- Viral resurgences further set back incipient recoveries
- Balance sheet distress intensifies, not least in the EMs
- Fiscal policy support is withdrawn too soon
- Real activity takes several years to return to recent highs
- Near-zero inflation becomes embedded in the euro area
- A ‘no-deal’ Brexit greatly adds to the UK’s economic woes
OECD: the recovery process faces tough challenges
- OECD real GDP fell an unprecedented 9.8% q-o-q in Q1 (-10.9% y-o-y), after registering a 1.8% decline in Q1.
- The pace of the initial recovery from the pandemic-related shutdown of March-May if anything exceeded expectations.
- However, suppression of the virus was partial, and flare-ups and voluntary social distancing continue to restrain activity.
- Business surveys have rebounded more strongly than consumer confidence, and credit conditions have tightened.
- The future trajectory of output will reflect the evolution of the virus; the policy response; confidence; and hysteresis.
- Continued large-scale fiscal and monetary largesse is likely to prove essential to underpin the expansion.
- That said, real activity is unlikely to re-attain its pre-crisis (Q4 2019) level for at least several years.
- Post-crisis patterns of demand stand to be quite different, with large effects on future resource and asset allocation.
- CPI inflation has recovered somewhat from its 0.7% May nadir but remained at an uncomfortably low 1.2% in July.
- With central banks in ‘whatever it takes mode’ and bond yields historically very low, risk assets have rallied strongly.
US: the Fed shifts focus as the political environment sours
- 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 lockdown easing led to a sharp bounce in May and June that has subsequently lost some momentum.
- Enduring viral hotspots, tighter lending conditions, and high unemployment point to an uneven pace of recovery in H2.
- The jobless rate peaked at 14.7% and remains historically high at 10.2%. Moreover, the fall in initial claims has stalled.
- PCE inflation has begun to rebound from its lows, but remains well below target at 1.0% headline, and 1.3% core.
- The Fed has embraced so far uncodified average inflation targeting, elevating the importance of price expectations.
- Real Treasury yields have been negative for most of the year, and now corporate real yields have followed suit.
- Ahead of the Presidential election, the polarised and toxic political environment is redolent of 1968, if not 1860.
Bottom line: an uncertain recovery path sustained by a dovish Fed but complicated by an ugly political and social backdrop.
Watch for: regional dips; social unrest; election chaos; equity falls; more dollar weakness and protection; a yield-curve target.
Euro area: the ECB grapples with the spectre of deflation
- Real GDP fell 12.1% q-o-q in Q2, after a 3.6% dip in Q1, with particularly marked declines in France and Italy.
- A sharp overall rebound is in prospect for Q3, although, as with the downturn, the pace of recovery is far from uniform.
- COVID resurgences in some economies have halted or reversed re-opening plans, and set back spending.
- Headline CPI inflation slumped to -0.2% y-o-y in August, with the core rate marginally positive at a record low 0.4%.
- Near zero inflation and tighter credit conditions could result in the ECB extending the envelope and duration of its APP.
- The EU’s Next Generation Recovery Plan is impressive, focussing on the investment shortfall and levelling up.
Bottom line: a traumatic recession and inflation-undershoot requiring an increasingly dramatic macro policy response.
Watch for: enduring near-zero inflation; 10%+ joblessness; more QE and more negative policy rates; US trade tensions.
UK: a robust rebound but a worrisome yearend beckons
- UK real GDP fell by 20.4 % in Q2, after a 2.2% decline in Q1. This is by some margin the worst contraction on record.
- Warm weather, domestic tourism spending, and broadbased policy support all point to a robust rebound in Q3.
- This may not endure beyond the summer however, as policy initiatives are wound back, and viral resurgence beckons.
- High levels of unemployment and underemployment, much of it structural, are also likely to weigh on the recovery.
- The outlook is further clouded by a rising risk of a no-deal Brexit, and renewed calls for Scottish independence.
- Headline CPI inflation has temporarily rebounded from its lows to 1%, but is likely to slump again in the months ahead.
- 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.
Asia and Emerging markets: climbing out of a cavernous hole
- The resignation of Shinzo Abe on grounds of ill-health is unlikely to spark a dramatic policy re-orientation in Japan.
- COVID aside, EMs have been hit by softer external demand and commodity prices, plus weak tourism and remittances.
- India had been slowing down for four years, before a harsh lockdown resulted in a dramatic 23.9% contraction in Q2.
- The US currency’s recent weakness has not extended to the EMs, where high dollar debt is a source of vulnerability.
- Much increased poverty and inequality, and a cascade of defaults, are likely. More debt relief is sorely needed.
- On a brighter note, China’s recovery broadened out in Q3, as domestic tourism spending boosted the service sector.
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.
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