• China Sees Unprecedented Manufacturing Contraction

    China's factories provide key inputs to other manufacturers worldwide, so when China exports slow, or even stop, delivery times rise and bottlenecks ensue. This hits U.S. manufacturers (particularly in consumer goods and electronics) and construction the most.

    This supply side hit is nearly impossible for policymakers to adjust for. The options are limited to targeted fiscal policy, such as lowering tariff rates, but the Trump administration has shown little interest in that. The bright side is that a supply side recovery is most likely to be V-shaped, where catch-up can happen quickly due to pent-up demand.

    However, that assumes demand hasn’t fallen dramatically. That brings us to the second half of the equation, the demand shock. How to quantify this?

    First, those in quarantine are not working and they are also not spending (at least not at normal levels, even if some delivery companies are thriving). Drastically reduced personal and business travel has taken a toll on the global economy, and the cancellation of various industry events hurts specific metropolitan areas and industries.

    Hotels bear a lot of the brunt, and won’t necessarily benefit from a snap back in pent-up demand. As writes Jan Freitag, senior vice president for lodging insights at STR, a CoStar Group company focused on the hospitality sector: “Since this is still Q1 a lot of meetings were ‘start of the year’ meetings that will not be postponed but simply canceled. Likewise, a lot of very large citywide events take years to plan and cannot simply be pushed out, demand for those events will just go away. Those events will then take place again in 2021.”

    The full extent of the demand shock is impossible to quantify, but it is likely getting worse with every extreme swing in the stock market and every conference that gets cancelled.

    If there is a bright side here, it’s that demand side shocks are much easier to ameliorate through policy actions. That is what the Federal Reserve attempted to do on Tuesday, cutting interest rates by 50 basis points to mark the first intra-meeting cut since the crisis. As it turned out, this did little to appease the market, as stocks plummeted nearly 3% that day and roughly 4.5% since then (as of the time of this writing). Before the emergency rate cut is even a week old, market participants are already telling the Fed that it isn’t enough: Contracts betting on the future of Fed fund rates are already pricing in additional cuts at the panel's March 17-18 meeting.

    Fiscal policy can also help here, especially by patching up income declines for workers who may be stuck at home with no paid leave. As the chart below shows, this is especially a concern in lower wage industries.