Fiscal cliff = Double-Dip

The coronavirus has imposed both a supply shock and a demand shock to the global economy. The supply shock was in the form of disruption to supply chains as factories were shuttered. The supply shock has largely been corrected.

The demand shock was in the form of a loss of demand as lockdown and stay-at-home orders cratered demand. Governments around the world acted to cushion some of the demand shock by way of fiscal support. In the US, a significant part of the fiscal cushion is expiring, which is the risk of a double-dip slowdown.

One puzzle of the stock market rally since the March lows is how stocks can strengthen in the face of the worst economic slowdown since the Great Depression. Sure, central bankers took steps to mitigate the worst of the damage. While they can print money, they cannot print sales or customers for businesses, nor can they print equity.

While some of the risk-on tone could be attributable to central bank action, the real reason for the market's strength is fiscal policy. While the stock market isn't the economy, and the economy isn't the stock market, the two are nevertheless connected. I pointed out last week (see Analyzing the bull case) that US fiscal support had strengthened household incomes to pre-pandemic levels. Retail sales were therefore recovering strongly as a consequence.

All that is about to end as the $600 per week supplemental unemployment insurance payments expire at the end of July. Congress has failed to act to extend the benefits, and the economy is going over a cliff. Brace for the double-dip recession.

The full post can be found here.