Fathom Recovery Watch 29.05.2020

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Headlines

• Growing sense that new COVID-19 cases are falling because of factors other than lockdowns
• The reasons for the decline are highly uncertain, but key to the economic outlook
• The number of new cases in several southern hemisphere countries continues to rise, suggesting that weather could help explain transmission rates
• US continuing claims fell by 3.9 million to 21.1 million in the week ending 15 May (the first decline since February); a welcome development but there is a long way to go for the labour market to recover

There is a growing sense that the number of new coronavirus cases is falling for reasons other than lockdowns. After all, several countries that have eased lockdown in recent weeks have seen the number of new infections continue to decline. Germany and Italy, and to a lesser extent the UK and US, are cases in point.

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There are several possible reasons why this might be the case, each with different implications for the economy. First, we may be on the way to achieving so-called herd immunity — the point at which infections peak because the virus is running out of new people to infect. Second, other behavioural changes might have caused the infection rate to fall. Third, the fall in infection rates may be seasonal.

In the early stages of the pandemic, it was estimated that around 60% of the population would need to develop antibodies against the virus for the population to develop herd immunity; these studies assumed that the basic reproduction rate (or R0) of the virus was about 2.5, and that this figure applied to more or less everyone (i.e. someone who had coronavirus would infect between two and three others when everybody in the community is susceptible to the disease).

A series of studies have shown that a far smaller share of the population has developed antibodies to the disease, even in hotspots such as the UK and Spain (studies earlier this month suggested that about 5% of the population in each country had developed antibodies, although it was higher in some areas such as London, at 17%). Despite this, the effective reproduction rate is falling in some of these places, and significantly, it seems to be staying below one even as lockdowns ease.

It is possible that the initial estimates of herd immunity thresholds and R0 were wrong. It is also possible that since different cohorts of the community have different propensities to catch the virus and spread it (due to physiological, lifestyle, behaviour or other reasons), those who were more likely to catch the disease and spread it have already done so, and that the effective transmission rate of the rest of the population is therefore now a lot lower. If herd immunity has been reached, people could go about their business (including economic activities such as travelling, visiting bars, restaurants, etc) and infection rates would continue to decline. This outcome would be good for the economy.

Another possibility is that infection rates have fallen due to behavioural changes. If true, a key question is what type of behavioural changes have been effective at reducing infection rates and whether there is an economic cost in maintaining them. It would be a good outcome if relatively small changes like washing hands had a big impact. It would not be so good if it is due to changes in behaviour that reduce economic activity, such as not attending sporting events, travelling or going to restaurants.

That an easing in lockdown measures has not been accompanied by a new spike in cases has raised hopes that restricting economic activity may not be necessary to reduce infection rates, and indeed this seems to have underpinned the rally in cyclical equities this week. It also should be noted that while this development is positive, economic activity has not returned to normal in many places that have eased lockdown so it seems premature to conclude with any great certainty that economic activity can go back to normal without case numbers rising again. For example, Citymapper’s mobility index suggests that life, and economic activity, has not returned to normal, even in places like Stockholm which never went into lockdown. (And as demonstrated in previous Recovery Watch notes, data on the movement of people is better at explaining the variation in economic output than official government stringency measures.)

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A final factor to throw into the mix is the extent to which weather and changing seasons affect transmission. Some studies have suggested that exposure to warmer weather (in particular sunlight and vitamin D) might have a small effect in reducing infection rates, while others found no evidence of this. An initial estimate by Fathom did not find a significant difference between the northern and southern hemisphere when trying to model the decline in infections.

Nevertheless, the widely commented on recent decline in new cases has, by and large, occurred in countries in the northern hemisphere. Meanwhile, cases are on the rise in many countries in the southern hemisphere, where it is now winter, even though some of these are countries that have implemented some of the strictest lockdown measures globally (South Africa and Argentina) or where lockdown measures are have become stricter over the last month (Brazil and Indonesia).

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Admittedly, the situation is under control in both Australia and New Zealand, but it is possible that this was due to swift and effective measures taken which eliminated the problem before the change in weather. It is also true that the number of new cases is still increasing in some large economies in the northern hemisphere (such as India and Mexico), but new cases have been trending down in most large northern economies, including hotspots such as Russia and Turkey.

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Some consider Brazil to be the new global coronavirus epicentre and their president’s handling of the crisis has been cited as a reason. While it is true that he fired a popular health minister, has downplayed the severity of the disease and encouraged his supporters to attend political rallies, some leaders in some northern hemisphere countries have also been accused of bad handling of the crisis, yet new cases are falling in those countries. It is also true that lockdown measures in Brazil have been imposed by states and cities, and not the president.

One possible reason for the continuing rise in the number of confirmed cases in Brazil is an increase in testing, but this is also the case in other countries, including the UK, where infection rates are falling. Furthermore, South Africa’s testing capabilities were good to begin with, yet the number of cases continues to rise there too even though it has had one of the strictest lockdowns globally. It seems unlikely that changing in testing capacity explains the differing case trajectory between countries in the northern and southern hemispheres.

The bottom line is that weather could be playing a part in transmission rates, both in the north and south. If warmer weather has been driving the decline in transmission in the north, the economic implications are potentially large, and negative, since this raises the prospect of further lockdowns the autumn. Many businesses and sectors are struggling to get through the current lockdown, never mind having to deal with a second wave and further lockdowns. This is a risk to the global economic outlook.

Finally, asset markets seem to have priced in a relatively low weight of such a scenario unfolding. Of course, countries in the north will have time to prepare for a second outbreak before the autumn, but there is no guarantee that track-and-trace measures will be effective at curbing the spread of the virus or allowing the population to avoid economically costly social distancing measures. It is true that well prepared countries such as South Korea, Japan and Taiwan avoided large outbreaks of the disease during in initial stages of the outbreak, but they all recorded contraction in their economies in Q1. The chances of a V-shaped recovery have now risen (we now estimate them to be 55%), but a range of other letter-shaped scenarios (notably U, L or W) remains high. Investors would do well not to ignore the risks.

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