What protests say about the state of the economy

Yahoo Finance’s Alexis Christoforous and Brian Sozzi speak with Deutsche Bank Chief Economist Torsten Slok about how corporations shutting their doors due to the protests may impact the economy.

Video transcript

ALEXIS CHRISTOFOROUS: Civil unrest is sweeping our nation, the worst we've seen in decades, as protests continue after the death of George Floyd. And some of those protests we have seen turned violent, causing small mom and pop shops to close across major cities in America, but also big corporations like Target and Walmart shutting their doors, just as America was starting the reopening process. How might all of this affect our economy going forward? Let's talk about it now with Deutsche Bank's chief economist Torsten Slok.

Torsten, always good to see you. Can you offer us some historical perspective here? Our nation has certainly seen civil unrest before. How might this unrest this time-- which is unique in the fact that we have a pandemic as the backdrop-- how might this impact our economy, at least in the short-term, Torsten?

TORSTEN SLOK: So the thing about the current situation is, as you say, Alexis, that the unemployment rate is 14.7%. And when we get numbers on Friday, we expect it to go up to 19%. This, of course, a terrible statistic. It's eye-watering that there are so many people who unfortunately don't have a job. We are all hoping that employment will come back very quickly, but the backdrop for the things that are going on is unfortunately very, very bad. And that's, of course, why a lot of the outlook here comes back to a conversation about what will the reopening look like, how many of these jobs will come back.

And all this combined becomes very important for the overall shape of the recovery going forward. And there is just unfortunately, a lot of uncertainty about those things because it depends on a number of different things, namely the social distancing requirements. It depends also on whether the PBP program will be lifting employment. It also depends on whether small businesses will be able to carry through such a very extended period that we have still ahead of us where we will not have an economy that's functioning the way that it normally does.

BRIAN SOZZI: Torsten, as an economist, how do you factor in social unrest into your models? Do you factor it in?

TORSTEN SLOK: It is very difficult to quantify, so you're right, Brian. In some sense, the toolbox we have in markets and the toolbox that they have, and that we have on the sell side just doesn't have any good ways of assessing and quantifying social risks and social unrest. And as we know and as we've seen historically in many different episodes, this can turn out to be extremely important.

I don't have a view on whether this is going to be dramatically important or not important from a market perspective. It certainly is extremely important in its own right, but I do think that at this point, it is just really difficult to quantify what this means. And the market today when we open up, I mean, just suggest that there is focus on ISM which came in exactly on expectations, around 43, this is what the market had in mind and this is the number that we got. This is, at least for now, telling us that the market is not paying too much attention to either economic data.

There's also other issues going on, of course, with China and Europe and other things you can worry about in terms of the broader picture, what this might imply for the shape of the recovery. But I think that the market is just having a pretty hard time quantifying very unquantifiable risks.

ALEXIS CHRISTOFOROUS: Yeah, good point. So then having said that, Torsten, what metrics are you looking at when you consider the timeline for an economic recovery? I guess it's a two-part question. What do you see the recovery looking like? And then, what is the timeline? Are we looking at 2021 being an extremely tough year for the economy, perhaps even going into 2022?

TORSTEN SLOK: Yes, so one way to answer that quick question, Alexis, is to look at the congressional budget office estimates that by the end of this year, the unemployment rate will still be more than 10%. So if we go up to 19% here in May and then we only see the unemployment rate come down gradually over the next six, seven months and we'll still be double digits by the end of the year, that's telling you that the CPO implicitly has basically a swoosh, a very, very slow recovery ahead of us. This is not a [INAUDIBLE] recovery by any means.

This is also our own forecast. We also expect unemployment rates to be more than 10% by the end of the year. And with that backdrop, you begin to worry about what are the consequences for the number of companies that go into bankruptcy, the number of households that may start to fall behind on payments on auto loans, on credit cards, what does that mean for loan losses in the banking sector?

So the big issue continues to be, to what extent this situation is going to move from a liquidity crisis to a solvency crisis, and the huge uncertain part of that discussion to the upside is, of course, will fiscal policy come in and try to solve some issues and support the household balance sheet or corporate sector balance sheet so that we don't get the solvency crisis playing out as severely as some people fear. So that's sends the upside risk into policy reaction. More fiscal policy could lift us faster, and we don't really know at this point whether that's coming.

The other more known upside risk is that the PBC program making loans to small businesses, that were just extended to the end of the year. So when we need to get employment back to the level it was at in February, so there is also some upside risk to hiring process on the [INAUDIBLE] side. But the short answer to your question is that there are both downside risks.

Of course, we're involved with the virus, and the virus and potentially getting a second wave and what that might mean for more social distancing-- in the worst case, another shutdown. But there's also upside risk from politics doing things that we just really don't have any good grasp and understanding today.

ALEXIS CHRISTOFOROUS: We didn't even talk yet about China, Torsten. And how much of that is really going to be a challenge for investors? And do you see President Trump perhaps really-- you know-- raising the heat on China, especially in an election year? Because one has to think this is only going to fuel the fire that has already been fueled by this pandemic, and now this civil unrest.

TORSTEN SLOK: Yeah, so this is also a very unquantifiable risk that is also very difficult to put into a model. I mean, think about it. The Fed has a model purpose of the US economy, which essentially has 300 equations that is an attempt to try to figure out if I push one variable up a little bit, what happens to other variables elsewhere in my little system of equations? And you don't really have a variable for social unrest. You don't have a variable for a geopolitical risk, the way that things could or could not play out with China.

We do have some variables that we can move around and so the level when it comes to the trade war. So that's why a lot of discussion now about what will happen to the trade deal that we have with China? Is that completely off the table, or how much of those things will actually be playing out? And it's right adding to that that we are an election year, and you just have in statistical terms, a significant standard deviation in terms of outcomes, which is why it makes sense that there's just such a wide disagreement in the marketplace around what will the economic shape of the recovery look like.

BRIAN SOZZI: Torsten, we've had-- with good reason, I think-- a lot of folks starting to see or get worried about a second wave of COVID infections. Based on what we're seeing out there with the social unrest, some people wearing masks, some people not wearing masks, what do you estimate in terms of GDP and unemployment in the second half if we do get a second wave of infections?

TORSTEN SLOK: Yeah, this is very important. I mean, the main way that we assess this is really just to look at the daily data that we have that tries to figure out what is the shape of the recovery? One important piece of statistic is the daily data for the number of restaurants bookings from OpenTable, and that has actually-- in a number of states doing-- going up, in my view, quite surprisingly quickly that we now have-- of course, when we were in shutdown, the number of bookings was down 100%. But now, we are quote, unquote, "only down" in a number of states, sort of 60-70%. So that means that a lot of people are beginning to come back.

So the way that we tried to answer your very difficult question is to figure out well, how is this social distancing behavior, how are these things that are going on? How is this actually ultimately feeding into indicators such as number of restaurant bookings? You also have indicated a number of people who take the New York City subway. That's actually also slowly beginning to go up. I know this is a very local New York City indicator, but that's still telling you something.

Likewise, the number of people that are going through TSA checkpoints. In other words, the number of people who are flying with airplanes is also gradually beginning to move up. It's still very low relative to where it was before, but I think the market is genuinely focusing on indicators that are trending higher. And as long as these trend-- if you put your ruler down these lines, as long as these lines continue to move up, I think that demand will begin to focus at the light at the end of the tunnel.

If those indicators-- to your question, Brian-- start to flatten out or in the worst case, start to go down again, then you will get to the conclusion that means that social distancing and the virus coming back is not becoming so pronounced that people begin to hold back in terms of spending. And that, then, begins to become a conversation about well maybe this second wave could be having a more severe impact on the economy. But for now, it looks like many of the indicators are still crawling out of the bottom. The spending at the bottom of the canyon and many economic indicators are beginning to look up, and we're only gradually moving out of the canyon. But it is going to take some time.

But as long as we are moving out, I think the market will focus on the trend of where that line is going.

ALEXIS CHRISTOFOROUS: All right, Deutsche Bank chief economist Torsten Slok, always good to see you. Have a good rest of the day.

TORSTEN SLOK: Cheers.