Global economies: What we see ahead
09 April 2020 | Markets and Economy
The COVID-19 pandemic has knocked the global economy sideways. A year in which we expected global growth to slow amid trade tensions and other policy uncertainty has suddenly provided an additional development: the global economy is most likely already in recession, and we expect negative growth for the year.
Fast-moving events involving the coronavirus, as well as the immense unpredictability about the duration of the world's containment measures, require a flexible framework for assessing the effects of the outbreak on the global economy. The Vanguard Investment Strategy Group's (ISG's) global economics team has considered three potential scenarios, and sees the most optimistic one as the most likely. We expect that the worst of the economic disruptions will have passed by the end of the second quarter, allowing global economies to start to recover in the second half of 2020.
This article presents Vanguard's view, as of 6 April 2020, based on such a scenario. It looks at global economies in the context of their pre-coronavirus status and how they may be positioned to withstand the pandemic. Our view would become more pessimistic if strict containment measures were required beyond the second quarter.
Several global themes emerge from the views of the global economics team:
- Monetary policy responses have largely helped keep markets functioning.
- Fiscal policy responses are a matter of stabilisation—keeping businesses and individuals afloat—rather than stimulus.
- The strength of eventual recovery will depend in large part on the duration of required containment measures, the depth and breadth of unemployment and the extent to which consumers overcome lingering fears of resuming normal activities.
- It will be crucial to avert a second wave of infection and renewed containment efforts that could carry on long beyond the second quarter.
- Without knowing more about the progression of the virus and containment efforts, it's impossible to conjecture whether equity markets have hit bottom.
- The world is in recession, but strong recovery remains possible if stringent lockdown measures can be lifted in the second quarter.
We know that this period is deeply concerning for reasons of both health and welfare, and that a lack of definitive answers is frustrating. We caution investors—now more than ever—that such a period of great uncertainty is not a time to change a well-considered investment plan created with specific goals in mind.
China: The original epicentre and a bellwether for recovery
The world, with some parts still only approaching the expected peak of infection, is looking to China for a sense of what may lie ahead, including numbers of infections and deaths and what recovery looks like. Just over two months after the first lockdowns in several Chinese cities, business has resumed in the country, with estimates of activity as high as 90% of pre-coronavirus levels. Although China hasn't stamped out new infections, the rate appears to have slowed dramatically, with the government reporting that most of the few new cases it has identified have been in people who have travelled outside China.
The United States, Spain, Italy, Germany and France all have surpassed China in infections, according to the widely cited Johns Hopkins University & Medicine Coronavirus Resource Center.
Flattening the curve of new infections
Sources: Vanguard calculations, based on data as at 2 April 2020, from the Johns Hopkins University & Medicine Coronavirus Resource Center, sourced from Bloomberg.
Among the biggest questions for China's economy is how long it takes for face-to-face businesses to recover. Although the government can strongly influence manufacturing, electricity generation, commodity production and state-owned enterprises, it has less sway over the private, small to medium-size enterprises that are typical of face-to-face businesses.
“The government can only do so much to boost consumer sentiment in such a fear-driven environment,” said Adam Schickling, ISG economist. “They can encourage non-essential consumption with stimulus, but until people feel safe leaving their house and returning to more populated activities, those sectors of the economy will continue to be hit. So we're watching China because it will provide insight into how fast people in other parts of the world will resume going to restaurants, movies and shopping malls.”
China's economy will still face challenges even after its economic activity resumes, given slowdowns in countries that are less far along in the progression of the virus and containment efforts. Vanguard thus expects China's growth for 2020 to be the lowest in the four decades since it opened its markets.
Italy: The second epicentre
Even as the world is beginning to look to China to learn about recovery from the virus, it's looking to Italy and elsewhere in Europe for clues about the effectiveness of containment. A cluster of cases was identified in the northern Lombardy region in late February, and strict containment measures quickly followed. “Broadly speaking, we're now at a point where most of the large countries in Europe—Italy, France, Spain as well as the United Kingdom—all have quite strict containment measures in place,” said Shaan Raithatha, ISG economist.
Germany has taken a softer stance, with less stringent containment measures, yet it has fewer confirmed cases and significantly fewer deaths than Italy and Spain. “Germany has also been able to test at a much larger scale than most other countries in Europe,” Mr Raithatha said. “They've been able to test health workers very quickly for current illness and also test to see if they've had it already and are able to come back to work.”
Italy and Spain, hit hard in both infections and deaths, have imposed some of the strongest containment measures, according to the Oxford COVID-19 Government Response Tracker. They're also beginning to see the infection curve flatten, a sign that new cases may have peaked.
“Each day the number of new cases, while growing, is not growing exponentially,” said Alexis Gray, senior economist. “In countries in Europe that have been in lockdown for several weeks, it's evident that those measures are starting to pay off and that we're just starting to turn the corner.”
European response: Stabilisation, not stimulus
Italy's economy was struggling before the coronavirus outbreak, as its GDP contracted in the fourth quarter of 2019. Its manufacturing sector, like Germany's, took a hit from the global trade uncertainty that Vanguard's 2020 economic outlook highlighted as weighing on economies globally. The United Kingdom, where infection data suggest it may be a week behind Europe in virus transmission, had been looking for a pickup in economic activity in the first quarter, after its official exit from the European Union removed a key source of uncertainty.
The role of fiscal and monetary policy in addressing the challenge, however, is one of stabilisation, not stimulus. Mr Raithatha said: “The response on both the monetary and fiscal side has been very strong and pretty much unprecedented in the scale of asset purchases. The welfare package in terms of providing guarantees on income and loans to companies has also been pretty big.
“The problem is, this is only partly a demand shock,” he said. “It's probably more akin to a natural disaster than anything else, so there's a limit to how effective both monetary and fiscal policy can be, at least in the very short term.”
United States: Looking to weather a coming storm
The US Federal Reserve has cut its benchmark interest rate target to near zero, made large-scale asset purchases and taken other measures to calm bond markets that faced liquidity challenges. Spreads on mortgage-backed securities and corporate bonds have narrowed, reflecting improved sentiment since the Fed action and lowering transaction costs. The federal government has announced more than $2 trillion worth of fiscal measures.
But the United States most likely hasn't reached the peak of infections and has lagged many other countries in the stringency of containment efforts. Concerns about growing US debt need to be tempered by acceptance that the country faces a health care emergency and that “we need to get to the other side with a recognisable economy,” said Andrew Patterson, senior economist.
Notes: Each country's composite measure has been calculated by attributing a score to seven indicators measured on an ordinal scale, rescaled to vary from 0 to 100. Data as of March 31, 2020.
Source: Hale, Thomas, and Samuel Webster, 2020, Oxford COVID-19 Government Response Tracker.
US GDP could contract at a significantly greater degree in the second quarter than it did at the worst point of the global financial crisis, Mr Patterson said, with the extent and timing of recovery dependent on when containment efforts can be rolled back. Even then, it will take time for activity to return to normal as consumers come to terms with their fears.
“Containment measures to date are putting nearly three-quarters of activity in arts, entertainment and hospitality out of commission,” Mr Patterson said. “It will be crucial to that sector for people to come back quickly.”
Yet absent a vaccine or a discovery that an existing medicine can combat the virus, the strict containment efforts are necessary. Fiscal policy providing small-business loans and expanded unemployment insurance is essential. “Money needs to get to small businesses and unemployed individuals as soon as possible so they can weather the storm,” Mr Patterson said
Japan: A new challenge for a struggling economy
With its tourism from China, population density and elderly population, Japan might have seemed susceptible to the worst of COVID-19. Individual rights afforded by Japan's Constitution limit the severity of government action; the government can't legally constrain people from going outside by imposing punishments and a wider array of businesses continue to operate than in the euro area or the United States. So the modest case numbers, fewer than 4,000, are an encouraging albeit surprising development. A spike in recent days, however, suggests that Japan may not yet have seen the worst of the outbreak. (On 7 April, Japan declared a month-long state of emergency in its largest population centres.)
Japan's economy, meanwhile, was struggling even before the outbreak. GDP fell at an annualised rate of 7.6% in the fourth quarter of 2019, with the imposition of a value-added tax straining an economy already late in the business cycle and with monetary policy stretched seemingly to its limits. Although Vanguard had foreseen recession in 2020 as a risk for Japan, it wasn't our base case. Now we see an economic contraction for the year as inevitable.
An economy that, according to the World Bank, derives nearly 7% of its GDP from travel and tourism, much of it from China and South Korea, saw tourism decline 80% in the first quarter. Consumption has faltered, hurting the retail sector in a country where bricks-and-mortar sales still predominate. Slowing global demand for automobiles, machinery and other durable goods is likely to hit Japan's manufacturing sector.
Postponement of the Tokyo Olympics until 2021, however, isn't a significant blow to Japan as the bulk of economic activity from such an event is front-loaded as a country engages in related infrastructure projects.
Emerging markets: Hard times are likely
Emerging markets may have it harder than any others. The worst of the pandemic may be yet to come in Asia's emerging markets, which have densely populated cities and fewer resources than developed markets to protect inhabitants. Without the pandemic, we would have foreseen 2020 GDP growth of 5% to 5.5% for India and Indonesia and 4% to 4.5% for Malaysia, Thailand and the Philippines. Although that potential may be gone, Asia's emerging markets are likely to fare better than other regions.
Countries in central and eastern Europe would follow Asia in their ability to protect themselves. Latin America presents a mixed bag, with Chile and Peru ahead of others in their readiness, while Africa may be least able to protect itself. “So many of the investable emerging markets want to do the right thing to protect their citizens and shore up their economies,” said Jonathan Lemco, senior investment strategist, “but there are limits to their financial ability to do that”. The International Monetary Fund pledged on 3 April to make $1 trillion in emergency financing available to emerging markets.
For many emerging markets, the biggest economic challenges will come from reduced commodity prices, as many of these countries are commodities exporters, and from reductions to their role in global supply chains as trade slows amid containment efforts.
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