“Benefits Cliff” Warns of Downside US Risks

The US faces a “benefits cliff” at year-end. With the economy already suffering from widening lockdowns across the country, the Q4 outlook is bad and the year-end expiration of emergency unemployment programs suggests Q1 may be even worse. All the more reason to pass another fiscal stimulus package, and possibly see increased Fed action.

RECENT DEVELOPMENTS

A recent paper by two prominent labor specialists is sounding the alarm. They calculate that around 12 mln Americans will lose their emergency unemployment benefits by year-end. This will be a huge hit to income and spending, to put it mildly. By our calculations, it will be even more. Our number includes 9.4 mln currently on Pandemic Unemployment Assistance and another 4.1 mln on Pandemic Emergency Unemployment Compensation, totaling 13.5 mln that will see their emergency benefits end next month. Of note, the government did not let extended unemployment benefits from the Great Financial Crisis expire until the end of 2013. And that loss of benefits affected 1.3 mln, only a tenth of what we are about to see next month.

The labor market wasn’t getting that much better even before the most recent lockdowns were announced. Regular weekly initial jobless claims are running close to 700k now, with another 300k of PUA weekly initial jobless claims. The two together have been running close to 1 mln since early October. Regular continuing claims have been edging lower to just under 7 mln, which is on top of the 13.5 mln combined PUA and PEUC continuing claims referenced earlier. That means over 20 mln are receiving some form of unemployment benefits currently, despite the millions of jobs that have come back already. Of note, PUA and PEUC data are not seasonally adjusted and so we will maintain that methodology for the regular claims data as well.

Recognizing the risks from this “income cliff,” stimulus talks may be back on the table. Reports claim that Democratic leaders in the Senate have approached Senate Majority Leader McConnell about restarting talks. Aside from the unresolved issues of aid to state and local governments, there is still a dispute about the size of the package (with Republicans at $500 bln and Democrats at $2.4 bln).  If they split the difference to reach a roughly $1.5 bln package, this would put it at the compromise number proposed by the so-called Problem Solvers Caucus.  The Democratic-led House has already passed two versions of a stimulus package that would extend the deadline for these emergency unemployment benefits and would also reinstate the $600 weekly bonus that expired July 31. The Republican-led Senate has pushed for extending the emergency benefits but at a lower amount as part of its $500 bln skinny plan.

McConnell probably feels he has the upper hand now and may not budge that much, especially with the decisive Georgia runoffs in sight.  So far, Senate Republicans have not paid much of a price for resisting a large-scale stimulus package before the election. On the other hand, House Speaker Pelosi saw her Democratic majority narrow even as she did not bend much from their $2.4 trln package. Meanwhile, the White House has basically abdicated its role in these negotiations.  Further complicating matters is the fact that the future of the Senate still hangs on the balance with the January Georgia runoffs, which could eventually play a decisive role in these negotiations. A Democratic sweep is seen as a long shot, with betting markets putting 20-25 % odds of that happening. With the Blue Wave seen as unlikely, any fiscal stimulus package is likely to come in at the low end of expectations.

 

ECONOMIC OUTLOOK

US GDP rebounded strongly in Q3. The economy grew 33.1% SAAR after contracting -31.4% in Q2. Looking at absolute levels, we are nowhere near reaching pre-pandemic levels. Indeed, if we plug in Bloomberg consensus numbers for the next year or so, real GDP in absolute terms will not reach its Q4 2019 pre-pandemic peak until Q4 2021.  Of note, the Fed sees GDP contracting -3.7% this year before rebounding 4% in 2021 and 3% in 2022. We see downside risks to these forecasts, to state the obvious.

Let’s look ahead to Q4. Atlanta Fed’s GDPNow model estimates GDP is growing 5.6% SAAR while the NY Fed’s Nowcast model estimates growth at 2.86% SAAR. Bloomberg consensus stands at 4.0% SAAR. With unemployment benefits set to expire and the labor market likely to stall out again with rising virus number and this latest round of lockdowns, there are clear downside risks to both Q4 and Q1. Of note, October retail sales came in weaker than expected, along with significant back month downward revisions. Of note, the so-called control group used for GDP calculations rose only 0.1% m/m and followed a revised % (was ) in September. To put things in perspective, this control group was expected to rise 1.9% over the past two months, but it rose only half that pace. We expect significant markdowns in Q4 GDP forecasts as a result. If unemployment benefits expire, then Q1 forecasts will also have to be marked down.

Nonfarm payrolls as measured by the establishment survey stood at 142.4 mln in October. Despite steady and at times spectacular job gains since May, total NFP still stand 10 mln below pre-pandemic levels. The household survey is slightly better, showing a net loss of 9 mln jobs through October that leaves the unemployment rate at 6.9% vs. the 3.5% pre-pandemic trough. The difference between these numbers and the elevated continuing claims numbers is due largely to the fact that the emergency programs include gig workers and the self-employed. Recall that 638k jobs were added last month, continuing a 4-month streak of sequentially smaller gains in NFP. November data will be released December 4 and there is no consensus reading yet. We expect these gains to continue shrinking.

As a result, the Fed will maintain its ultra-dovish stance for the foreseeable future. Indeed, there is growing speculation that the Fed may adjust its asset purchases at the December 16 meeting. Why? As we have noted before, the Fed is likely to be unhappy with the recent bearish curve steepening in the US curve.  While the 1.0% level for 10-year yields appears tough to crack, the steepening seen so far tightens financial conditions and this is something the Fed wants to avoid for quite some time. Mortgage rates are already rising as a result and so it’s possible the Fed tilts its asset purchases more to the long end of the curve. Bank of Canada did this already at its October meeting, while the Reserve Bank of Australia considered it this month before deciding not to. If the Fed does do this, it should be viewed more as Yield Curve Influence than Control, another Operation Twist if you will.

 

INVESTMENT OUTLOOK

The virus numbers in the US show no signs of slowing.  Daily cases recently hit a new record high near 200k, while the 7-day moving average has risen above 150k for the first time ever. Predictably, hospitalizations and deaths are now rising sharply as well, albeit with a lag.  There still has been no coherent federal response and so we are even more pessimistic on the near-term US outlook.  Fed Chair Powell continues to warn of downside risks from the virus, noting that “With the virus now spreading, the next few months could be challenging.”  He has been joined by ECB President Lagarde and BOE Governor Bailey in sounding the alarm, as Europe grapples with its own second wave.

Yet given Europe’s past success in controlling the virus, we have more confidence that policymakers there can do it again.  Indeed, lockdown efforts are already being seen in many countries there.  These will have a negative short-term impact as economic activity slows again, but set the table for reopening sooner rather than later.  The US has never fully controlled it and the continued lack of effort coupled with Trump’s reluctance to help with the transition to the Biden administration suggests things will get much worse before they get better.  Yes, the US economy has been resilient in recent months but at what cost?  This renewed divergence in virus control efforts underscores our ongoing weak dollar call.  Until we can control the virus in the US, the short-term economic gains will eventually give way to greater medium-term pain.

We believe the weak dollar trend remains intact.  The next obvious target for DXY is the September 1 low near 91.746.  But given our bearish US outlook for Q4 and early Q1, weakness should persist beyond that level and so we are left looking at the February 2018 low near 88.253.  There’s really not much in the way of significant chart points in between.  With regards to the euro, that suggests the September 1 high near $1.2010 is the next big target.   After that the equivalent February 2018 high comes in near $1.2555. Sterling is marching to the tune of its own Brexit drummer but a successful deal should see cable teat the September high near $1.3480 and perhaps make some good headway towards the April 2018 high near $1.4375.

That said, we will refrain from making any longer-term calls for the demise of the dollar.  We note that weakening to those 2018 lows would still keep the dollar within broad trading ranges seen since 2015. That is, it should not be seen as some historic dollar decline. We still think this is cyclical dollar weakness, not structural, and believe that President-elect Biden’s efforts to rein in the virus will eventually be key to improving the dollar’s medium-term outlook. Aggressive Fed easing has once again set the table for a solid rebound, but much work needs to be done to actually serve the meal.

 

APPENDIX: SUMMARY OF EMERGENCY UNEMPLOYMENT BENEFITS

The CARES Act created three new unemployment programs to supplement existing ones. Each of these programs provides different coverage and has different eligibility requirements. All three are funded by the federal government but are administered by the states.

  1. Pandemic Unemployment Compensation (PUC) – The PUC program provided an extra $600 per week of benefits above and beyond the standard weekly benefits. This expired July 31, 2020 and despite some limited efforts by the Trump administration to extend the extra payments, they have effectively expired.
  2. Pandemic Unemployment Assistance (PUA) – This is designed to provide unemployment benefits to individuals who would not ordinarily qualify for unemployment. These include (but are not limited to) independent contractors (including gig workers) and the self-employed. Qualifying individuals can receive up to 39 weeks of benefits until the program ends at the end of December.
  3. Pandemic Emergency Unemployment Compensation (PEUC) – This provides an extended benefit period to individuals who have exhausted all of their unemployment benefits. It extends benefits by up to 13 weeks for qualified individuals until the program ends at the end of December.