August 31, 2020


    The U.S. suffered an unprecedented GDP decline in the second quarter due to the lockdown for the COVID-19 pandemic, which severly affected economic activity.  However, some signs of mending started to surface at the end of the second quarter and the beginning of the third as housing activity continued to exceed expectations and the wide swing in the inventories.  Inventories climbed during the lockdown, but quickly fell on pent-up demand by consumers and the re-opening of manufacturers once coronavirus-related restrictions began to be eased.  But the negative output gap between real and potential GDP is large and it will be a long slog until it is closed, keeping inflation muted in the near term.

Manufacturing Inventory


    While the health situation is gradually improving it is far from ideal and its path remains uncertain.  The policy impasse around fiscal stimulus and rising election uncertainty represent added risks for the economy with new coronavirus cases still at an elevated level.  Spending momentum appears to be slowing after a strong initial rebound.  The labor market is also showing a slower pace of recovery.  Flows into unemployment have eased but the 4-week moving average of initial claims for jobless benefits are still around 1 million.  Continuing claims, which represent the number of people receiving unemployment benefits, is also flattening at a higher level.  Businesses continue to face headwinds from soft demand and supply-chain disruptions.  The econmic recovery is likely to be slow and uneven with the risk of a double-dip recession not out of the realm, though it’s not in the majority of forecasts.

Retail Inventory Sales Ratio

   As noted in the minutes of the July Federal Open Market Committee (FOMC) meeting, participants focused on the importance of fiscal policy in holding up spending, investment, and the labor market until a health solution is found.  Several Committee members agreed that without convincing fiscal support, more stimuls may be needed to sustain the economic recovery.  At that meeting, they decided to maintain the taret range for federal funds rate at 0 to ¼ percent and expected to keep its foot on the monetary accelerator until they are confident that the economy was well on its way to health.  In the meantime, meeting participants agreed the economic outlook was dependent on the path of the virus, which itself is highly uncertain.

Weekly Initial Jobless Claims

     In an address to the annual, but virtual, Kansas City Fed Economic Policy Symposium at Jackson Hole, Wyoming, Fed Chairman Powell shed some light on the Monetary Policy Framework Review, which was initiated in November 2018.  He said that after a long-term review the Fed views a robust job market can be sustained without causing an outbreak of inflation.  The new strategy represents a new inflation approach, aiming to average 2% on the core Personal Consumption Expenditures (PCE) Deflator rather than as an absolute goal.

Fed Funds

    With the Fed prioritizing one mandate (employment) over the other (inflation), it signifies that the Fed is prepared to tolerate a higher level of inflation than it has in the past.  It also means that borrowing rates will likely remain ultra-low, to the detriment of lenders, fixed income investors and savers.  In turn, it may be a threat to financial stability if the Fed’s credibility suffers and bond vigalantes re-group at some point in the future.  In the interim, COVID-19 and the governments response or lack thereof, will dictate the path of the economy and monetary policy.