After lockdown: Should we expect an economic surge?

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On both the health and economic fronts, the war on Covid-19 is far from over. But there might be grounds for optimism, argues BNY Mellon Investment Management chief economist Shamik Dhar.

There’s both good and bad news. In many countries it looks like we might have passed the peak of the pandemic. That’s the good news. But then there’s the cumulative hit to the economy and we still can’t be sure how much harm has been done.

Shamik Dhar, chief economist, BNY Mellon Investment Management, is surveying the damage wrought by Covid-19 on the world’s economy. His estimates are for a median H1 hit of around 10-15% to GDP globally – an extraordinary figure given that the Global Financial Crisis (GFC) of 2008-9 resulted in ‘only’ a 6% annualised decline in GDP in the US.

The GFC’s still fresh in most people’s minds but, really, it pales into insignificance when compared with what we’ve been through this year,” he says. “You’d need to go back to the end of the First World War to find anything equivalent in economic terms.

Cumulative hit to economic activity in Q1 & Q2
Cumalative hit to economic activity in Q1 & Q2

Source: Fathom Consulting. Monthly data as of August 2019.

Extraordinary times call for extraordinary measures and Dhar highlights how, in response to the crisis, policymakers the world over have stepped up to the crease. “There’s been a huge amount of stimulus,” he says. “We’re looking at around 12% of global GDP split between traditional forms of fiscal intervention and non-traditional forms such as loan guarantees and income support for individuals. It demonstrates how seriously governments across the world took the crisis and how quick they were to respond. And this unorthodox approach was necessary since traditional government spending has no way of filtering through to people during lockdown.

The stimulus package

*US, China, Japan, UK, Germany, France, Italy, Switzerland, Australia, Canada, Brazil, Russia, India, Korea, Indonesia, Mexico, Poland, Turkey. 2019 GDP. Fiscal guarantees refers to maximum amounts announced by governments. Quasi-fiscal measures include lending and support packages to be financed by various public sector institutions and agencies such as national development banks, and which are not guaranteed by or part of the government. Source: Fitch Ratings, IMF, and Strategas.

When it comes to monetary policy, the picture – of extraordinary times calling for extraordinary measures – is the same. For the world’s major economies, the interest rate tool may have run out of headroom but central banks have taken to quantitative easing with gusto. Estimates for this latest round of QE come in at c.8% of global GDP. The US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England between them have committed to around $6.5 trillion of additional QE.

A V-shaped recovery?

Looking forward to how the world economy might perform in coming months, Dhar assigns a reasonable probability to a V-shaped recovery – that is, a fairly swift return to pre-crisis GDP growth trends with no permanent scarring of economic capacity.

Partly this is down to the amount of pent-up demand sitting on the side-lines during lockdown. This, he says, equates to significant “dry powder” which, when combined with the unprecedented levels of fiscal and monetary stimulus in the system, should spark a robust rebound in economic activity once quarantine measures ease off. “Household leverage is better than it’s been for years, while the level of stimulus is extraordinary,” he says. “Obviously, we can’t discount the current high levels of unemployment but it does argue for a swift pick-up in spending if we can get out of lockdown.

There is a historical basis for this optimism as well, says Dhar – and he points to data from research firm Fathom Consulting which suggest the vast number of recessions between 1870 and 2016 took the form of a sharp downturn followed by a swift rebound.

Recession Shapes, 1870 to 2016

Speed of exit: the percentage increase in GDP from the trough to its level when it first exceeds the previous peak, divided by the number of years it takes to get there. *This analysis is based on the Jorda-Schularick-Taylor macro history database which uses 30+ macro and financial market variables for 17 advanced economies over the period 1870-2016. Source: Fathom Consulting.

Clearly, however, we are in unchartered waters, and Dhar is keen to stress that the course we take from here depends on the virus – first, whether societies have been successful in curbing its transmission through lockdown and, further ahead, whether treatments or a vaccine become available.

But here too, Dhar says there’s cause for hope. Additional research from Fathom Consulting suggests the R number – the infection rate of the virus – has fallen further and faster than lockdown alone would suggest. This could perhaps be down to seasonal factors – but other as yet identified factors could also be at play. Either way, says Dhar, it points to a less pessimistic scenario than some might expect.

Estimated Rt
Estimated RT

Data as of May 31, 2020. Rt: number of Covid-19 cases transmitted per infected person. Teal line: time trend capturing the impact of unidentified factors, other than social distancing, on lowering Rt. Please bear in mind that the increasing divergence between the teal and gold lines is a construct of the model and does not suggest a growing impact of unidentified factors. Source: Fathom Consulting and Google.

Of course, there’s still an enormous amount of uncertainty out there,” he says. “Anything could happen in the next few months and that could determine whether we experience something more akin to a W-shaped recovery or, worst-case scenario, a more enduring downturn that has longer lasting repercussions. That means the V-shaped scenario is far from the only game in town – yet I remain optimistic. For now, I believe it’s one of the more likely outcomes.

Click here to download the latest version of Vantage Point, BNY Mellon Investment Management’s quarterly overview of markets and macroeconomics.

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