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Breaking Down the Worst Quarterly GDP Decline in US History
July 30, 2020
The long-awaited 2020 Q2 GDPa came out today after months of deliberation on how the COVID-19 outbreak and the lockdown would initially impact the economy. Consensus estimates suggested that 2020 Q2 GDP would fall about -34% from the previous quarter in the largest drop in economic output in history. The official advance estimate came in at -32.9% just above expectations but still the worst quarterly GDP data point ever reported. Stocks saw mixed reactions as the Dow (-0.85%) and the S&P 500 (-0.38%) finished lower while the Nasdaq (0.43%) actually saw a gain. The 10-year Treasury yield dropped back to its low near 0.55% as investors continued to move away from risk.
Personal consumption, which has been a strong driver of GDP growth in the past, tanked -34.6% in the second quarter with service spending seeing the largest drop at -43.5%. Goods expenditures fared slightly better at -11.3% as the goods economy adjusted to the new COVID-19 environment relatively well. The service consumption drop ended up contributing -22.93% to the overall GDP drop with recreation services spending losses contributing -4.69% and food services and accommodations spending losses contributing -4.69%. Interestingly, health care expenditures accounted for a large -9.50% of the overall GDP drop despite the public health crisis. With consumption being the largest contributor to the GDP losses in Q1 and Q2, it's clear that it will be the most important component of a recovery in GDP from this bottom, specifically service spending. The importance of services is also why reopening processes are being pushed so hard.
It wasn't just households that stopped spending last quarter but businesses as well. Gross private domestic investment fell -49.0% in Q2 with large losses across categories. Nonresidential investment was down -29.9% with investment in physical assets, structures and equipment, tanking, and residential investment was down -38.7% (despite a housing market in short supply). Even though the drop in fixed investment was larger percentage-wise than personal consumption, it only accounted for -9.36% of the overall GDP drop. Equipment spending was the most significant subcategory of investment accounting for -2.13% of the overall drop.
Net exports actually made a positive contribution of 0.68% to GDP with the drop in imports offsetting the drop in exports. This is likely caused by the US going into a more severe lengthy lockdown due to more COVID-19 cases in the country. Similarly, China, one of the US' most important trading partners, came out of the crisis relatively quickly suggesting their demand for goods and services in the trading relationship outweighed the US'. The pandemic has also caused severe supply chain disruptions for companies doing business overseas. Firms in the US that were forced to halt production to reduce inventories likely reduced orders abroad as well.
Government consumption grew in place of losses in investment and personal expenditures but only at a 2.7% rate. The federal government grew their spending 17.4% in Q2 with a 39.7% increase in non-defense spending. State and local governments, which have been struggling financially during the crisis, saw spending drop -5.6%. Despite the uptick in government economic activity, it only contributed 0.82% to overall GDP growth. There's little that the government can do in pure consumption to disrupt the economic declines. However, state and local governments can't be allowed to go under while the unemployment system is at its current level of stress.
Despite the declines in consumption and investment, disposable personal income still increased 42.1% this quarter caused by the large increase in government social benefits. That lead to a jump in the personal savings rate from 9.5% in the first quarter to 25.7% in the second quarter since all of the new cash infused in the system was not spent. The hope is that when things start to open up, that cash infusion will intensify a recover in consumption and boost GDP. However, a prolonged lockdown can limit the effects that excess disposable income will have. Third-quarter GDP will be very significant in that it will describe how the rebound in consumption may develop.