Fathom’s Recession Watch 21.04.2020

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Headlines

• Oil plunges, highlighting risk of financial market dislocation from widespread lockdowns
• Government borrowing to rise to 6.2% of global GDP in 2020
• European countries starting to exit lockdown
• UK chancellor expects over one million workers to be furloughed
• Singapore extends lockdown until June

The price of a barrel of WTI oil for May delivery fell into negative territory for the first time in history as refiners were forced to pay for others to take their excess inventory due to a lack of storage space. That move was the latest in a series of COVID-19 ‘firsts’ as financial market participants continue to adjust to an unprecedented sudden stop in economic activity. The price of a barrel of WTI for June delivery remained in positive territory, trading close to $20, but has declined by 65% this year and 30% over the past week. The bigger picture is that developments in the oil market highlight the risks of severe dislocations in financial markets due to the large negative shock to aggregate demand. Despite substantial policy stimulus enacted in recent weeks, it highlights the difficulty for policymakers in trying to play whack-a-mole to neutralise the fallout for companies and sectors affected by policies designed to ensure public health.

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Despite severe personal and economic costs associated with lockdowns, one notable feature of the COVID-19 crisis has been widespread support among the general public for them. In the UK, 91% of those polled by YouGov last week said that they ‘strongly’ or ‘somewhat’ supported the government’s three-week extension to the lockdown. With large fiscal support to cushion the blow, some might say that this is an advanced economy luxury. However, survey data from Bangladesh showed public backing for lockdown measures in less prosperous economies. Of the over two thousand people polled, 68% supported the country’s ‘public holiday’. That figure seems particularly large, considering that the average respondent had seen a 75% drop in income over the prior month and 96% had received no government support.

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While the economic shock from COVID-19 has been unprecedented, the policy response has been too. The IMF expects the sum of individual country fiscal deficits to amount to 6.2% of global GDP this year, marking an increase of more than five percentage points on last year’s figure. That is a bigger increase than that seen during the Global Financial Crisis, when the equivalent figure peaked at 4.9% of global GDP. On a relative basis, the US is punching above its weight in terms of increased borrowing, accounting for more than a third of the overall increase. However, the European response remains a laggard, with ongoing disputes about debt mutualisation, which appear likely to reduce the probability of a strong rebound. Emmanuel Macron has warned it could even threaten the sustainability of the European project, highlighting the longer-term geopolitical risks from COVID-19.

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Perhaps motivated in part by concern about the longer-term impacts of lockdown, several European countries have announced or initiated exit strategies. These tend to be broadly similar and offer an indication of what is to come: a gradual opening of key businesses and schools initially, with less critical businesses such as cafes and restaurants due to open later. Individual governors in the US have followed a similar approach for states, including Georgia, whose governor yesterday announced a relaxation of restrictions. At the moment, we know that severe lockdowns work to flatten the curve. In the UK, the rate of transmission (R0) for each infected case has fallen from 2.5 or 3 to below 1. French researchers have identified a similar decline there.

While we can be confident that severe lockdowns reduce R0, we cannot yet be sure about the marginal impact of individual social distancing measures – for example, schools open versus small shops. Evidence from fatalities in London suggests that its peak in cases may have arrived before the UK formally entered lockdown. Meanwhile, Sweden’s ability to flatten the curve without some of the more severe restrictions imposed in other countries also suggests that a mixture of better hygiene practices and social distancing from the public can be consistent with controlling the virus if not eliminating it. Evidence from other European countries that exit early will be critical in designing future policy. It will also help to inform our view about whether systems of test-and-trace can be rapidly scaled up and effectively implemented. Both will shed light on whether a gradual relaxation in social distancing measures, which is a key assumption underpinning our V-shaped scenario, is likely in the coming months.

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Interesting reading

• A European study finds that higher pollution levels are associated with worse COVID-19 outbreaks 
• French study estimates that by May 11 5.7% of the country’s population will have contracted COVID-19, well below the levels required for herd immunity
• Study positing that higher ACE2 expression in testes can help to explain the sex differences in COVID-19 cases
• Novel dataset that tracks the pandemic’s impact on political violence around the world
• A Chatham House fellow warns that authoritarian governments could use the current crisis to increase their international standing

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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