Fathom’s Recession Watch – 22 April 2020
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Headlines
- 185,000 UK firms applied for state aid in support of 1.3 million workers on day 1 of the government’s furlough scheme
- FT analysis suggests total UK deaths from COVID-19 running at more than twice the latest headline figure
- Investors continue to view the pandemic as negative for inflation – are they right?
Based on an analysis of excess deaths reported by the ONS in the week ending 10 April, and scaled up to reflect more recent trends, an article in today’s Financial Times suggests that total UK deaths from COVID-19 to date are likely to be around 41,000. That is more than twice the headline figure of 17,337 reported by UK hospitals. In more positive news, the same article concludes that the peak in UK deaths is likely to have occurred around 8 April. This is important because most analysis suggests the period between infection and death is probably at least three weeks. If the peak in UK deaths occurred two weeks after the country was placed in lockdown, that gives hope that some easing of restrictions can take place while keeping the all-important reinfection rate, R, below 1. Precisely how much easing can take place without triggering a second exponential rise in the number of infections is the key issue facing policymakers around the world.
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It is perhaps of little surprise that investors appear uncertain how to price the medium- to long-term consequences of the COVID-19 pandemic. The S&P 500 dropped more than 30% from its peak in late February in the space of a few weeks, far outpacing anything seen during the Global Financial Crisis. But by close of business yesterday, it was just 19% below its 19 February reading. That matches more or less precisely the hit to global GDP in our most optimistic scenario, for this year alone. On that basis, we see significant downside risks to equity prices from here.
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Understandably, commercial property values have been hit hard. Our second chart shows the evolution of real estate investment trusts (REITS) relative to all equity prices since the start of the year. While industrial REITs have outperformed the global equity market, office and retail REITs have underperformed substantially. High Street retailers have, of course, been under threat from online stores for a number of years. Although the COVID-19 pandemic may cause some bricks-and-mortar retailers to fail earlier than they might have done otherwise, it is hard to see that it will have a sizeable impact on the long-term outlook for that sector. The same cannot be said of the market for office space, in our view. In recent weeks, many office workers have learned that they can operate reasonably effectively from home. It is possible that the COVID-19 pandemic will have an enduring impact on the demand for office space. In that respect we find the relative performance of retail and office REITs a little puzzling.
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Long-term inflation expectations, as measured by a comparison of the yields on conventional and index-linked bonds, remain volatile. In the US, five-year breakevens are currently more than 100 basis points below their level at the start of this year. Some of this will reflect the arithmetic consequence of a much lower price for crude oil, which has a particularly large effect on US inflation. But even 20-year breakevens have fallen some 70 basis points.
In our next Recession Watch Forum, scheduled for Monday 4 May, we will consider some of the potential long-run macroeconomic and financial market consequences of the COVID-19 pandemic.
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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