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Institutional Perspectives

The good news is that going into this situation, the U.S. economy was in pretty good shape, putting us in a better position to withstand the negative impact of this exogenous shock.

With one of the most volatile weeks in market history behind us, and uncertainty as to what the next week(s) will bring forth, we wanted to offer our perspective on these extraordinary times, particularly as they impact the U.S. economy and markets.

The Risk
The risk of further downside in asset prices is likely to remain elevated until the United States begins widespread testing for the Covid-19 coronavirus and the extent of infection here is known. Only then can we have any idea of the scope of mitigation steps that may be necessary and the magnitude of potential loss to the economy.

Depending on the test results and, more importantly, on how many of those tested are in need of hospitalization, the health care system could be overwhelmed very quickly. Under the circumstances, one would expect significant mitigation measures to be rolled out at some point in an attempt to minimize the spread of the infection. The impact on the U.S. economy would likely be severe, as both aggregate supply and demand would be interrupted, resulting in a deep recession.

The Role of Monetary and Fiscal Policy
Monetary and fiscal policy measures can’t prevent a downturn driven by disease mitigation but might help stimulate a more rapid recovery. Low interest rates, targeted credit, income support, and socialization of healthcare costs would prevent short-term damage from bankrupting households and businesses with weak balance sheets that might otherwise be unable to participate in an economic recovery.

If comprehensive income replacement is offered, particularly to consumers and small businesses with a high propensity to spend, the production of goods is likely to accelerate rapidly to both meet demand and rebuild inventories, i.e. a V-shaped recovery. On the services side of the economy, production is likely to reach previous levels of demand once the need to avoid contact with other people passes, but would only overshoot earlier levels in limited circumstances since, usually, production and consumption occur simultaneously.

Economic Growth
The growth rate of the economy in the longer-term might also be affected by the specific steps taken to foster a recovery. If too much stimulus is applied, it could undermine the low inflation/low volatility growth path the economy was on before the virus struck. In addition, global trade could be damaged, and the growth rate of the global economy could slow, as was the case following the downturn in 2008-2009, if multinational businesses decided to re-localize their operations as a response to unexpected delays in deliveries from overseas suppliers. This might also contribute to greater inflation pressure as effective aggregate supply is reduced.

In an echo of the previous downturn (the financial crisis of 2008-09), high debt outstanding and large structural budget deficits globally could cause countries to throttle back stimulus very early, restraining economic growth soon after recovery took hold. If the downturn were to trigger widespread distress in the financial system, among European banks for example, the subsequent recovery, following the initial snapback, would be weakened.

The Good News
The good news is that going into this situation, the U.S. economy was in pretty good shape. Growth over the past few quarters has been right around the current estimates of trend, which is about 2.1%, according to Bloomberg. In fact, the GDP Now figure (as of March 9, 2020) produced by the Federal Reserve in Atlanta is an estimated 3.1% for the first quarter, putting us in a better position to withstand the negative impact of this exogenous shock.

Transitioning from strong growth directly into recession is highly unusual, but the threat posed by the novel coronavirus is unprecedented. If mitigation measures become very harsh, the economy could decelerate sharply into a contraction in the second quarter and an outright recession (i.e., two consecutive quarters of negative growth) would also be possible.

However, for now, we believe the most likely scenario is a sharp deceleration from an unexpectedly strong growth rate in the first quarter of 2020. In our opinion, If the negative shock passes relatively quickly, the record-long U.S. economic expansion should resume. 

 

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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