GDP: Bad, And Getting Worse

Before the Coronavirus, the US economy was cruising for what looked like 3% annualized growth in real GDP in the first quarter. But the effects of both natural social distancing and government-mandated lockdowns crushed economic growth in March.

As a result, we now think real GDP contracted at a 3.7% annual rate in Q1, led by a massive drop in inventories as well as declines in consumer spending, business investment in equipment, and commercial construction. That 3.7% is not set in stone, however. We'll get some reports on inventories and international trade on Tuesday morning, and may refine our forecast then. Either way, it's going to be bad.

But the second quarter, which we're already in, is going to be worse. How much worse? Put it this way: Since 1947, the worst quarter in our history was a 10% annualized drop in the first quarter of 1958, on the heels of the Asian Flu. In the current quarter, real GDP is likely to drop at about a 30% annual rate, rivaling declines last seen during the late-1945 wind-down from World War II as well as the Great Depression.

We also expect an unemployment rate that flirts with 20%, compared to highs of 10.0% in the aftermath of the Great Recession in 2009 and 10.8% at the end of the brutal 1981-82 recession.

The key for investors to remember is that none of this is going to shock anyone; the markets already know it's going to be awful. Instead, investors need to focus on how quickly we are going to recover, which will depend on finding ways to carefully ease lockdowns, the virulence of the Coronavirus in the months ahead, the timeline for developing therapies, and, ultimately, the timeline for developing a vaccine.

In the meantime, the loss in output is going to be huge. Real GDP for all of 2020 will be about 5.0% lower than 2019, versus the roughly 2.5% higher it would have been in the absence of the Coronavirus. In turn, federal revenue will be down, and would have been lower even in the absence of recent policy changes, like the IRS sending out checks for $1,200 per adult and $500 per child, as well as delays in employers paying their share of payroll taxes.

The Congressional Budget Office recently updated its forecast for the budget deficit for the current fiscal year (ending September 30) and expects it to be about $3.7 trillion, or roughly 18% of what we estimate to be fiscal year GDP. To put that in perspective, the budget deficit hit 9.8% of the GDP in 2009 and the deficit peaked at 29.6% of GDP in 1943.