Economic Signs Converge, Most Point Down
A new report takes a look at the best- and worst-case scenarios as it relates to the economy and the coronavirus.
Signs began popping up in 2018 that the economy would be at risk of a recession in 2020.
In fact, Steven Rick, chief economist for CUNA Mutual Group, called it in April 2018, predicting a mild recession in 2020 because credit unions would start noticing savings rising faster than loans.
“Lower spending leads to slower economic growth if not an outright recession,” he wrote in the April 2018 Credit Union Trends Report. “The loan-less-deposit growth rate gap is expected to remain positive through 2018 and 2019 then turn negative in 2020, marking the onset of the next recession.”
He forecasted both loans and savings would grow 8% in 2019, with savings starting to outpace loans in 2020.
He was a little off; it started last year. Loans grew 6.6% in 2019, while savings grew 8.2%. As of Feb. 28, Rick said he expects loans will grow 5% this year, while savings to grow 9%.
Currently, Rick sees positive economic growth this year even when factoring in the effects of the coronavirus.
If the current spread of the virus develops into a pandemic, he said it could lower U.S. GDP growth this year to 0.5% to 1%, compared with his December forecast of 1.4% to 1.5% in 2020. Either way, it would be down from 2.3% in 2019 and 2.9% in 2018.
“It’s not a full-blown recession. It’s another thing weighing on the economy,” Rick said on Feb. 28.
Likewise, NAFCU Chief Economist Curt Long on Feb. 25 dialed back his forecast for GDP growth by 30 basis points from 2% to 1.7%, citing economic risks raised by the spreading virus.
CU Times doesn’t usually cite the date of interviews in print stories, but it has become vital information for our readers because the situation has become more murky and fast-moving as we go deeper into March.
In the last week of February the S&P 500 blue-chip stock index lost 12% of its value since hitting a historic peak Feb. 18. It marked the index’s biggest one-week drop since 2009, though it was regaining a lot of ground on March 2.
But whatever direction it turns, that last week in February marked the market as officially volatile.
Meanwhile, bond yields inverted again. But that second dip hardly matters if the prognosticating power of a yield inversion is to be trusted.
The inverted yield began May 24, 2019, when the yield on 10-year Treasury bonds dipped below yields on 3-month notes. Every recession since 1955 has been preceded within 12 to 18 months by such inverted yields.
The inversion lasted until July 22. It went 2 basis points positive July 23 before dipping negative again through Oct. 10. The widest point was 52 points on Aug. 28.
By then CUNA Mutual Group had walked back from its recession prediction. CUNA had remained more optimistic. Last fall both organizations became more concerned, but still shied away from predicting a recession.
Rick said the most powerful version of prediction in the savings-versus-borrowing dataset is unique to credit unions: Comparing 12-month growth of lending per member to savings growth per member.
By that measure, the pendulum swung sharply toward recession last year. In 2019 loans per member rose 3.2%, while savings per member rose 4.8%. The last time savings grew faster than loans was 2012, ending a savings surge that began in 2008.
Saving more sounds like a noble behavior, but for lenders it means losing more of their main source of income (namely loans), and for economists it can be shorthand for recession. This savings surge comes at a time when consumer spending has been the main bulwark of an economy that has already seen faltering business investment.
“When savings per member gets up to around 5% growth, that normally triggers recession,” Rick said. “Growth driven by new members is one thing, but growth per member is the number I’m watching.”
Meanwhile, Professor of Finance Nikolai Roussanov at The Wharton School of the University of Pennsylvania and other economists published a paper in February that found cash-out refinancing surges have been reliable predictors of recessions occurring within one or two years – much like yield inversions.
This might appear to make the opposite argument, but its significance is perhaps less in the reasoning than the reliability. The researchers built a predictive model and tested it against detailed historical data.
The researchers examined total cash-out dollars as a percent of refinance originations tracked by Freddie Mac. This peaked in 2006 at 31% of the value of originations – about the same time the housing price bubble was getting ready to burst.
“We’re nowhere close to that now, but it peaked in 2018’s fourth quarter at 23%,” Roussanov said.
They also looked at the number of refinanced mortgages that had some type of cash-out portion. The loan counts as cash-out when it is 5% above the value of the prepaid loan. In 2006, a year before the Great Recession began, 89% of the number of refinanced mortgages had some cash-out portion. In the third and fourth quarter of 2018 it was 82%.
“Because household leverage had increased so much through this process of cash-out refinancing, in particular, when house prices fell and people started losing their jobs in the recession, the fact that they had all these debt obligations they had to satisfy made the drop in household spending even more dramatic,” he said.
There is no indication that housing prices are over-inflated now, meaning households are less vulnerable to a drop in value than in the overheated market of the early 2000s.
Maybe this time will be different.
Also, concerns about the coronavirus have transitioned into true economic worries for 2020.
A report issued March 2 by the Organization for Economic Cooperation and Development said the coronavirus (COVID-19) outbreak has already caused major economic disruption.
“Output contractions in China are being felt around the world, reflecting the key and rising role China has in global supply chains, travel and commodity markets,” it said.
Similar, but smaller-scale effects are occurring among the more than 60 countries where outbreaks have occurred, according to the report titled, “Coronavirus: The world economy at risk.”
“Temporary supply disruptions can be met by using inventories, but inventory levels are lean due to just-in-time manufacturing processes and alternative suppliers cannot easily be obtained for specialized parts. A prolonged delay in restoring full production in affected regions would add to the weakness in manufacturing sectors in many countries, given the time it takes to ship supplies around the world,” the report said.
The degree of economic damage will depend on the severity of the outbreak. If it peaks by the end of March, OECD forecasts worldwide economic growth of 2.4%, instead of the 2.9% it forecast in November, which would have been a continuation of the “already weak” 2.9% growth of 2019. U.S. growth would be 1.9%, down 0.1 percentage points.
If the virus continues to spread throughout Asia, Europe and North America, growth could drop to 1.5%, and according to the report, would become a “domino scenario” that “could push several economies into recession, including Japan and the euro area.” North American growth would drop by 1.5 points.
The coronavirus shows the fragility of economic indicators collected just within the borders of the U.S.
“Relative to similar episodes in the past, such as the SARS outbreak in 2003, the global economy has become substantially more interconnected, and China plays a far greater role in global output, trade, tourism and commodity markets,” the report stated.
“This magnifies the economic spillovers to other countries from an adverse shock in China. Even if the peak of the outbreak proves short-lived, with a gradual recovery in output and demand over the next few months, it will still exert a substantial drag on global growth in 2020.”
Weaknesses surfaced in the global economy last year, before the virus became a factor.
The OECD recommended quick action and more cooperation among nations. It said solutions to mitigate economic damage will involve some element of monetary policy, although many central banks have little room to lower interest rates. That will put more pressure on governments to increase spending.
“Governments need to ensure effective and well-resourced public health measures to prevent infection and contagion, and implement well-targeted policies to support health care systems and workers, and protect the incomes of vulnerable social groups and businesses during the virus outbreak,” it said.