The COVID-19 outbreak has hit five countries that make up one-quarter of global GDP: China, Japan, South Korea, Italy and Iran.

In this interview (recorded Thursday March 5th) Jeffrey Mosher speaks with PNC VP and Senior Economist Bill Adams based out of Toledo, OH. 

Hear Bill's discussion with Jeffrey in the PodCast below!
PNC has reduced its forecast for first quarter GDP growth in China to 4.3 percent on a year-over-year basis, down from 6 percent before the COVID-19 outbreak. This implies a contraction in the Chinese economy in Q1. Chinese growth is expected to rebound through the rest of 2020 thanks to monetary and fiscal stimulus from the Chinese authorities. This assumes that the vast majority of Chinese workers return to their jobs over the next few weeks.

So far there is no sign that COVID-19 has affected the US real economy (as opposed to financial markets). Going forward, the first indications of problems from COVID-19 in the US will show up in survey measures (both consumer and business) and initial unemployment insurance claims. 

The most likely initial hits to the US economy will be supply chain disruptions and reduced tourism flows. If there is an outbreak in the US, it would lead to reduced output, because of workers unable to report to their jobs, and reduced consumer purchases.

US economic fundamentals are still solid. In particular, consumers are in good shape with the excellent labor market. The expansion should continue, although COVID-19 is a downside risk to the outlook. 

PNC expects real GDP growth of around 1.2 percent annualized in the first half of 2020, down from growth of closer to 1.75 percent before the COVID-19 outbreak. The Boeing production cuts will also be a drag on growth in the first half of the year. Growth is then expected to rebound in the second half of the year. 

The FOMC will keep monetary policy on hold in the near term, waiting to see how events play out and for signs that COVID-19 is hitting the real economy, and not just financial markets. The likelihood of a FOMC rate cut in the near term is much higher than the likelihood of a rate increase. 

Some of the big drop in stock prices and lower interest rates is from financial markets pricing in downside risks. Financial markets will remain volatile in the near term given all of the uncertainty surrounding COVID-19. 

COVID-19 will weigh on near-term US inflation, primarily through lower commodity prices, especially oil prices

The US economy added 273,000 jobs in February, well above the consensus forecast of 170,000 and PNC’s forecast of 140,000. Job growth was also a very strong 273,000 in January, a big upward revision from the initially reported 225,000. December job growth was 184,000, revised up from 147,000. Combined upward revisions to job growth in December and January were a very strong 85,000. Job growth over the last three months has averaged 243,000, the best three-month pace since September 2016, and well above the monthly pace of 178,000 for all of 2019. Some of the recent strength has come from hiring for Census 2020; government job growth was 45,000 in January and 51,000 in December. But private-sector job growth was excellent at 228,000 in February and 222,000 in January.

The unemployment fell to 3.5 percent in February from 3.6 percent in January. Along with three months in 2019, this is the lowest U.S. unemployment rate in 50 years. There was a modest increase in employment as measured in the household survey (different from the survey of employers) and a modest decrease in the labor force. The labor force participation rate was unchanged in February at 63.4 percent, its highest level since mid-2013, but well below the 66 percent rate prior to the Great Recession.

Goods-producing industries added 61,000 jobs in February, the best month since January 2019, with another huge increase in construction employment (42,000) and a big increase in manufacturing employment (14,000). Private-services providing industries added 167,000 jobs in February.

Average hourly earnings increased 0.3 percent in February from January, and were up 3.0 percent from a year earlier. Wage growth continues to run at well above the rate of inflation, but is still somewhat disappointing given the very tight job market.

Normally a jobs report this strong would be the big economic story, but COVID-19 continues to cast a pall. The jobs numbers come from the week of February 10, before COVID-19 fears intensified and the stock market dropped precipitously. So far COVID-19 has had minimal impact on “hard” U.S. economy data, on things like consumer spending, production, and jobs. But there have been hints of a COVID-19 impact in “soft” data, such as the ISM manufacturing survey, released earlier this week. And anecdotes of COVID-19’s economic hit are starting to show up.

The U.S. economy is at a crossroads. The fundamentals are strong, as the February jobs report indicates. Firms are adding jobs, wages are increasing, household incomes are rising, and consumer spending is going up. The housing market is a big positive, as seen in big gains in construction jobs over the past couple of months. But if supply chain disruptions lead to a drop in manufacturing output or tourism drops off, the economy could be in trouble. The hit would be much greater if restrictions on movement cause workers to stay away from their jobs, or consumers to stop spending.

But a U.S. recession is not inevitable. If COVID-19 does not lead to significant restrictions on movement and supply chains from abroad eventually return to normal, strong economic fundamentals and lower interest rates could allow for continued expansion, albeit with weak growth in the second quarter of this year. Housing has been strong in early 2020, and is set to further add to growth this year with mortgage rates at record lows.

The strong February jobs report is basically useless for the Federal Open Market Committee, which next meets on March 17 and 18. The FOMC cut the fed funds rate by a large 0.50 percentage point on March 3, in their first intermeeting move since the financial crisis in 2008. Even with the surprise cut U.S. stock prices have continued to fall. PNC expects the FOMC to cut the funds rate again, by 0.25 percentage point, on March 18, lowering it to a range of 0.75 to 1.00 percent, and then wait to see how much COVID-19 is harming the economy. If COVID-19 starts to drag on the U.S. economy, the first signs will be in consumer and business confidence surveys, and in weekly unemployment insurance claims.