'Confidence shock will persist' in the long run: Economist

Frances Donald, Manulife Investment Management Global Chief Economist & Global Head of Macroeconomic Strategy, joins Yahoo Finance’s On The Move panel to weigh in on the Fed’s latest response to the coronavirus and discuss the outlook for the U.S. economy.

Video Transcript

ADAM SHAPIRO: Let's look more at this potential for insolvency crisis and this economy recovering. We're going to do that with Frances Donald, Manulife Investment Management global chief economist and global head of macroeconomic strategy. Thank you for joining us "On The Move."

FRANCES DONALD: Thanks for having me.

ADAM SHAPIRO: So let me start with this. I'm watching markets right now, I'm looking off at another computer. The Dow is up almost 800 points. You point out that the market has likely priced in some probability of a second wave of COVID-19, but you don't believe it is appropriately discounting an economic second wave that could come in the next three to six months. What do you mean by that? Are we overvalued?

FRANCES DONALD: What I mean is that we need to turn our attention away from what we already know about this market-- which is the Fed will provide as much liquidity as possible, there are plenty of government policies, and there are a lot of medical advancements that will come-- and focus on what the market has yet to anticipate. And those things include cascading credit defaults, they include the possibility that we actually see elevated levels of unemployment that persist for periods of time, and they include the idea that I don't think the market has fully grasped the possibility that we see US-China trade tensions start to worsen here. So the market is really focusing on what drove this acceleration-- the reopening, the stimulus measures-- now we need to think second half of the year. What have we not been talking about that could be the driver?

JULIE HYMAN: So Frances, it's Julie here. It sounds like you really agree with Jay Powell's assessment that we're looking at a situation that could persist for quite a long time before we see a meaningful recovery in the economy. So as we get into the second half of the year and even into 2021, as far as what we can tell now, what does that path look like?

FRANCES DONALD: Well, the likelihood is that we actually see a sharp re-acceleration in [INAUDIBLE] from all of our weekly data. You've seen OpenTable reservations, TSA passengers-- all that alternative data that we've been looking at does tell us the worst of the drawdown occurred by mid-April. That doesn't mean the economy stopped slowing at that point. It just slows at a slower pace.

But as we get through that first bulk of re-acceleration, our anticipation is that we do see unemployment rates that remain elevated. And those 80% of job losers last month who said their job is temporary will have to have a reality moment when they realize, I wasn't temporarily laid off. I'm not getting my job back-- very, very painful.

Now, that is going to contribute, in part, to a confidence shock that will persist and we will see consumers in the United States recognize that this was not just a short-term shock, there will be ramifications. That will slow behavior, it will slow activity in the economy, and this is what leads, unfortunately, to delinquencies and defaults.

BRIAN CHEUNG: Frances, it's Brian Cheung here. You mentioned labor market-- Chairman Powell saying in that "60 Minutes" interview yesterday that he could see unemployment going somewhere into the neighborhood of 20% to 25%. But it seems like the timing for what happens after that is still unsure. And a lot of people are saying, why doesn't the Federal Reserve offer more forward guidance in terms of where they can see a rate policy in the next two years or, let's say, if we don't know exactly what it's going to be-- what's it's going to look like in that time?

What do you see as the proper forward guidance from the Federal Reserve? What more do you think they could communicate as we look forward to the next meeting in the first week of June?

FRANCES DONALD: Well, my opinion is that they're holding off on giving us a number because that's actually another tool in the toolkit. When Chair Powell says to us, you know, there's plenty more we can do-- on that list includes refining forward guidance.

My focus, however, is as Chair Powell continues to unveil additional policy measures, how much more is that going to boost the market. The efficacy of each additional policy that comes through is lower and lower. What this market needs is not additional commentary from Chair Powell who tells us rates are going to be low. We know that. Is it really going to change the market outlook if we know they're on hold for four years versus five years? What we need is another tranche of fiscal policy to come through. That's much harder to predict, it takes longer to do, and, of course, we have an election coming up which complicates that analysis as well.

ADAM SHAPIRO: Well, Frances, I think it's probably a good bet, as you've pointed out, we'll get another fiscal stimulus-- whether it's $3 trillion or something much less, that's what Congress will debate. But will that stimulus be enough to push aside the fears of near-term or even long-term deflationary pressure? Because we're watching a commercial real estate bubble that may be about to pop and there maybe other issues down there that drive down asset prices.

FRANCES DONALD: This is exactly what I mean by economic second phase. What are the repercussions that we have delayed through this period, but not entirely eliminated? So what concerns me is not necessarily whether we get that package or how big it is but the lag it takes to deliver it.

We're looking at a difficult two to three months where we really have to catch on to the idea that this has been temporary. And unless we have another tranche of fiscal stimulus that tops up unemployment insurance, that refines some of the problems with the PPP, then I suspect that we're going to have a little bit more of a deepening of a confidence shock and this is where I have the biggest concerns with that lag between when we most need the fiscal stimulus and when that next tranche actually arrives in everyday American pockets.

JULIA LA ROCHE: Hi, Frances, it's Julia La Roche. I want to go back to the idea of the US-China trade tensions flaring up again and that you're saying this is something the market isn't talking about and you do bring up a really good point because the narrative before COVID-19 was about the China [INAUDIBLE] tensions. I guess if you had to discern the probabilities of how this plays out in the latter half of the year, what does that look like to you?

FRANCES DONALD: Well, they're higher than what the market is anticipating. We will get measures of US-China trade uncertainty like the economic policy uncertainty index. And they tell us-- virtually nobody is talking about this issue, but it never went away. We still have very high tariffs on US and Chinese goods that are weighing on manufacturing activity, that are slowing supply chains. It never disappeared. We just sort of acclimatize to it and was focused on a bigger problem.

But what worries me more about US-China trade is that we probably don't have the policy support that would back it up like we did with COVID. If we see US-China trade tensions worsen, that's not going to necessarily give us additional fiscal and monetary policy, so we don't have that backstop within the market sentiment. It's also consistent with deglobalization, which probably means inflationary pressures. That'll lift rates on the back half. There are a series of issues related to this problem that I do not think the market is currently thinking about and needs to.

ADAM SHAPIRO: All right, Francis Donald, Manulife Investment Management global chief economist and global head of macroeconomic strategy. Thank you for being with us "On The Move."