Thoughts From The Divide – Stock vs Flow and Uncertainty

“Slower Declines are the New Gains”

As the world continues to grapple with CV-19, there is no lack of negative economic data. Continuing claims are rising, with more than 20 million people collecting unemployment. More than four million borrowers are in forbearance. Credit standards are tightening for both businesses and households. And if coronavirus were not enough, there are even voracious desert locusts devouring crops throughout Africa, Asia, and the Arabian Peninsula.

But in a twist on Rumsfeld’s known unknowns, there are recent headlines highlighting that some of the latest bad news is… good? In an article on how a 10% plunge in spending is positive, Sam Ro of Yahoo Finance explains that “before you can talk about a recovery you must first slow the rate of declines”, meaning good news comes in the form of “a deceleration in the deterioration”. Though Continuing Claims are rising, Initial Claims have been dropping from week to week. Loans in forbearance is growing, but “the pace of forbearance requests continued to slow in the second week of May”. Even hiring may have hit its nadir, with LinkedIn’s chief economist thinking ”we may have been through the worst of the job losses”. While these data come with some caveats, they are places to look for green shoots as the world hopes the worst is over. P.S. Air pollution readings point to continuing recovery in Chinese manufacturing.

“The Outlook… is Uncertain”

With good bad news and bad good news, continued uncertainty may be the name of the game, and the latest Financial Stability Report from the Fed appears to bear this out. In addition to offering a handy guide to the Fed’s “Actions and Facilities to Support the Economy since the COVID-19 Outbreak”, the report highlights a number of uncertainties and vulnerabilites in the economic outlook. Among the Fed’s worries are asset prices.

“Price declines could be especially pronounced in areas where valuations have remained high and where asset values are sensitive to the pace of economic activity. CRE markets are an example, as prices were high relative to fundamentals before the pandemic, and disruptions in the hospitaility and retail sectors have been severe”.

The Fed also noted increased vulnerabilities stemming from leveraged lending (which CBs had discussed as a risk even before CV-19) and warned that CLO downgrades “could result in margin calls”. With the potential for additional economic stresses from Europe, China, and emerging market economies, as well as a prolonged outbreak here in the US, the Fed cautions that there could be “strains on the financial system that worsen the downturn”. While the Fed’s report is simply its outlook, and couched in “could” and “may”, it is a worthwhile reading for anyone wanting to be prepared for a rainy day.