are cautiously optimistic that the number of daily confirmed infections may have peaked last week.

Overall, the U.S. economy is gradually progressing through the COVID-19 pandemic. To echo Len’s comment from last week, we are cautiously optimistic that we are beginning to see early signs that the pace of infections is starting to moderate.



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