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Headlines
- Three scenarios unchanged, V still equally weighted with L
- Pivot to fiscal being led by Germany, the country traditionally most averse to fiscal stimulus — multiplier likely to be highest there too
- Liquidity collapsing in all markets along with oil prices
- Risk in IG corporate and EM sovereign debt rising — one way we might get from V to L
- WHO is to blame? Sharper rhetoric points to the shape of things to come
The global appetite for reading and talking about coronavirus has waned — unsurprisingly. But that does not mean that we have passed the peak in terms of the humanitarian and economic impact of the virus.
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The number of fatalities continues to grow, expressed below per million of population in each country. There are encouraging signs that these lines might have started to flatten in most countries, but it is far too soon to be sure that is the case.
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The economic effects of the virus and the government and private response to that are undoubtedly huge, but it remains unclear for how long they will persist. Chinese business confidence collapsed in February according to the PMI, both for manufacturing and non-manufacturing industry. The March reading came all the way back. Strictly speaking, that should imply the level of output is more or less unchanged in March compared to February — i.e. still a long way down on January. However, it is hard to look at that chart and not feel that it could be consistent with at least some bounceback in March — respondents might be at least partly recording how they are feeling about their company right now, rather than how its output compares to last month. They felt terrible in February, but feel OK now. That would be consistent with an extremely rapid fall in output in February and an extremely rapid recovery in March: a V-shaped recession. The truth is probably somewhere in between.
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Most major economies have launched enormous fiscal stimulus packages, a mixture of cash and loans or loan guarantee schemes. Leading the pack is Germany, that staunch defender of fiscal probity these many decades. The German strategy, of resisting calls for fiscal stimulus in normal times but responding in scale in extremis, makes a lot of sense. Because German government debt (at least if you exclude contingent liabilities arising out of the euro system) is relatively low, the multiplier on fiscal loosening over the medium term is likely to be higher than elsewhere, at a time when it really needs to be. Other countries who have played the fiscal card in more normal times might come to regret it now.
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Liquidity has collapsed across all markets to a level last seen during the Great Financial Crisis, according to Fathom’s proprietary Liquidity Indicator, derived from the average discount in closed-end funds. This is classic liquidity trap territory: investors are pulling liquidity from the market, holding onto their liquid assets, in order to have enough liquidity to tide them over in the event of a collapse in activity. That behaviour, writ large, ensures that the collapse in activity occurs, their income falls, and consequently they still do not have sufficient liquidity — so they save even more. The appetite for private savings increases, but the quantum of private savings might not change or might even fall because of the impact that saving behaviour has on income. It is precisely in circumstances like this that Keynesian fiscal stimulus is fully justified.
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Despite the deal to cut oil production, brokered by President Trump, oil prices have continued to track downwards — the promise of reduced supply has not kept pace with the expected reduction in demand, so far. It is one of life’s curiosities, for macroeconomists, that the US president would intervene to keep oil prices up, unless for environmental reasons, which feels unlikely with this administration. The US economy, like most advanced economies, is a substantial net beneficiary in the round from lower oil prices, even if the oil-producing sector is hurt. Falling oil prices are a classic and important way of softening the blow to the economy as a whole. Oil prices are now lower in real terms than at any time since the first oil shock of the early 1970s. That will create enormous problems for oil producers who were already operating at or below their fiscal breakeven oil price before this crisis.
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Fiscal stimulus is available to large, mature economies with a strong track record of not defaulting on their sovereign debt: countries like Germany, the US, the UK etc. But smaller, emerging economies will struggle to raise the necessary finance to support such stimulus — especially those who have played fast and loose with fiscal policy recently. Venezuela is careering towards default again, but the risk of a sovereign crisis has ballooned right across the EMs. The corollary of fiscal stimulus within advanced economies is debt relief or restructuring for emerging economies, brokered by institutions like the IMF. The time for such measures is now, otherwise a severe EM sovereign debt crisis beckons, and a humanitarian disaster will probably follow, especially in the poorest economies like those in sub-Saharan Africa. Also, if oil prices remain this low, then some of the oil-producing nations will come into the frame.
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The growing problem of sovereign fragility in EMs might not yet extend to DMs, but there is an issue around corporate debt in some EMs. Returns collapsed as the crisis took hold, but have recovered much of their lost ground in the US and the UK since then: not so in the euro area.
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Meanwhile, the war of words about who, or WHO, is to blame for the early spread of the virus has cranked up a few notches: with First Secretary of State Dominic Raab dismissing the idea that we could return to business as usual in our relations with China post-crisis, insisting on a deep-dive investigation of how the crisis started; Peter Navarro claiming on Fox News that China used the WHO to cover up the virus’ early spread; a journalist from Germany’s Bild newspaper claiming that the Chinese authorities covered up the initial outbreak and should be made to pay for some of the global impact as a result; and President Trump withdrawing funding for the WHO. Get used to this tone of voice: these are the early salvoes in what will be the defining geopolitical struggle of the coming decade and more.
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.
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