Fathom’s Recession Watch 14.04.2020

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Headlines

• New imported cases in China, Russia spikes; top of the hill visible elsewhere? Exit strategies starting to trend
• China facing a big moment for its Q1 GDP print
• ‘Good outcome’ now looking unlikely in UK, already surpassed in Spain, Italy
• Oxford University suggesting vaccine by September
• Bank of England announces monetary financing
• Equities retracing too soon: no change to Fathom’s forecast
• Markets still treating COVID-19 and associated policy response as net deflationary

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Nevertheless, some countries are already starting to talk about exit strategies, led by President Macron of France, who has announced that the lockdown there will be eased from 11 May onwards.

The discussion of exit strategies means the bad news from China is particularly unwelcome as it is indicative of trends that might occur elsewhere later on: eliminating the virus in your own population is only the first step. China is due to publish its estimate of Q1 GDP in the next few days. Fathom is not alone in having expressed scepticism regarding the accuracy of official Chinese data — but this print will be watched with unusual interest. In our view, Chinese GDP probably contracted by large double digits in Q1 (though there is a great deal of uncertainty about how large). As a recent note indicated, this is an opportunity for the Chinese statisticians to tell it how it is, and to help the rest of the world understand how it is likely to be here.

There has been some good news though, most strikingly from a team at Oxford University led by Sarah Gilbert, who claim 80% confidence that a vaccine will be available from September, much earlier than had previously been estimated. There might be some degree of over-optimism here, but it is encouragingly clear that the race is on in earnest among the top institutions globally to be first across the line with a successful vaccine.

Moreover, the aggressive policy response around the world shows some signs of working. Our measure of negative signals for corporate earnings and lay-offs has fallen back significantly during April, at least until the last few days.

That qualified good news has been reflected in equity prices, which have generally retraced between a quarter and half of their losses. Investors are still discriminating between US and European markets, but all markets have picked up. In the UK, the most recent intervention by the Bank of England, announcing direct monetary financing (temporarily) of government debt issuance has not had a noticeable impact on equities yet — perhaps because the distinction between QE as it had previously been undertaken and direct monetary financing was reckoned to be more about semantics than anything real.

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In our view, the partial recovery in equity prices is too soon. We do not see clear evidence to shift our weights across the three scenarios V, U and L: they remain 45%, 10% and 45% respectively. A clear shift towards a V would support a rally in equity prices, but we are not yet at that point.

Markets have also changed their minds about the impact of this crisis on inflation. The virus has had an impact on both the supply and the demand side of the economy — people unable to work and supply chains disrupted; people unable to travel, go to restaurants, etc. and suffering a shortfall in income on the other. The balance between those two flavours of impact will determine the impact on inflation: if the shock is predominantly demand, then inflation will fall; if it is predominantly supply, then inflation will rise. Early on, bond markets were interpreting the shock as predominantly a demand shock, therefore disinflationary. More recently, though, that view has moderated, and inflation expectations embedded in bond prices have increased again, though they remain below their levels at the start of the year.

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One way of thinking about this chart is as the markets’ judgement on whether the policy response has been sufficient. If policymakers had overdone it in the view of bond markets, the net impact of this shock would be inflationary. As things stand, in the US anyway, markets judge that policymakers have still not done enough. Fathom would concur with that judgement — which is replicated across most advanced economies.

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Interesting reading

• Good news from the University of Oxford
• EU calling for coordination of exit strategies
• A debt deal for Africa
• Andrew Bailey on monetary financing
• A paper discussing the optimal policy on lockdowns
• Discussion of a proposed app to track the virus

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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