Global Daily – Recession will be deeper…rebound will take longer

by: Nick Kounis , Aline Schuiling , Bill Diviney , Arjen van Dijkhuizen

Global Macro: We have slashed our forecasts on the back of the coronavirus shock – We have revised down our global economic growth forecasts. This reflects our expectation of a deeper economic contraction in the near term, but also a longer delay before a strong and durable rebound takes shape. Below we set out our GDP forecasts for the main economic zones compared to our old forecasts (see table) and also discuss our macro policy expectations for these economies. We will follow up with changes to our forecasts for other economies as well as for a broad range of asset classes in the coming days.

For the US and eurozone economies we have factored in more wide spread and severe sudden stops in economic activity due to lockdowns and shop and school closures. These lead to breathtakingly sharp contractions in economic activity over the next two quarters. Although hopefully these stops will eventually be followed by re-starts, which should lead to a short-term bounce in GDP, this is only part of the story.

There are four dynamics in play, which will have longer effects on economic activity. Financial conditions have tightened dramatically. The sharp falls in output will be followed by rising unemployment. There will be financial stress for companies. Finally, supply-side disruptions will take longer to normalise. Although macro policymakers will do their best to reverse and restrain these forces, we doubt that they will be completely successful. As such, the bounce in GDP in Q3 will be followed by a period of more subdued growth as economies continue to work their way through these negative dynamics. The eurozone in particular could experience a double dip recession at around the turn of the year. We expect sustained above-trend growth to eventually materialise during the course of next year.

1. Below we set our main assumptions and considerations in more detail. We expect measures that severely restrict economic activity – whether lockdowns or shop closures – to last one month across most of the eurozone (second half of March to first half of April). In the US, we expect the major east and west coast states (the ‘hotspots’ of coronavirus infections so far) to eventually go into lockdown, starting from the last week of March and ending in late April. These states represent around 25% of US GDP. For the remainder of the US, we expect moderate social distancing policies to prevail.

2. We assume that non-essential consumption excluding e-commerce has a share of 30% in total consumption. This part of consumption will drop by around 90% in lock-down periods.  In areas where there are no lockdowns and shop closures, we expect moderate social distancing policies to prevail, meaning some hit to GDP through reduced discretionary consumption, albeit nowhere near as severe as in lockdown areas.

3. Consumption will rebound after the full lockdown. This is mid-April in Europe and early May in the US. However it will not rebound to 100% of ‘normal’ levels, because unemployment will rise and financial conditions have tightened dramatically. Therefore, consumption bounces back to 90% of the ‘normal’ level.

4. After a sharp Q3 bounce, economic growth will be more subdued in the months thereafter. Supply side disruptions will last longer and the drag from corporate retrenchment – impacting labour markets and capital spending – will remain in place. Fixed investment in the eurozone, for instance, is expected to contract in every quarter of this year. Macro policy will for sure make these effects less negative than they would have been otherwise. However, it would be naive to assume that macro policy will be implemented in such a perfect and timely fashion to eradicate these drags entirely. For instance, monetary policy easing has failed to reverse the tightening of financial conditions so far, while discretionary fiscal stimulus will take time to put in place. Meanwhile, schemes to sustain liquidity to companies have been flagged, but the details are still being worked out (see number 6 below for more on the policy response).

5. Our initial revisions on the back of coronavirus shock was centred on China with spill over effects to other economies. Now the reverse is true. We are factoring in the hit to the eurozone and the US with spill over effects to China. While our assumption that the Chinese economy would normalise in the course of March still generally holds (following the major disruptions in early 2020), we have downgraded our Q1 forecast on the back of the macro data published for January-February. We now expect a negative annual growth rate in Q1, followed by a sharp recovery in Q2 extending into Q3. However, the profile of growth has been lowered to reflect the impact of weaker global growth.

6. The macro policy response we have seen and expect going forward is a combination of government measures and central bank measures. As far as government measures go, these can be split into three areas. First, allowing automatic fiscal stabilisers to work fully. Second discretionary fiscal stimulus. Third, measures aimed at sustaining liquidity provision to companies. We assume initially 1.2% GDP of discretionary fiscal stimulus in the eurozone, and around 2.5% GDP in the US, though more may follow at a later point. Although much larger numbers have been announced by governments, these are referring to bank loan guarantees. An example is the up to EUR 300bn scheme signalled by the French government. Although vital, this does not count as discretionary fiscal stimulus.

The Chinese authorities have also been very focused on targeted measures. The government has announced special tax breaks as well as targeted state support for sectors most hit by the corona crisis, such as the airline industry.  Meanwhile, macroprudential regulation is also being relaxed, as financial sector supervisors have for instance allowed banks to delay the recognition of bad loans extended to SMEs suffering from the corona crisis. On the fiscal front, China’s authorities have already frontloaded and raised the local government bond quota for the issuance of special bonds to finance infrastructure projects.

7. As far as monetary policy goes, we think the Fed is now done in terms of the immediate future. On the other hand, the ECB does have more work to do in the near term. We think that at the April Governing Council meeting, it will increase the envelope of net asset purchases for this year by another EUR 240 bn and cut the deposit rate by 10bp to -0.6%. We also expect it to reduce the TLTRO rate to 40bp below the deposit rate and increase the maturity of the programme by a year. Further down the line (probably in September), we expect it to raise the size of net asset purchases for next year. All other things being equal, monthly purchases would fall back to EUR 20bn, though we think it will raise this amount to EUR 40bn. Given the demand shock the eurozone is facing, which means inflation will fall from already low levels, the ECB’s stimulus earlier this month was simply not enough.

8. We expect global economic growth to durably move above trend during the course of  2021. The second round effects from the coronavirus shock should fade, while macro stimulus should kick in more strongly. (Nick Kounis, Aline Schuiling, Bill Diviney and Arjen van Dijkhuizen)