Cabin Fever Setting In…Mentally and Economically
It is Good Friday and the Covid 19 Quarantine continues. With approximately 50% of the world’s population subject to a “lockdown” of one form or another and cabin fever taking hold, we’ve all heard many conversations around…
- Is this the next great depression?
- What will change in our lives when this is all over?
- How quickly will we get back to “normal”?
- How will we behave differently?
- How will the world do business differently post-pandemic?
We are some distance from knowing the answers to these questions but to get there, we need to revisit where we are today and how that will set the stage for that unforeseen future. Below are the highlights from some very thoughtful research from Insight Investment at BNY Mellon.
The GDP hit! Three things to watch amid painful GDP contractions
1. GDP contractions around 15% peak-to-trough are likely in most economies
2. Fiscal and monetary policy responses will be key, but business closures may limit the impact
3. Closely watch unemployment, supply chain constraints and behavioral changes for clues on the strength of the eventual rebound
Travel, leisure and arts and entertainment sectors could see the biggest downdraft with -80% hits
Insight Investment put together projections by applying sector-level impact estimates to each nation’s economic composition. They believe sectors tied to travel and leisure will be particularly hard hit (Figure 1) as well as arts and entertainment. Elsewhere, growing restrictions on nonessential work will likely mean most sectors will face some negative impact, particularly where activity cannot be conducted remotely. Based on announced policies as of 3/31, the majority of the US will be restricted to essential activity for a minimum of six weeks.
They expect sectors such as construction and manufacturing will face both labor constraints and potential supply chain disruptions, although they believe the impact will be less severe declines than with restaurants, for example.
Figure 1: Insight’s sector-by-sector impact of the crisis
At this early stage, understand that these forecasts have unavoidably wide margins of error as no one can yet know how successful each nation’s lockdown strategies will be or how long the authorities will pursue them.
Labor markets are under pressure as a result
In the US, Google searches for “unemployment” have risen fourteen-fold compared to a month ago. In the UK, the factor is 3 and in France, 14. There has been little change in Germany, however, which has a unique labor market stabilization mechanism. (Google March 2020) In the US, we have seen an increase in initial jobless claims to nearly 16.8 million or almost 10% of the US workforce. (US Department of Labor)
Policy response will be a key factor – but business closures limit the stimulus impact
The implementation of fiscal policy in each country will be the key determinant of the extent labor market issues will be contained and in determining the strength of the eventual economic recovery.
Unlike in a typical recession, fiscal and monetary policy is limited in its ability to mitigate the economic contraction. Even where an element of ‘helicopter money’ is being considered (such as in the US), discretionary consumption is limited by social distancing policies and business closures.
These measures are therefore more aimed towards providing enough liquidity to businesses, individuals, and markets to ride-out the downturn and help facilitate a sharp rebound in activity.
Double-digit GDP growth declines are likely
The varying nature of each nation’s service sector and trade balances will likely lead to somewhat different economic outcomes. However, we expect double-digit declines in GDP peak-to-trough, with the US falling slightly less due to a smaller restaurant sector and trade deficit. Due to unknowns around the duration and effectiveness of containment measures, there is much higher uncertainty to these forecasts than during normal economic times.
Figure 2: Insight’s peak-to-trough GDP forecasts
Policy response will be substantial
Monetary policy will likely be highly accommodative for over 12 months while fiscal policy will need to be loose to ensure firms and individuals have the necessary liquidity to withstand the downturn.
Should authorities be able to contain the virus, this stimulus will likely set the scene for growth to run well-above trend. In most regions, we expect it will take more than 12 months to return to pre-virus levels of activity.
Three things to watch for the eventual rebound
1) Unemployment: While helicopter money combined with standard safety net benefits can help displaced workers, they will need to return to the labor market to maintain consumption eventually.
But how quickly workers are rehired at restaurants, hotels or (for example) airports, is a key question. The greater the initial rise in unemployment or corporate bankruptcy filings, the greater the risk of lingering unemployment is to the economy.
2) Supply chain constraints: These will likely delay the return to full capacity. In China this has been a multi-week process even as virus restrictions are removed. In all likelihood, not all countries will remove restrictions concurrently. With the global nature of the supply chain, production may not return as quickly as demand, prolonging the recovering in output.
3) Behavioral changes: The key question here is how long will it take (if ever) for consumers to be as willing to eat out, go to large sporting events, fly and / or travel as before? These preferences can be quickly tracked via real-time data like film tickets, restaurant reservations, as well as information on weekly oil demand and number of flights. But the potential longer-term psychological behavioral impact of this event also needs to be considered. Will businesses and individuals want to maintain less leverage or hold more liquidity, which could increase the savings rate, lower consumption, or defer business investment? These changes may take more time to grow clear.
As these lockdown policies are phased out, we would expect economic activity to begin to bounce back with the recovery likely to begin in the second half of this year. While there should be a large bounce back, in our view, it will not be immediate. For instance, it will take time for hotels to re-occupy rooms, restaurants to build inventory, or airlines to schedule flights. As such, it will take some time for the economy to return to its pre-crisis levels, particularly as lockdown measures may be phased out incrementally.
Imagine the economy like traffic on the highway. The coronavirus has been a multiple car pile-up, which has brought traffic to a stand-still. As we’ve all experienced, it takes a lot longer for traffic to get back to normal speed than it did to halt it. Jams take some time to unclog themselves, and we think that will be the case. Given this we expect it will take the economy more than 12 months to return to peak pre-crisis levels of output.
Here, the role of fiscal and monetary stimulus is incredibly important in greasing the tracks to ensure that the economic damage of the virus does not linger too long beyond the lockdown policies. As you can see below, there has been unprecedented action by policymakers to support growth with a direct fiscal stimulus in excess of 6.5% of GDP. The US is engaged in a hybrid policy of limiting the rise in unemployment, by subsidizing some employers’ payroll, and mitigating the impact of unemployment by increasing cash payments. Doing these two things successfully is critical for laying the groundwork for a strong recovery.
Public health policy has essentially frozen “economic time” in many sectors (restaurants, malls, hotels, etc. closed). However, “financial time” continues to march on (rent, mortgages, credit card bills, continue to accrue). Absent a response, this mismatch would lead to erosion in savings in the corporate and consumer sectors as they tap into reserves to make essential payments. We would see a sharp rise in unemployment, business closures, delinquencies, and defaults. The policy response needs to bridge this mismatch until economic time resumes, minimizing the erosion so that the economy can more quickly rebound.
We believe policymakers have taken significant steps to greatly reduce second-round damage from the virus, particularly for the consumer and investment-grade corporate sectors. However, small and medium-sized businesses may need more assistance than has been announced so far. Importantly, we believe the speed and size of the response thus far speaks to policymakers’ willingness to do whatever it takes. If it turns out small businesses need $577 billion, not $377 billion, members of congress are unlikely to say “we did what we could” and let there be mass failure. At this stage, we believe policymakers have largely bought into the mantra “in for a penny in for a pound” and will provide the necessary assistance, which means corporate and personal defaults will be a fraction of what they would otherwise have been.
Figure 3: US Policy responses to date
Winston Churchill once said, “You can always count on the Americans to do the right thing after they have tried everything else.” The same Congress which has failed to pass a budget on time in every year since 1997 managed to pass a $2 trillion support package within 8 days of the first draft. While these policies will not arrest the downturn (no amount of stimulus can make consumers go to restaurants that have been closed for public health), we think they will greatly reduce the collateral damage and lay the groundwork for a sustained recovery. While this recovery will take time given the magnitude of the shock, the promise of continued policy support, should it prove necessary, will give investors the ability to better look through near term volatility. Positioning for recovery will require careful security selection focusing on attractively valued securities with the balance sheet, structure, and policy support to benefit from, as the economy eventually recovers.
As we all contend with how to process the ever-changing events that unfold before us…both economic and psychological…we ask you to remember what is truly important. Your family and friends, your health, and those in need around you. Take care of those close to you and take time to care for yourself. We will all come out for the better when this is behind us.