On Tuesday, Treasury Secretary Steven Mnuchin stated in a meeting with Republican senators that the U.S. unemployment rate could reach 20% if significant fiscal action was not taken immediately. While this could be in part a threat to persuade the Senate to pass more fiscal stimulus, it is a terrifying reality the U.S. could experience in the short term. A fifth of Americans out of work may seem outlandish because it has only occurred during four out the past 100 years — but pandemics of this magnitude are also very rare.
I set out not to scare anyone, nor am I normally overly pessimistic, but I feel it is a reasonable and logical exercise to model how the U.S. economy could get to 20% unemployment sometime soon. First, I will lay out the industries that are most affected by mass lockdowns. Next, using estimates from Moody’s and investment banks, I will detail layoff estimates for scenarios with and without fiscal stimulus. Lastly, I will present the case for significant fiscal stimulus.
The impact to weekly jobless claims has already begun: Jobless claims jumped to 281,000 this week, a significant rise from last week’s 211,000. The chief economist at Pantheon Macroeconomics, Ian Shepherdson, told CNBC that next week’s jobless claims may show a tenfold spike to 2 million. The fact is, restaurants, museums, tourism service companies and many other businesses have already furloughed or outright laid off employees. This is just the beginning of mass winding down across many industries that will see unprecedented, but likely short, declines in revenue.
Moody’s published a breakdown of exposure by sector in “Heat map: Coronavirus will negatively impact corporate credit, effects widen in downside scenario” on Monday. While Moody’s criteria for exposure is focused around credit quality and possible ratings implications, most assumptions hold when using this analysis as a proxy for overall exposure to downside effects from COVID-19. Other investment bank downside scenarios are utilized later on.
Moody’s heat map allows us to create critical assumptions regarding the possible layoff scenarios by industry. I have chosen to look at industries with more than 50% aggregated medium and high exposure (i.e. any industry with less than 50% green).
The thesis is that airlines, cruise lines and hotel operators will be hit by a slowdown in travel and tourism; consumer nondurables, gaming and restaurants will be damaged by reduced consumer discretionary spending; oil and gas, chemicals, and mining will be hurt by lower commodity prices; and supply chain disruptions will be increasingly painful for automotive and technology companies.
Goldman Sachs published its revised GDP estimates with revenue projections by industry. Even the least-disrupted sectors are expected to see 20% lower revenue through the end of April. These estimates represent a significant drawdown in Q2 GDP. Goldman’s projections are slightly more optimistic than those of JP Morgan, which estimates Q2 GDP decline of 14%.
It is understandable and even expected that rational estimates during an irrational time would vary wildly. After all, estimates are exactly that — best guesses in a time of great uncertainty.
Source: Goldman Sachs
Source: JP Morgan
Currently, 5.7 million Americans are unemployed. If this number is held constant while adding the estimated 18.8 million layoffs, the unemployment rate would be nearly 15%. Mnuchin stated he had no plans to release his model that computed 20% unemployment, but I believe our assumptions are similar. Again, Mnuchin’s statement to senators may have been a threat, but he is not wrong in thinking the unemployment rate will skyrocket if unprecedented fiscal action is not taken soon.
Goldman Sachs and JP Morgan analysts now expect 6%-7% unemployment in the coming months as retail, leisure and hospitality, and other industries contract.
JP Morgan estimates a quarterly GDP decline of 14%, which would be steeper than in the fourth quarter of 2008 — the worst of the Great Recession — when the economy shrank 8.4%. These projections are based on the virus peaking within the next eight weeks and slowing thereafter (plausible, but certainly not guaranteed).
While there will undoubtedly be a production and overall economic snapback when the virus is contained, 8% quarterly growth has not happened since 1984. The impact to consumer sentiment from many millions of Americans being laid off is yet to be determined, but it will be considerable.
Using Moody’s exposure map and investment bank estimates, I created a separate heat map with baseline layoff estimates in the short term by industry.
At the time of this writing, no “bailout” plan has been passed, but it does seem inevitable in the coming days that certain industries will receive extensive fiscal help (airlines, cruise lines, casinos and hotels have all been discussed). When these bailouts occur, it will drastically reduce the baseline layoff estimate for each of the exposure level groupings. The scenario with significant fiscal stimulus will be detailed later.
Using data from the Bureau of Labor Statistics, the following layoff estimates were created:
The layoff percentages chosen are based on expected revenue declines by industry. Companies in many industries will be attempting to keep their costs declining in-line with or less than revenue. With revenue expecting to decline 20% in even the least exposed industries, it is reasonable to expect 10% headcount reduction to the least impacted industries.
It seems inconceivable that the modern U.S. economy could ever reach the Mnuchin-suggested 20% unemployment. During the Great Recession, unemployment topped out at 10.2% in October 2009. One could argue the 2020 economy is much stronger than the 2008 economy, despite some similarities (historically high valuations and high debt ratio, among others).
It must be noted that the current variables pressuring employers to reduce headcount are far more temporary than those in 2008. It will take several quarters before we are confident COVID-19 is contained — in 2008, we were talking about years before full recovery. So while the number of layoffs will be stratospheric for a time, the unemployment rate will materially increase very soon.
One can see how a rising unemployment rate cascades quickly into lower consumer sentiment, lower discretionary spending and temporary loss of hope. The federal government must step in now to aid the industries most affected. It is outside the scope of this exercise to determine where the aid should be aimed, but without it the U.S. economy will enter uncharted waters in terms of job loss, even by comparison with the 2008 recession.
The most recent unemployment rate print from February stated a current unemployment rate of 3.5% and a total of 5.7 million unemployed persons. In 2009, the peak number of unemployed persons climbed to 15 million. For comparison, the unemployment rate peaked at 24.9% at the height of the Great Depression in 1933 but remained above 14% from 1931-1940. If 15% unemployment is frightening in today’s economy, you now know why Mnuchin is fighting for fiscal stimulus.
Fiscal stimulus will most certainly not curtail all of the economic impact of mass quarantines and lost production, but we estimate the impact can be halved. City and statewide lockdowns are already occurring across the country, and businesses are reacting accordingly — trimming any nonessential roles as quickly as possible.
In my stimulated economic scenario, the layoff expectations have been cut in half for the low- and high-exposure groups, and the extreme-exposure group has been brought down from 75% to 50%. My reasoning is sentiment for air travel has been disproportionately affected by COVID-19 fears, and variables besides the virus are at play in depressed commodity prices.
Once again holding current unemployment constant, the stimulated model still estimates a total of nearly 15 million unemployed persons. This would nearly match the height of the Great Recession but would not stay elevated nearly as long.
The impact to company top and bottom lines will be tremendous, but transient. Employers will look to shed weight by any means necessary, which will certainly include major headcount reductions. The economy will recover — let us not forget this economy is the most powerful in the world in part because of its resilience. Make no mistake, fiscal stimulus is necessary as soon as possible. Americans are losing their jobs rapidly, and both employees and many of their employers are in need of government assistance. Without it, the economy will take many more quarters to recover.
The Freight Intel Group will release a follow-up to this exercise in the near future, which will include the estimated impact to domestic freight volumes.