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By Peter Westaway, chief economist and head of investment strategy, Vanguard Europe.


Just because some shops are beginning to reopen and activity is beginning to revive as people slowly venture out again, don't be fooled into thinking that the global Covid-19 pandemic is now largely under control. It isn't – it's just that the epicentre has moved away from Europe to developing countries, not least in Latin America and the Middle East.

Here too, despite the change in mood as the lockdown measures begin to be lifted in Europe, the challenge of how to manage the very real risk of secondary outbreaks also looms large.

Still, having broadly halved their Covid-19 losses, stock markets, led by Wall Street and the US tech sector, appear to be in glass-half-full mode for the time being. So now that we have some hard economic data to work with, it may be useful to draw comparisons between different parts of the world, to remind ourselves of the strong headwinds markets are still pushing against and why it is as important as ever to have a globally diversified portfolio.

The table below summarises our current thinking and the sharp extent to which our expectations have changed since we published the Vanguard Economic and Markets Outlook (VEMO) at the end of last year. It also highlights just how wide we see the range of possibilities between our base-case, worst-case and best-case scenarios due to the high degree of uncertainty that remains as countries seek to beat a retreat out of the Covid-19 crisis and the search for a vaccine continues.  

2020 global growth forecasts

2020 global growth forecasts

Source: Vanguard ISG. As at 27 May 2020.
Notes: VEMO represents Vanguard Economic and Market Outlook. Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

But however different economies end up performing, such is the impact of the Covid-19 pandemic that we're likely to see the global economy shrinking in a calendar year possibly for the first time in recorded history. And in this respect, it's Europe that's leading the way down.

Our forecasts for UK and euro area growth show slightly larger hits to growth compared with North America. We also expect generally higher headline growth in China and Australasia.

Why that should be is largely a reflection of the extent to which virus mitigation measures have been applied more stringently and for longer in Europe, which accounts for almost half of all reported Covid-19 deaths to date.

How confident are we in our projections? Well so far our prognosis is proving to be pretty much in line with the available data.

The preliminary reading of first-quarter GDP, for example, showed the UK economy shrunk by 2%, with a disproportionate hit to services. Now that is obviously pretty bad but nothing like the 15% to 20% peak-to-trough falls that economists like me had been talking about.

Unfortunately, when you dissect the first-quarter numbers and note that UK GDP fell by 6% in March alone, when the lockdown was in force for just 10 days, it's pretty easy to see how GDP might end up a lot lower once we factor in subsequent months.

Where do we go from here? Well one thing worth noting is the degree to which our base-case projections are closer to our expected upside scenarios than our downside forecasts. This is because it's quite hard to improve on our baseline forecast, which already assumes a successful unwinding of lockdowns with any flare-ups in the virus largely contained.

As a result, we expect an initial jump in activity as some industries are brought back online followed by a much slower recovery as the fear factor and the limits of social distancing restrictions continue to limit the rebound.

But with the number of new cases of Covid-19 still high in some countries, notably the UK, and with test and tracing capabilities not yet up and running everywhere, the risk is that the more pessimistic downside scenario could yet play out. This would see further waves of the virus and possibly the reintroduction of lockdown measures.  Fingers and toes crossed that this can be avoided.

Policy responses

Now this huge hit to growth is not happening because policymakers have stood idly by. As well as the huge contributions that central bankers have made by cutting interest rates and conducting quantitative easing to ease financial conditions, governments have also been making huge fiscal policy injections – either directly, by supporting the incomes of the unemployed or providing money to firms, or by providing loans and guarantees to firms and local governments.

And here too there are notable differences between Europe and the rest of the world, as the chart below shows.

Announced fiscal measures (as a % of GDP)

Announced fiscal measures (as a % of GDP)

Source: IMF, Vanguard calculations. Notes: G20 aggregates calculated using PPP-adjusted GDP weights. Estimates focus on government discretionary measures that supplement existing automatic stabilisers, which differ across countries in their breadth and scope. Data as of 13 May 2020.

What's clear from this chart is just how much more generous the US, Australia and Japan have been on the direct fiscal front compared with Europe. In Italy and Germany, especially, but also in the UK and France, loans and guarantees have been the more favoured policy instrument.

It is difficult to say whether one approach is inherently superior to the other. Both measures are designed to provide, in different ways, a bridge of financial support to households and firms to allow the economy to return more quickly to normal when activity resumes. And at $9 trillion (and counting) it is a staggering amount of collective support and is the basis upon which markets have been able to stage a partial Covid-19 recovery.

Altogether, it represents close to 10% of the G20 group of nations' aggregate GDP.

Within that, there has been an important step towards facilitating fiscal transfers within the European Union (EU) after agreement was reached to create a €500 billion fund (subsequently increased to €750 billion) to support member countries hardest-hit during the crisis.

For now, individual countries still have to finance this in proportion to their size within the EU, so this is not yet a true “Coronabond”, where funds are raised at an EU-wide level fund. The details also remain unclear and agreement still needs to be reached from some critical EU members such as the Netherlands.

The news, even so, has given bonds a lift in Italy and Spain, two of the fund's likely beneficiaries. And more generally, it represents an important step towards a strengthening of the EU institutional framework which in the long run ought to be positive for economic prospects in Europe.

Investment risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Past performance is not a reliable indicator of future results.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

Funds investing in fixed interest securities carry the risk of default on repayment and erosion of the capital value of your investment and the level of income may fluctuate. Movements in interest rates are likely to affect the capital value of fixed interest securities. Corporate bonds may provide higher yields but as such may carry greater credit risk increasing the risk of default on repayment and erosion of the capital value of your investment. The level of income may fluctuate and movements in interest rates are likely to affect the capital value of bonds.

Other important information:

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© 2020 Vanguard Asset Management, Limited. All rights reserved.

© 2020 Vanguard Investments Switzerland GmbH. All rights reserved.