Economic Facts – 24th March 2020


General: Put simply, a supply shock means that manufacturers don’t have the parts to produce final goods, which results in stores no longer having goods to put on their shelves. The best example of a recent supply shock was the oil-supply shocks of the 1970s. Production bottlenecks, shortages of heating oil and gasoline, long lines at the gas station and rising prices followed in their wake. As the flow diagram above illustrates, the coronavirus outbreak is an exogenous shock that — because of the need to engage in self-distancing and remote working — is causing the current supply shock.


Interest rates

General: In developed markets, policy rates are now close to what central banks see as their effective lower bound. As a result, we expect only small moves in interest rates in DMs between now and the end of the year –only Canada has still scope for major rate cuts.

General: With rates sitting at zero, it’s not impossible for the Fed and other central banks to begin toying more seriously with the idea of negative rates. Such a move would be bold, but also seen as highly experimental and risky with unforeseen consequences.

General: As the turmoil in financial markets has deepened, significant strains have emerged in money markets. The spread between US dollar Libor and the 3-month Treasury Bill yield has jumped.



What’s next

General: In practice, helicopter money is likely to be an incremental process. Should central banks’ move to helicopter drops become broad based, this could trigger the ultimate reflation trade which will be positive for risk assets in the first instance. Developed equities could rally hard, possibly creating new bubbles, while inflation-linked assets, real assets and commodities – particularly gold – would be likely prospers well. It would be likely to be very bearish for nominal bonds. The world would become even more volatile and unpredictable.



General: Investors usually buy bonds for two reasons: income and safety. Treasury bonds, whose yields have been declining for around four decades don’t provide much income anymore, but at least they used to provide safety. (Not anymore) The rise in Treasury yields, which move in opposite direction of prices, makes a strange kind of sense. Investors have been loading up on longer-term Treasuries during a flight to safety, and now many of them are being forced to sell what they can to raise cash.



General: We remain of the view that equity prices are only likely to find a floor once evidence emerges that the measures to contain the virus are proving successful. That is what happened in China, where equities had started to recover after their sharp falls in January, before the virus spread rapidly elsewhere.

General: It’s possible investors would wait for signs the policy was working, and that the daily number of new Covid-19 cases was peaking, before stepping back into the markets. The EU and US may still be weeks away from a turning point. As a result, “until there is a credible policy response, or the daily numbers of new cases peak, investors would be well advised to minimize their exposure to risk assets.”

General: Something strange last week. While Treasury yields spike—the 10 Year yield rose 0.272 percentage point to 0.994%—utilities gained more than 13%, posting their best day since 2008. So why were investors scooping up utilities, even as the 30-year Treasury yield rose the most since 1982? Investors bought up stocks they were buying safe stocks, and it doesn’t come much safer than a utility. They’ll never provide fast profit growth, but regulated utilities have consistent sales, even in bad times. As a result, they can survive pretty much any downturn. And that looks pretty good right about now.


Downturn now set to be deeper than the financial crisis

General: We now expect global GDP to fall by about 1% this year, which would be twice the decline seen in 2009. And while the rebound will hopefully be quicker, downside risks are rising. More worrying risk is that this downturn gathers a momentum of its own. With activity shutting down, there is a growing risk that otherwise solvent companies start to hit the wall, with knock-on effects on unemployment and consumer spending. This could result in anything from a lengthy recession to another financial crisis. Policymakers are pulling out all the stops to try to stop this from happening. But central banks now have very little ammunition left, meaning that the onus falls firmly on fiscal policy to prop up demand.




How to think about the long-term effects of the virus

General: It’s possible to think of three plausible outcomes. The best case is that economies suffer no permanent loss of output and return to their pre-virus path of GDP. The worst case is that economies suffer a permanent loss of output and then settle on a permanently lower path of GDP. In between, it’s possible that economies suffer a permanent loss of output but eventually return to their pre-virus path of GDP. These scenarios are shown in the chart above.

General: A short-lived recession (2 quarters) wouldn’t likely lead to persistent GDP weakness, while a prolonged downturn (3-6 quarters) would put considerable pressure on growth for next 5-10 years.

General: The sectors that tend to perform the best after a recession are health care and consumer staple stocks.


General: Policymakers typically try to stimulate consumer demand during a recession and start recovery as quickly as possible. Right now, the goal is almost the opposite. What they are trying to do is provide some assistance to households so they can sit at home and don’t have to go out and shop.


China as our barometer

China: Only six weeks after the initial outbreak, China appears to be in the early stages of recovery. Congestion delays currently stand at 73% of 2019 levels, up from 62% at the worst part of the epidemic, indicating that the movement of people and goods is resuming. Similarly, coal consumption appears to be recovering from a trough of 43% to currently 75% of 2019 levels, indicating that some production is resuming. And confidence appears to be coming back as seen in real estate transactions, which had fallen to 1% of 2019 levels but have since bounced back to 47%.

China: The OAG data also reveals that there will be about 66,100 flights departing from Chinese airports next week, up from 53,300 this week. The total number of departures dipped as low as 28,700 during the week beginning February 17, at the height of the COVID 19 coronavirus outbreak in China. China: Earlier this month, the Civil Aviation Administration of China announced a series of support measures to encourage airlines to recommence air services. This includes offering subsidies to Chinese and foreign airlines to resume non-stop international services that have been suspended

China: Yesterday the prime minister Scott Morrison announced a second stimulus package of $66 billion to help the economy survive the impacts of the COVID-19 outbreak. The federal parliament could sit for just one day today to pass the government’s stimulus measures as quickly as possible, before members of parliaments reduce meetings for social distancing purposes.

China: The $66 billion stimulus package aims to assist workers, households and businesses and comes on top of $17.6 billion on measures announced 11 days ago.



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