Catalyst News

Global Economist Bernard Baumohl Continues Forum 2020 Q&A on the Economy

by Catalyst Corporate | Oct 27, 2020

From the upcoming election to the ongoing pandemic, Chief Global Economist Bernard Baumohl shared his insights on the economy at the virtual Economic & Payments Forum earlier this month. In his presentation, “The U.S. Economy: COVID-19 & the Presidential Election,” Baumohl addressed challenges credit unions face in the current economic climate. And the 376 credit union attendees responded with numerous questions…in fact, too many to get answered that day.

However, Baumohl agreed to address some of those unanswered questions after the Forum. Here’s a look at a few of them:

  1. How much of the loan loss reserve (LLR) increase can be attributed to changes in accounting rules (i.e., CECL)?

    The irony here is inescapable. CECL took effect the same quarter the coronavirus struck. What timing! 

    We know lenders will need to substantially add to loan loss reserves. However, even if the virus never happened, the new accounting rules still would have forced bankers to raise LLR. CECL requires lenders to make projections on potential loan losses for the entire life of all loans – not simply loans that are delinquent or in danger of becoming nonperforming.

    What is so complicated this time is how one computes future loan losses in the middle of a catastrophic pandemic. There are no models for such an exogenous shock, no recent historical reference to use as a guidepost. The global economy has been pulverized by a microscopic pathogen for which there is still no effective vaccine! All that is left is for each financial institution to assess the credit risks on their books and make difficult and untested assumptions to calculate which loans (over their lifetime) will go bad during this viral blaze.

    I would argue that LLR could jump by at least 30 percent because of BOTH the game-changing CECL rules and the damaging fallout from this historic virus.

  2. How will U.S. multinational firms be impacted by geopolitical unrest and the reliance on a global employee base?

    Several forces affect the operations of multinationals today.

    Rising geopolitical tensions is one of them. For instance, the last two years have been exasperating for U.S. companies with plants and offices in China (as well as for U.S. importers) as they have attempted to duck and weave around an escalating trade war. (By the way, Europe may be the next major target should President Trump win a second term.)

    To avoid the geopolitical crossfire, many of these firms sought to move their factories and supply chains to other Asian nations. But such a transition is rarely smooth. Virtually no Southeast Asian country has skilled labor, equipment, roads, rails and ports on the same scale as China. Secondly, transporting goods across the Pacific has also gotten more expensive because of consolidation in the trans-ocean cargo shipping industry.

    So what options do multinationals have? There is little likelihood we’ll see geopolitical tensions cool off in the near term, at least not in the South China Sea or when it involves hotspots such as Hong Kong, Taiwan, North Korea, Iran and Venezuela. Nor will disruptions to global supply chains suddenly cease. As a result, virtually all CEOs with major assets abroad are evaluating how to restructure their supply chains and labor needs so they can operate profitably, more securely and with fewer geopolitical headaches. One option is to repatriate their plants from Asia to the U.S. (or to North America under the USMCA umbrella). The advent of innovative technology – AI, robotics, 5G wireless networks, 3D printing, the Internet of Things – is changing the economics of producing goods closer to the U.S. Such technologies can increase a company’s productivity and overall efficiency to the point where it could potentially produce more, with fewer labor inputs. Bi-partisan proposals in Congress also would provide subsidies and other incentives to get multinationals to domicile their operations in the U.S. Simply put, we are entering a phase of deglobalization fostered by new technology, a desire to simplify supply chains and an effort in Washington to lure companies back to U.S. shores.

    We should not count on, however, this new economic nationalism to automatically lead to greater employment in the U.S. In other words, don't be surprised to see a sign in the future that reads, “This American flag is now proudly made in the U.S….by robots.” 

  3. In our new post pandemic world, there is increased reliance on technology. How do you think cyberterrorism will impact economies due to vulnerabilities?

    Cyberterrorism is the single greatest threat that looms over the global economy. It’s really the only practical weapon superpower rivals can use against each other. Using conventional battlefield weapons runs the risk of escalating into a nuclear conflict. Moreover, cyberwarfare is cheaper to wage, can do massive damage and allows for plausible deniability. So it should come as no surprise that superpowers are investing heavily in both offensive and defensive cyberwarfare/hacking technology. The U.S. intelligence community has already observed how Russia successfully destroyed part of Ukraine’s economy by hacking into its power grid and shutting down electricity. Russian hackers also penetrated major U.S. utility companies and had full access to that U.S. control panel – though they did not take any destructive action, so far. It was enough to see them flex their cyber muscles.

    The fact that foreign state-sanctioned hackers can wreak tremendous economic and financial (and presumably electoral) damage on the U.S. without firing a single bullet tells you how vulnerable we are to such attacks. My assessment is that we are still woefully unprepared to protect our infrastructure and business sector from such incidents. Companies must prepare contingency plans now in the event of massive cyberattacks – which I dare say are inevitable.  What do you do when a company’s wireless network/Internet communication system fails?  What happens if a foreign power shuts down the U.S. financial system – or your access to credit lines – or deletes vital records – or causes a massive power failure? 

    From what I have seen and read, we are not adequately protected against such hi-tech destructive attacks. That poses an existential threat to the U.S. and, indeed, the global economy. 

  4. Most rate projections reflect a 3-4-year low interest rate environment; however, you mentioned a period of 6-7 years. Do you feel investment yield will remain low and loan demand will remain soft as well?

    The outlook for short- and long-term interest rates will depend on four factors: 1) when the public has access to an effective and safe vaccine; 2) when the next pandemic stimulus takes effect and how large it is; 3) what kind of policies we get from the next occupant of the White House; and 4) what business and household scars this pandemic leaves behind.

    At this point, we do not know the answers to these questions. That makes interest rate forecasting especially challenging. We’re left with the following assumptions:

    1) A vaccine will not be fully available until summer or fall 2021 at the earliest.

    2) and 3) I’ll combine them, because one is dependent on the other. Assuming the Democrats win the White House and control both houses of Congress, we’re likely to get more stimulus and that should provide support for the economy.

    As far as 4) is concerned, we expect to see permanent changes in the economic and business landscapes. So much so that it will take time for households and businesses to re-orient to the post-COVID world. The level of unemployment, for example, will remain elevated for several years as industries consolidate and lay off a redundant workforce. 

    As a result, our view is that the Federal Reserve will maintain its zero-bound policy on fed funds beyond five years. The inflation target on core PCE price index has been relaxed to an “average of two percent,” which means the central bank will allow inflation to exceed two percent for an indeterminate period. Keep in mind, the last time we had a full year with core inflation at two percent was 13 years ago.

    Since we do not expect the Fed to pursue a policy of yield curve control, 10-year Treasury yields are expected to creep higher to 1-1.60 percent in 2021, as the U.S. economy slowly emerges from its current slump.

    The U.S. economy will probably be on more solid ground than Europe or Japan. That should encourage more foreign capital flows to the U.S., which will increase demand for U.S. fixed incomes and, thus, prevent any sharp rise in yields.   

  5. The housing market seems strong, with low rates, little supply and prices escalating quickly in many areas. What is your outlook for this sector over the next couple years? Should credit unions expect requests for more mortgage loans and refinancings in 2021-2022?

    Housing has been extraordinarily resilient. New and existing home sales are at a 14-year high! Behind this powerful drive are the lowest mortgage rates in half a century, a desire to live outside congested cities and a greater willingness by companies to have employees work from home. Another potentially positive development for housing could be a Democratic administration that reverses limitations placed on deducting residential real estate taxes imposed in the 2017 tax act.

    The current strong pace in home sales and residential construction will continue through 2021, but then taper off in 2022, as both surging home prices and rising mortgage rates (driven by higher Treasury yields) cool off applications for home purchases and refinancings.

  6. How are stock prices expected to react under the Biden Administration, compared to a second term with Trump?

    The stock market discounts future earnings. If investors anticipate a robust economic recovery with stronger earnings, equity values will keep climbing. So, let’s look ahead. A Biden administration is expected to pass a hefty stimulus package in Q1 2021 and that should support economic activity. Moreover, the closer we get to a vaccine, the sooner the economy gets back to a normal business cycle. Those two factors – a larger stimulus program and a vaccine – should push equity value higher in the initial year or two of a Biden administration.

    But, as the saying goes, the higher you climb a tree, the thinner the branches. At some point, we could see a stock market bubble emerge and get pricked. What could possibly cause a major pullback in shareholder values? Here are several scenarios to monitor:

    1) A proposal to hike personal and business taxes that would be viewed as punitive, such as a much higher levy on capital gains or a costly financial transactions tax. While I fully expect a Biden government to raise corporate and individual taxes, the details I’ve seen so far fall short of any truly draconian measures.

    2) Federal Reserve officials voice concerns that equity values have risen too far, too fast. Such sentiments would resemble the warnings articulated decades ago by Alan Greenspan (“irrational exuberance”). Any similar warning by the current Fed will take the wind out of the market.

    3) The Fed hints the time for easy money is coming to an end and prepares financial markets for tighter monetary policy in the near future.

    4) Foreign investors show increasing reluctance to finance-swelling U.S. budget deficits and, instead, diversify their portfolios out of dollar-denominated financial assets. That could lead to higher market rates and endanger any U.S. economic recovery.

    5) China strikes back at America’s blistering attacks on Beijing’s domestic and foreign policies by reducing its holdings of U.S. Treasuries. They currently hold $1 trillion of U.S. sovereign debt and have issued veiled threats to cut that to $800 billion. If they take such action, market rates will rise and that may choke off U.S, economic activity.

    To summarize, I expect to see stock prices march higher in the first year or so of a Biden administration and then take an extended breather. But we still need to be on the lookout for the five risks described above that could abruptly end the momentum on Wall Street.

For an in-depth look at the economic insights shared during Baumohl’s presentation, check out his session on the on-demand section of the Forum Hub.