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- The recovery process proves beholden to course of the virus
- Policy support is insufficient and withdrawn too soon
- Underlying growth potential is further significantly reduced
- Balance sheet weaknesses spark a cascade of EM defaults
- A ‘no-deal’ Brexit leaves the UK ‘the sick man’ of the OECD
- A chaotic US Presidential election roils risk asset markets
OECD: an initially sharp recovery has moderated somewhat
Responding to the COVID-19 pandemic, policymakers put the world economy into the equivalent of an induced coma.
- OECD real GDP fell 1.8% q-o-q in Q1, the deepest contraction in output since the depths of the financial crisis.
- The drop in Q2 was less severe than initially feared, but could exceed 10%, prompting a similar slump in world trade.
- The easing of lockdowns sparked an initially sharp rebound, but it has flattened off as the virus has flared up again.
- The future trajectory of output will reflect the evolution of the virus; the policy response; confidence; and hysteresis.
- However, real activity is unlikely to re-attain its pre-crisis (2019) level for at least several years.
- The post-crisis pattern of demand could be very different, with large implications for future resource allocation.
- CPI inflation was 1.1% in June, down from 2.4% in January, and is headed towards zero or below in the months ahead.
- A suite of fiscal support measures, equivalent to some 20% of advanced-economy GDP, has been put in place.
- Central banks have continued to innovate, applying, inter alia, extra asset purchases equivalent to 5% of global GDP.
- Risk premia have collapsed in the face of extraordinary policy largesse, but bond yields remain historically very low.
US: ending the lockdown early has had its economic costs
- The US economy contracted by 1.3% in Q1, and by a further 9.5% in Q2, largely because of a collapse in activity in April.
- A relatively early easing of the lockdown led to a sharp bounce in May and June that lost some momentum in July.
- The emergence of new viral hotspots and the reaction to them point to an uneven pattern of recovery during H2.
- The jobless rate peaked at 14.7% and is now 11.1%. But viral flare-ups portend a choppy pattern of decline from here.
- Consumer price inflation has dropped off sharply since Q1. Both headline and core annual PCE inflation are below 1%.
- Fed assets are now some $7trn (⅓ of GDP). Outlook-based forward guidance is more likely than yield curve control.
- Congress is deadlocked over the nature of an extension of fiscal support that so far accounts for some 15% of GDP.
Bottom line: the evolution of the pandemic will shape the recovery process ahead of the Presidential election.
Watch for: regional setbacks; social unrest; a relapse in risk assets; more protection; yield-curve targeting; election chaos.
Euro area: an increasingly robust policy response
- Real GDP fell 3.6% q-o-q in Q1, with particularly marked falls in France and Italy, which locked down early.
- A deeper q-o-q decline of 12.1% occurred in Q2, although a strong, if uneven, recovery ensued in May and June.
- Job and income losses plus elevated uncertainty continue to weigh on consumer spending and business investment.
- Headline CPI inflation was 0.4% y-o-y in July. The core rate rebounded to 1.2%. The 2% target is several years away.
- The ECB is content for now with the increased envelope and extended the time horizon of the APP announced in June.
- However, a marked tightening of bank credit standards for corporates in Q3 suggests the risk remains of further easing.
- The EU’s Next Generation Recovery Plan is impressive, focussing on the investment shortfall and levelling up.
Bottom line: a traumatic recession, but one that has over time resulted in an impressive policy response on a number of levels.
Watch for: sub-zero inflation; 10%+ unemployment; a 12% of GDP budget gap; further monetary easing; US trade tensions.
UK: Brexit looms as the economy picks up
- UK real GDP fell by around 25% in the first four months of the year – unsurprisingly, the sharpest decline on record.
- Perhaps half of the UK workforce has been unemployed or underemployed. Again, this is unprecedented.
- Recovery has so far exceeded expectations, and many forward-looking elements of surveys remain encouraging.
- But the outlook is clouded by the potential for new virus flare-ups, more job losses, supply-side damage, and Brexit.
- Headline CPI inflation is well below target at 0.6%, and could approach zero over the months ahead before reversing.
- The extra £100bn of QE will push BOE assets up to 45% of GDP, while total fiscal support equals some 20% of GDP.
Bottom line: an unprecedented downturn and substantial risks to the recovery as Britain prepares to face another major shock.
Watch for: pandemic resurgence; a flood of business failures and redundancies; monetary finance; a ‘no-deal’ Brexit.
Emerging markets: China leads the way, but others trail
- China is leading the global recovery, expanding by 3.2% y-oy in Q2 – a case of first into recession, first out.
- COVID aside, EMs have been hit by soft external demand and commodity prices, plus weak tourism and remittances.
- High (often dollar-denominated) indebtedness enduring source of vulnerability for many EMs.
- Portfolio flows have recovered, but EMs as a whole may contract by 3% this year, with a near 10% decline in LATAM.
- Macro policies have been relaxed everywhere, with LSAPs activated for the first time across a range of EM economies.
- Much increased poverty and inequality, and a cascade of defaults, are likely. More debt relief is sorely needed.
Bottom line: deep recessions, if not more acute economic, social, and political crises, extending to some of the larger EMs.
Watch for: social unrest; humanitarian crises; IMF packages; defaults; SDR issuance; monetary finance; GDP-linked bonds.
Charts of the month
Amamiya. M., 2020. Japan’s economy and monetary policy. 29 July. Bank of Japan.
Bailey. A., 2020. LIBOR: entering the endgame. 13 July. Bank of England.
Brainard, L., 2020. Navigating monetary policy through the fog of COVID. 14 July. Federal Reserve Board.
Davies. G., 2020. The anatomy of a very brief bear market. . Financial Times. 3 August.
Jenkins. R., 1998. The Chancellors. Macmillan.
Legrain. P., 2020. Europe rescues itself. 22 July. Project Syndicate.
Lowe. P., 2020. COVID-19, the labour market, and the public sector balance sheet. 21 July. Reserve Bank of Australia.
Office for budget responsibility., 2020. Fiscal sustainability report. 14 July.
Policy Reform Group., 2020. Improving provision of healthcare and social services. July.
Stiglitz. J., 2012. The price of inequality. Allen Lane.
Zhang. E., 2020. Coronavirus crisis may accelerate Japan’s structural reform. 22 July. Peterson Institute.