Economy suffering coronavirus growth shock

03 April 2020

7 minute read

By Henk Potts, London UK, Senior Investment Strategist

As the medical and economic scars of the coronavirus outbreak are felt, what could be the implications for the global economy and growth prospects?

While the coronavirus outbreak is foremost a medical crisis, it clearly has widespread implications for the global economy and in turn financial markets.

Containing Covid-19’s spread

In early March the World Health Organisation officially declared Covid-19 a global pandemic, though the organisation stated that the spread of the virus can be slowed, or even reversed, through implementing robust containment and control activities. Evidence from China suggests that this works, where the number of newly infected daily cases has fallen from thousands in January and February to zero new organic cases by mid-March. Although the rapid expansion of cases in Europe continues to scare public health officials.

Mitigation measures have led to significant disruption to the regular functioning of the global economy. Countries have closed borders and global travel has grounded to a halt. Officials have enforced the closing of schools, restaurants and sporting events. They have encouraged social distancing and unprecedented numbers of people have been forced to change their working patterns.

Economic impact

The magnitude of the economic effect will be determined by the disruption to supply chains and the reduction in demand. Certain sectors are more vulnerable than others to the initial shock caused by the Covid-19 pandemic, including travel, retail and events. On the industrial side, manufacturing has been under pressure, but is likely to recover more quickly. This pattern has been observed in leading economic indicators, where services has been much more affected than manufacturing.

Central banks and governments have reacted aggressively to support economies and stabilise markets. The former slashed interest rates to historically low levels, restarted quantitative easing programmes and injected massive amounts of liquidity into the system. Meanwhile, the latter instigated substantial fiscal policies aimed at reducing the risk of the medical crisis turning into a financial one that could have long-lasting implications for global growth prospects.

Policymakers learnt a number of lessons during the 2008 financial crisis, including the importance of acting early and in size. As we have seen by the speed and scale of the policy response to Covid-19, officials are hoping not to repeat past mistakes. While the measures will not solve the immediate medical concerns and resulting disruption, they will support long-term demand and perhaps, more importantly, will provide much needed liquidity for companies and financial markets.

Policymakers learnt a number of lessons…including the importance of acting early and in size

Radical cuts to growth forecasts

Given the sheer scale of the disruption it’s no surprise that economists have been forced to make radical reductions to their global growth forecasts. We project significantly weaker levels of activity in the first half of 2020. Certain regions, such as China and Europe, are likely to be hit harder than others.

China is an important component of the global economy, accounting for about one-third of global growth and 16% of gross domestic product (GDP). Recent retail sales and industrial output figures showed that the Chinese economy ground to a halt in February. We expect the economy to contract by 8% in the first three months of 2020.

While the government has been implementing a more proactive fiscal stance and looser monetary policy to help stimulate growth, it’s been in a less aggressive fashion than seen in previous bouts of weakness.

Recent reports suggest that Coronavirus-related restrictions are starting to be eased and manufacturing operations are now coming back on stream. That said, we still predict growth of just 1.3% for 2020, substantially less than the 6.1% growth rate achieved in 2019.

Epicentre now in Europe

Europe has been hit hard too, with Italy experiencing more deaths than seen in China. Europe’s open and export-orientated economies remain vulnerable to weaker external demand. European growth has been supported by loose financial conditions, improving labour markets and somewhat healthy domestic demand. However, with more countries moving into lockdown, household consumption will inevitably take a hit.

We now see the bloc entering a technical recession in the first half of the year. The European Central Bank has dramatically increased its asset purchase programme and improved its loan programme to the banking sector. However, coordinated fiscal support and structural reform is the key to limiting further damage to the economy. We forecast a 5.5% contraction in GDP growth this year compared to growth of 1.2% in 2019.

US feels the heat

Hopes that the more insulated, domestically-focused US economy could be sheltered from the impact of the coronavirus have quickly evaporated as more preventative containment measures have been introduced. Survey data for March suggests that there was a sharp drop off in restaurant visits, hotel bookings and domestic airline travel. There has also been a big jump in initial unemployment insurance claims and a sharp fall in readings from the available regional manufacturing surveys.

Even if the authorities deliver on the fiscal promises, we now expect the US economy to contract by 0.6% this year

The fiscal response by US officials has been relatively slow. However, Congress and the White House finally agreed a $2tn spending package on 25 March, amounting to 10% of GDP. Half of that package consists of permanent fiscal transfers to the private sector. The package consists of a $1,200 cash payment to individuals, grants to small businesses, maintaining their payroll, and a temporary increase in unemployment insurance payment to cover 100% of lost wages for four months.

Even with the aforementioned measures, we now expect the US economy to contract by 0.6% this year, including a 7% reduction in the second quarter.

UK tries to limit the downside

The UK’s growth prospects will also be determined by its ability to contain Covid-19, the success of fiscal and monetary stimuli and negotiations on a Brexit trade deal. The Bank of England has cut rates to 0.1% (below the level of the 2008 financial crisis) and increased its asset purchases. The central bank introduced a term funding scheme that supports lending for small and medium-sized businesses and lessened the counter cyclical buffer which reduces the capital that banks have to hold. These measures should make credit cheaper and more available.

In a coordinated approach, the chancellor has outlined a massive £330bn worth of government-backed loans, which equates to 15% of GDP. There are also grants and tax cuts for struggling companies, plus support for airlines, shops and the hospitality industry. While these are broad range of measures, they are unlikely stop the UK economy shrinking this year. We expect the economy to contract by 1.1% in 2020 compared to growth of 1.4% in 2019.

Growth bounce in 2021?

There’s little doubt 2020 will prove to be a miserable year for the global economy, we are now predicting growth of -0.3% compared to 3.2% in 2019. Economists regard growth of less than 2% a global recession.

Mitigation measures are unlikely to eradicate the virus, but will give health systems time to prepare and researchers time to identify effective treatments and develop vaccines. The most effective approach to deal with the disruption of the coronavirus is the global coordination of medical, monetary and fiscal measures.

Inevitably, the outlook for global growth will remain tilted to the downside until the peak of the virus can be determined. The expectations are that this could occur in a few weeks and so we could see early signs of a recovery in the second half of 2020. On this assumption, the outlook for 2021 looks considerably brighter and we predict that the global economy will bounce back with growth of 4.4%.

Implications for financial markets

From a market perspective, the economic impact is certainly one of the main factors that will matter. But markets usually anticipate the economic data. The speed and magnitude of the fall seen in the past month already reflects part of the damage that the global economy is likely to suffer in the next few months.

This fall translated in valuations moving from expensive to attractive. While this is a necessary condition, it is not a sufficient one for markets to bounce back. The swift measures announced by the monetary and fiscal authorities in March should help to soften the blow, but the uncertainty regarding the duration of the crisis remains a drag on markets.

While a lot of conditions are in place for markets to rebound, the key missing factor, at the time of writing, is an inflection in the speed at which the virus is propagating in Europe and the US. As long as this cannot be assessed with more certainty, either through successful containment measures, new drugs or a large-scale testing plan, financial markets are likely to reprice the risks daily based on the latest outbreak numbers.

The key missing factor…is an inflection in the speed at which the virus is propagating in Europe and the US

Continue to focus on quality

As volatility is likely to stay elevated in the medium term, we believe that long-term investors should avoid a passive approach.

While value and “beaten down” sectors or companies will likely outperform in a recovery scenario, we remain convinced that focusing on quality and appropriate diversification is the best strategy to weather potential further sell-off without compromising the large upside which could materialise once fears subside.


Market Perspectives April 2020

Financial market sell-offs, in the face of unprecedented policy measures to fight the effects of the Covid-19 outbreak, suggest any rebound may be a few months away.


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