; Election Results Mixed for Stimulus

Pharmaceuticals manufacturer Pfizer announced very encouraging results on a potential vaccine for the coronavirus on Monday, raising the possibility that distribution could begin in late 2020 or early 2021. Investors welcomed the news, with the S&P 500 jumping 1.2 percent on the day, even with a stock selloff late in the afternoon. The price of a barrel of West Texas intermediate crude oil jumped from $37 to $41 on Monday because of expectations for stronger demand for energy with better economic growth. The yield on the 10-year Treasury rose by a quarter of a percentage point to 0.96 percent, its highest level since before the pandemic.

Coronavirus Pandemic Not Over, But News Encouraging

It is premature to declare the coronavirus pandemic over. Caseloads in the U.S. are at a record high, the vaccine needs to be approved, and there are huge logistical issues in distributing it. Even if the vaccine is highly effective, it would take months to make it available throughout the nation.

But the news is encouraging, and is positive for U.S. economic growth in the short run. Higher stock prices increase wealth, especially for upper-income households, encouraging consumer spending. Positive vaccine news is likely to boost business and consumer confidence. If businesses think the pandemic will end sometime in 2021, they are more likely to invest and hire in the near term, or at least not cut back on investment and hiring. Hope for a vaccine could make consumers more willing to make purchases, especially of big-ticket items like homes and cars, which are already strong.

More importantly, rapid distribution of a vaccine and a faster end to the pandemic would support long-run U.S. economic growth. If hope is on the horizon, businesses are more likely to ride it out until conditions improve. The big fear was that the pandemic would result in huge structural changes throughout the economy as some business models became unsustainable, in industries like restaurants, entertainment, and air travel. This type of restructuring takes time and is incredibly costly, and also results in big job losses as firms lay off workers. Reemployment for these workers would be difficult as they would need to switch industries; learn new skills, which takes time; and often take pay cuts. This restructuring would also litter the economy with unproductive investments, in equipment, buildings, and technologies, weighing on growth until new investments would arise to take their place. These risks are greatly lessened now.

Election Results Make Prospects for Economic Stimulus Mixed

While the vaccine news is good for the economy, the results from the recent election are more mixed. President-elect Biden is more likely to push for a big economic stimulus package than President Trump would have been. But the odds of getting a big stimulus are lower with a Republican-controlled Senate, which appears to be the most likely outcome. Republicans are likely to push back on the size of stimulus that President-elect Biden wants, both for political reasons (to avoid handing the new president a big win early in his term) and philosophical reasons (sincere, albeit misguided, concern about increasing the nation’s debt). That being said, Congress is likely to pass a productive stimulus package ahead of two runoff elections for the Senate in Georgia in early January; Senate Majority Leader McConnell would like to show progress to support the campaigns of the two incumbent Republican senators in the state. 

The Pfizer announcement does not obviate the need for stimulus. In fact, stimulus could be more effective in the near term, given that it can help bridge the gap to stronger growth with the distribution of a vaccine. Stimulus should focus on three main areas: aid to small and medium-sized businesses, support for households, and funding for state and local governments. Many small and medium-sized businesses face difficulties; a recent PNC survey found that one-third would go out of business within a year under current economic conditions. To let these businesses founder with the end in sight would be a huge mistake, as it would take time for new businesses to arise and take their place, weighing on the recovery. Households have powered the nascent recovery as stimulus payments have funded consumer spending, but for many households with unemployed workers that aid is running out. A temporary income boost could help support their spending until the labor market rebounds. And without assistance from the federal government state and local governments could be forced to make enormous spending and job cuts to balance their budgets, dragging on growth.

The recent news, especially about the vaccine, makes the Federal Reserve’s job a bit trickier. Although an effective vaccine is likely to support a strong recovery, there is still widespread unemployment in the U.S. The unemployment rate dropped from 7.9 percent in September to 6.9 percent in October, and is down from 14.7 percent in April. But the unemployment rate is still far above its pre-pandemic level of 3.5 percent. Job growth has slowed for four straight months, and more and more unemployment is permanent, rather than temporary; it is much harder for workers with permanent job loss to find a new position, relative to those on temporary layoff. Given the Fed’s focus on achieving full employment, the central bank wants strong economic growth to support hiring.

Long-Term Interest Rates Higher Due to Expectations for Stronger Economy; Further Fed Actions Possible

Because of expectations for a stronger recovery long-term interest rates have jumped with the Pfizer announcement, raising borrowing costs for businesses, state and local government, and households. Ironically, these higher rates could create a drag on the economy. Because of this the Fed is likely to intervene more aggressively by purchasing more long-term Treasurys and mortgage-backed securities to push long-term rates back down (a policy known as quantitative easing). Inflation is expected to remain low in the near term, giving the Fed lots of ability to run expansionary monetary policy. There are wide swathes of excess capacity throughout the economy, limiting firms’ ability to raise prices; wage growth will be slow given the high unemployment rate; and energy prices, although up with the vaccine announcement, are still down from early 2020. An effective vaccine does not change PNC’s forecast for the fed funds rate, the Fed’s key short-term policy rate, to remain near zero at least into 2024.

The Fed could also help bridge the gap to a vaccine by making sure credit remains readily available. Early on in the crisis the central bank stepped in to support the flow of credit to businesses and state and local governments, ensuring that an inability to access funds did not cripple the economy. Now, with a vaccine on the horizon, some credit may be needed to help businesses and governments make it through to better times. The central bank started the Main Street Lending Program to provide credit to small and mid-sized businesses, but take-up has been disappointing; the Fed may need to make changes, including taking on more risk, to beef up the MSLP and prevent more business failures ahead of a vaccine.                                                                                                                     

PNC’s Economic Forecast Unchanged

PNC does not expect to make major changes to its economic forecast with Pfizer’s announcement and the results of the election. The baseline forecast still assumes that the pandemic will abate in 2021, and that Congress will provide an additional $1.5 trillion in stimulus in late 2020 or early 2021. PNC currently expects real GDP growth of around 5 percent at an annual rate in the fourth quarter of 2020, with growth of a little above 3 percent for all of 2021. With the vaccine announcement risks to the outlook have moved to the upside. There are still substantial downside risks, however, including an inability of Congress to pass additional stimulus funding and potential state restrictions on economic activity, given that daily coronavirus caseloads are now at a record high.

The PNC Financial Services Group, Inc. is one of the largest diversified financial services institutions in the United States, organized around its customers and communities for strong relationships and local delivery of retail and business banking including a full range of lending products; specialized services for corporations and government entities, including corporate banking, real estate finance and asset-based lending; wealth management and asset management. For information about PNC, visit www.pnc.com.