By Liz Moyer and Yasin Ebrahim
Investing.com – Until this week, investors seemed to be buying the story of a swift economic revival. But the Federal Reserve ended those hopes, predicting the economy will contract by 6.5% this year, followed by a robust 5% rebound in 2021.
Is the Fed’s economic outlook for next year more hope than reality?
Liz Moyer argues that a rapid economic recovery is fraught with difficulty given the damage of the Covid-19 shutdowns and the potential for a second wave of infection.
Yasin Ebrahim contends that the well of stimulus from both the Federal Reserve and Congress will support the economy, which is already showing signs of bottoming out, until a vaccine is found, with hope sometime next year.
The Bear Case
On Friday, the Fed’s monetary report to Congress set a bleak picture. The economy, which entered recession in February, could be struck by a large number of small business failures, which would further slow recovery and lead to lasting damage.
Recovery, the report said, depends on these businesses for survival. The prospect of “widespread failure would adversely alter the economic landscape of local communities and potentially slow the economic recovery and future labor productivity growth.”
Job losses have hit small businesses harder, and such businesses make up about half the jobs in the private sector. Many of them were forced to close completely until social distancing rules can be loosened or lifted.
On the subject of jobs, some 20.9 million Americans were collecting unemployment as of last week. That’s down from the peak of 24.9 million earlier in May but still at record high levels since the post-World War II era. Businesses are slowly reopening, but there’s no way to quantify how many jobs have been permanently eliminated by the shutdowns, as businesses either go under or find new ways to operate in a post-Covid world.
The Fed was already projecting economic growth of less than 2% next year and the year after, even with historically low interest rates at practically zero. And that was with unemployment numbers at their lowest in 50 years and business humming. It’s hard to imagine bouncing back to growth of 5% next year after contracting 6.5% this year amid the start-and-stop of the pandemic.
As Fed Chair Jay Powell said himself, the pace of recovery depends on how well the U.S. manages the virus. “A full recovery is unlikely to occur until people are confident that it is safe to reengage.”
The Bull Case
There is no getting around the fact that a Covid-19 vaccine is the ultimate cure for the economy to prosper, once again. But short of a vaccine, stimulus is the next best thing.
Armed with an unprecedented wave of stimulus, the economy – after weeks of bruising attacks from Covid-19, the ‘invisible enemy’ – is showing signs of life.
The most recent report on the labor market showed an unexpected return in hiring that caught everyone, including the most revered economists, by surprise, further supporting the growing narrative that the worst of the pandemic’s impact on the economy is over.
Recently, the uptick in coronavirus infections across states has threatened that narrative, raising fears of ‘lockdown 2.0.’
But the economy-crippling lockdowns are unlikely to be resurrected.
“We can’t shut down the economy again. I think we’ve learned that if you shut down the economy, you’re going to create more damage,” Treasury Secretary Steven Mnuchin said in an interview on CNBC.
With the odds of another lockdown fast diminishing, and the economy showing signs of a pulse, the pace of developing a Covid-19 vaccine has taken on increasing importance to support the Fed’s bold prediction for the economy to grow 5% next year.
Fortunately, the race to develop a vaccine within the next year is well underway, with potential drugs and therapies already showing promising results in early-stage testing.
Early stage vaccine testing in animals and phase 1 testing in humans “looks quite promising,” said Director of the National Institute of Allergy and Infectious Diseases Dr. Anthony Fauci.
“I believe that if we get the trial going this summer, we will collect enough data by the Fall and early Winter, that by the end of this calendar year, we may know that a vaccine works and have doses to distribute and likely well into the early part of 2021,” he said.
With the dawn of the new year widely expected to bring a vaccine, and the well of stimulus set for fiscal and monetary top-up in the coming months, the economy could well be set-up for boom rather than bust.