Our central case now calls for a steep global recession in the first half of 2020, but there is an exceptionally high degree of uncertainty around that call and a high degree of variation across countries in terms of timing, severity, and the policy response.
To help our clients navigate through these turbulent waters, we are introducing a daily Recession Watch note, starting today. The main purpose of this note is to help understand how severe the recession is, and how long it is likely to last. The first means tracking the data; the second means creating metrics that will tell us whether ‘second-round effects’ are taking hold, which will lead us into a more protracted recession: a U or an L shape rather than a V.
Headlines
- Markets closed up – probably just another peak in the ‘sawtooth’ decline over recent days.
- Substantial new monetary and fiscal stimulus measures announced in US, France, UK, along with new restrictions on movement
- New cases slowing rapidly in China, South Korea; still rising elsewhere
- Number of virus-related articles passed 45 million per day
Fear and reality
The number of cases measures how the virus is spreading. The number of media articles measures how the fear of the virus is spreading. Both of these matter for the depth and severity of the recession.
Details: policy stimulus
Monetary policy has been loosened sharply in the US and UK (both policy rates and QE), with no material response as yet from the ECB. It is not clear that lower rates can help support growth in the very short term in this particular crisis, though these measures might help minimise second-round effects.
A number of finance ministries have taken what, on the face of it, is aggressive policy action. But in our judgement, much more will be needed. First off the mark, France announced a €345 billion package, split into €300 billion of loan guarantees and €45 billion of cash. The UK has subsequently announced something of almost identical size. In each country, even the loan guarantees are sufficient to over only around seven weeks of economic activity; the cash sums a few days. Even if none of the loans are repaid, this would add no more than 10 to 15 percentage points to the government debt to GDP ratio in each country. In the aftermath of the global financial crisis, government debt as a share of GDP rose by some 40 percentage points across the major economies. Most governments are using words too, along the lines of Draghi’s “whatever it takes”. It is to be hoped that they follow through on that commitment, as the economic case for such support following what will prove to be a temporary shock, even if of uncertain duration, is overwhelming. Unless a way of controlling the disease is found soon, massive government support, delivered almost immediately, could make the difference between entering and avoiding a severe financial crisis, and deep depression.
Details: policy restrictions
The stimulus packages are designed to offset the economic impacts of the restrictions on movement that have been introduced to control the spread of the virus. New, draconian restrictions have been announced in the US, the UK, France and Germany over the last few weeks, and are already in place in China, South Korea and Italy. In the coming days we will monitor daily changes in these restrictions.
V, U or L?
If this is to be a V-shaped recession, then a huge, lifetime buying opportunity awaits brave equity investors in the near term. But they need to be brave, since the risk of a much more protracted recession remains in place. The shape of the recession is critical and will be determined by the degree of second-round effects. The key factors that we will be monitoring include: corporate defaults and insolvencies; and unemployment. If the short-term hit is not contained, firms will go bust and even firms that remain in business will lay off workers. If those effects come to pass in scale then the likelihood of a sharp, V-shaped recession will fall. We will be monitoring these signals daily.
Corporate spreads have widened, but so far remain far below the peaks they reached during the crisis of 2008/09. We will shortly introduce a proprietary measure of corporate insolvencies on a daily frequency.
Unemployment is typically a slow-moving, lagging indicator of recession, as the chart below demonstrates. It is likely to pick up gradually as the months go by.
However, there are high-frequency data on corporate layoffs that we will be tracking over coming weeks, to help us gauge whether the V is shifting to a U or an L. Already there is anecdotal evidence that layoffs are beginning, especially in the retail sector, as well as B2C businesses like hotels, bars, restaurants etc.
Interesting reading
https://www.thelancet.com/journals/lancet/article/PIIS0140-6736(20)30566-3/fulltext
https://www.imperial.ac.uk/news/196234/covid19-imperial-researchers-model-likely-impact/
https://www.theguardian.com/commentisfree/2020/mar/13/why-is-the-government-relying-on-nudge-theory-to-tackle-coronavirus
https://fred.stlouisfed.org/tags/series?t=layoffs
