Covid-19: Beyond the horizon

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In times of crisis, it’s easy to get caught up in the short-term. In this Q&A, BNY Mellon Investment Management chief economist Shamik Dhar takes stock of recent weeks and looks for a route out of the current maelstrom.

What have the last few weeks been like for equity investors?

It’s been surreal. If you think about stock markets, we were in the depths of a bear market only a few weeks back. At that point we’d seen a massive and extremely concentrated sell-off. But since then, since 23rd of March, we’ve seen stocks rally both in the US and worldwide. Meanwhile, the oil price has taken its own journey – plunging to unprecedented lows.

That points to just how much volatility there’s been. Since the start of March, the average daily change in the S&P 500 has been almost 5% – a situation we haven’t seen since the days of the global financial crisis.

How have bond markets fared?

After an early wobble, fixed income has stabilized – that goes for both government bonds and credit markets to some degree. That’s in large part thanks to the actions of global central banks, particularly the US Federal Reserve.

It’s important to realize what those central banks did and why they did it. A month ago, the market was in full-blown panic mode. Essentially, people were selling assets indiscriminately in a dash for cash. The Fed and the other central banks saw this and said: “Look, we’ll supply as many dollars and as much cash as you like through various different mechanisms, of which QE is just one.” That was the first stage of the stabilisation process – and it’s one of the main reasons we avoided a complete meltdown.

But governments have also stepped up to the plate. What’s your take on their response?

Broadly speaking, I’d say governments around the world have done the right thing. They’ve thrown the kitchen sink at this – and understandably so. Economies around the world have come to a juddering halt, which is more or less unprecedented – at least in our lifetimes.

Just to put this in context, most economists are talking about the US economy suffering a 10% or a US$2 trillion loss because of Covid-19 and the associated lockdown. But the support package approved by Congress and the president comes in at US$2.2 trillion – so essentially we’re seeing that hit to output being more than compensated for. Other countries have followed suit with their own help packages.

Of course, there are all sorts of issues about how that support gets to the people that need it, whether the timing is optimal and so on – but my initial judgment is that both governments and central banks have done pretty much the right thing. That’s not to say they won’t have to do more if things get worse, but they have made a good start.

Where do we go from here?

A lot depends on the course of the disease. That’s a huge unknown, of course. We could see a secondary wave of infections if restrictions are eased too early, for instance, or, on the flipside, we could make progress on finding ways to fight or suppress the disease.

One scenario we’ve looked at is a V-shaped recovery: that is, a sharp fall and an equally sharp bounce back, maybe towards the end of this year. For that to happen, though, we’d need to really get on top of the transmission of the virus in hotspots such as Spain, the UK, Italy and the US. Crucially, we’d also have to avoid a second wave of infection after any lockdown measures were relaxed.

Meet those conditions and I don’t think it’s unrealistic to say the economy could bounce back quite strongly given the amount of stimulus in the system, perhaps by the fourth quarter.

What other less optimistic scenarios have you been modelling?

A U-shaped recovery is self-explanatory. It means a recovery, but maybe not until mid-2021. Here, we’d see affected countries fail to get on top of the disease quite so quickly and a secondary wave of infections.

The U-shape also becomes more likely if we experience another bout of financial market turmoil or volatility, which is by no means impossible. If that were to happen, credit conditions could tighten again – at which point you might see some of that stimulus effect being offset or reduced.

One final scenario we’ve looked at is the L-shaped recovery, which is less optimistic. Here, you’d get a short downturn followed by a pick-up – but not back to where you’d have been if the disease hadn’t happened.

That’s the kind of scenario we think we’d see if shutdown continues for significantly longer than current timelines allow – perhaps on through to the end of Q3. If that were the case, you’d expect a wave of bankruptcies, leading to spikes of unemployment above and beyond anything we’ve already seen. In this scenario we move beyond a temporary demand-side impairment to a situation where the economy is unable to supply the goods and services that we all need, with longer lasting and more severe consequences.

How will a post-Covid-19 world differ from the world we know?

No question the world has changed. I suspect this event has caused us all to sit back and reassess to some degree. Globalisation – or rather its decline – is just one area that’s in the spotlight. Ahead of Covid-19 we were already seeing pressure to shorten and re-domesticate global supply chains and the just-in-time manufacturing model – and I think the virus might accelerate that.

Geopolitics is another area under scrutiny. We’ve already had the emergence of a more fractious relationship between the two largest economies in the world, the US and China. I think it’s hard to see how this does anything other than exacerbate that.

Meanwhile, alongside Covid-19 we’ve had extraordinary changes in the oil market, with lots of volatility in oil prices. I think that’s another area to keep an eye on: the relationship between the US, the Middle East, Russia, and China. All of that, I think, is up for grabs in the longer term as well.

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