Subscribe here to receive Fathom’s daily Recession Watch newsletter, and opt in to join Fathom’s weekly Recession Watch Forum and participate in lively discussions with our team and others in the community.
Next forum date: Monday 6 April 2020, 3:00pm BST
Headlines
- Grim economic data drive another major downgrade to our forecast: the short-term impact is now worse than anything the world economy has seen in peacetime, possibly since the last plague
- The coming two weeks are critical, as they will tell us whether we have passed the point of inflection in the spread of the disease across the major economies
- The economic effects are terrible everywhere, but are likely to be even worse in emerging economies: that is the theme of our webinar this afternoon
- Despite all that, there remains (for now) a material chance of a V-shaped recession
- Some early indications of how the post-virus world will have been reshaped: trouble in the euro area, increased polarisation between the US and China
The fan chart above shows the probability distribution of our forecast for the level of GDP, not the growth rate that it would normally display. That is because the convulsion in the growth rate is now so extreme that it makes the fan chart difficult to read. The chart also illustrates the point forecasts consistent with the centre of the distribution for each of our three risk scenarios, the V, the U and the L shapes. In the V-shape, we are back to the pre-crisis level of global GDP by the end of next year. But in the L-shape, we remain below that level throughout the forecast period.
The last few days have seen a slew of exceptionally weak economic data, culminating in US payrolls on Friday, which contracted by 701,000 in March.
Refresh this chart in your browser | Edit the chart in Datastream
That would usually be greeted with shock and amazement but, in this case, it is merely a ripple from the storm that is to come: April payrolls could fall by 20 million or even more. These are extraordinary times. The short-term impact in all three of our risk scenarios is the same and has been downgraded substantially over the last week to around 17% on average. That magnitude of negative shock to the global economy has never been seen in peacetime – it exceeds even the impact of the Wall Street crash of 1929. It is important to stress, however, that just because the initial shock is huge, it does not follow that the recession will be correspondingly huge. Other, much better outcomes than that remain on the cards for now. We attach a 45% weight to the V-shaped scenario: a massive negative hit to growth quickly followed by an almost-equally massive recovery. Unfortunately, we also attach a 45% weight to the L-shaped scenario.
Within that colossal and synchronised short-term shock there are some important variations across countries. In particular, emerging economies are set to be hit harder than advanced economies in general – something that is not yet priced into equity markets. Listen into our webinar this afternoon to find out why.
Refresh this chart in your browser | Edit the chart in Datastream
The chart below shows the fatality rate per head of the population across countries, indexed to the date of the first fatality. It now looks increasingly likely that both Spain and Italy will breach the rate (the dotted horizontal line) that would be consistent with 20,000 fatalities in the UK. Both the UK and the US appear so far to be following a similar trajectory to Italy, though it is too early to have any confidence that either country will continue along that path.
Refresh this chart in your browser | Edit the chart in Datastream
Some countries (Australia, South Korea, China) are reporting encouraging falls in the number of new cases, though in South Korea this might be partly due to fewer tests being undertaken and in China there are worrying reports of new cases arising via domestic transmission. In Italy the number of new cases is definitely falling. But the UK, the US, Spain and others have yet to reach the inflection point in the spread of the disease, and anxiety is increasing as a result.
The key factors that will drive us from a V to an L in economic terms are corporate insolvencies and job losses, which between them would lead to another financial crisis. Some of these effects are unavoidable now (though had policymakers responded immediately and on the right scale they might have been avoided). But there is still an opportunity for policy to make its mark, preventing corporate failure and mass lay-offs through income support directed at companies and individuals. The cost in terms of government debt will be enormous, and eventually that will have to be reckoned with. But that day of reckoning can wait until the global economy is off the rocks: now is the time for decisive and aggressive government intervention.
On the corporate insolvency side, the chart above is Fathom’s metric of margin pressure in corporate earnings, which has eased slightly over the last couple of days, though it remains elevated. We will be monitoring this, along with data on lay-offs, over coming weeks.
A huge recession is obviously unwelcome everywhere, but arguably it is even more so in the euro area, where monetary policy is out of ammunition and the cross-country coordination required for a meaningful fiscal response takes time and a degree of political will that is difficult to achieve. This is already showing up in a renewed mutterings in Italy about the perceived lack of help from other EA nations. A shock of this magnitude definitely has the potential to drive the euro area back into an existential crisis of the sort that was resolved by Draghi’s magnificent bluff in July 2012. So far, markets appear sanguine about that risk, but the risk is there, nevertheless.
Refresh this chart in your browser | Edit the chart in Datastream
And other indications of the possible shape of a post-virus world are beginning to emerge too. The Trump administration’s choice of language (“the Chinese virus”) is unlikely to be accidental, and it chimes with other material too (see the reading list below). The US and China were already embarked on a journey of increased polarisation: the impact of this virus and the narratives about its cause and transmission are likely to accelerate that process. The post-virus world could see a renewed crisis in the euro area and a much clearer delineation between the twin poles of global economic and geopolitical power.
Interesting reading
Fathom forecast scenarios
Economic forecasting is difficult even at the best of times. It is particularly difficult today. At Fathom, we think in terms of scenarios and seek, wherever possible, to downplay point forecasts. A severe contraction in global economic activity through the first half of this year is inevitable – we are facing what French economist Pierre-Olivier Gourinchas has referred to as a ‘sudden stop’, something the global economy has never experienced before. But how long will it last? In our Global Economic and Markets Outlook for 2020 Q1, we set out three scenarios. The first was a V-shaped recovery, in which the number of cases peaks within months and begins to decline, allowing activity by the end of this year to return to normal levels. The second was a U-shaped recovery, where the virus continues to spread, depressing activity until a vaccine is found, but the economic and financial market infrastructure remains in place to deliver a strong rebound when that occurs. The third was an L-shaped recovery. Since we finalised our forecast on 17 March, a number of major economies have placed more severe restrictions on movement, and imposed a temporary shutdown on more industries than we had thought likely. This more aggressive action has caused us not only to anticipate an even sharper contraction in economic activity in the first few months of this year, but to increase the weight we attach to a V-shaped recovery. At the same time, we have also increased the weight we attach to our more severe risk scenario, making the outlook somewhat bimodal. In the event that COVID-19 returns with equal or greater vigour once restrictions that are holding back economic activity are lifted, then a severe financial crisis will be very hard to avoid.
_________________________________________________________________________________
Datastream
Financial time series database which allows you to identify and examine trends, generate and test ideas and develop view points on the market.
Refinitiv offers the world’s most comprehensive historical database for numerical macroeconomic and cross-asset financial data which started in the 1950s and has grown into an indispensable resource for financial professionals. Find out more.
