The health impacts and the economic impacts of the COVID-19 pandemic have both varied significantly between countries, and no clear pattern can be inferred linking the two. The US, which experienced one of the worst health outcomes (though not as bad as the UK), had no national lockdown of its economy and is now emerging strongly from the crisis — indeed, it is already close to surpassing its pre-crisis level of GDP, thanks to exceptionally generous and direct fiscal largesse. By comparison, most EU economies suffered a lower death toll than the US but saw a worse GDP outturn, thanks in part, perhaps, to the lockdowns that were imposed there (although generalisations are dangerous here as everywhere). It is also the case that fiscal support was slower and smaller in magnitude than in the US as a rule, and that lockdowns remain in place in many EU economies now. South Korea has seen a relatively benign outcome both in economic terms and in terms of health outcomes, without any national lockdown in place — but with other measures like social distancing and mask-wearing alongside the test and trace regime from the start. The UK has had one of the worst health outcomes alongside one of the worst economic outcomes, despite severe lockdown measures being imposed — as a rule rather late and with, let’s say, mixed messaging from government along the way.
The global recession was huge, and it was a double dip. It was not uniform across countries. It is probably already over, at least at the global level (Indian or other variants of the virus permitting). Early imposition of a comprehensive test-and-trace regime along with social distancing and mask-wearing appears to be extremely effective at protecting both health and the economy. Massive fiscal stimulus in the form of direct payments to firms and households appears to stave off the worst economic damage, in the short term at least. Other lessons are hard to draw at this stage.
So what next? Early in the recession, financial markets took the view that the net effect of the crisis would be deflationary or disinflationary. Markets have since come round to the Fathom view, that the impact on inflation would be neutral or even net inflationary. That is what is now priced into inflation expectations backed out of the relative prices of conventional versus index-linked government bonds, pictured in the chart below. Note, however, that despite the recovery in inflation expectations, in a longer historical context they remain low. The step down at the start of last year has been reversed and, in some cases, more than reversed. But we cannot yet conclude that the secular downtrend over a longer period has been arrested.
Many of the global forces driving inflation lower remain in place, and it remains to be seen whether the current conjunction of positive impulses (arising from the build-up of debt, the reversal of globalisation and the colossal splurge of money printing, among other factors) will win out.
Something similar is true when it comes to government bond yields. They jumped down with growth and inflation expectations at the start of the recession, and have since recovered that lost ground or slightly overshot. But in a longer historical context they remain extremely low. Was the recession a blip in an unchanged secular downtrend, or a turning point which will see yields recover back towards ‘old-normal’ levels?
The economic impacts of the crisis varied widely across countries, and the same is true across industrial sectors. The so-called ‘K-shaped’ recovery, with some sectors thriving and others in the doldrums, is borne out in equity markets, as the chart below illustrates. Sectors that benefit from infrastructure spending (construction and engineering; metals and mining) have done exceptionally well; healthcare and agriculture have done well; banks and aerospace have fared poorly. Some of that sectoral differentiation is cyclical and will go away; but some changes arising from the pandemic will have permanent effects that justify sectoral differentiation in equity markets.
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