Recession deeper still, but worse and better outcome possible

by: Sandra Phlippen

  • The extension and widening of the lockdown in the Eurozone and the US has driven us to make a further downward revision of our baseline expectations for the economy in 2020. We also sketch a negative and a positive scenario, with the former slightly more likely than the latter. All our scenarios, however, are subject to extreme uncertainty. Hence the more detailed look at our assumptions in this monthly.
  • In our baseline scenario the combination of longer and wider lockdowns causes more severe economic damage than we had assumed so far. In the US in particular, but also elsewhere, this is due to a concurrence of negative developments such as accelerating unemployment, a sharper slump in investments, more bankruptcies, tighter financial conditions and, finally, hard-to-resolve disruptions in the supply chain.
  • For the Netherlands, our assumption of a 2-month lockdown remains valid now that the cabinet has announced that the lockdown will stay in place until at least the May holiday. Our assumption that social distancing must be observed until at least the end of this year also remains intact. Despite these unchanged assumptions, we have also reduced our baseline scenario for the Netherlands in view of the longer and wider lockdowns being imposed in our key export countries.
  • Based on these developments jointly, our new baseline scenario foresees a somewhat deeper global recession as well as stronger second-round effects, which will delay the recovery and cause a double dip for the world economy around the end of this year. In this event, the eurozone will sink into a renewed recession in Q4 2020 and Q1 2021.
  • Unfortunately, an even weaker development of the major global economies than sketched in this new baseline scenario cannot be ruled out. We have therefore drawn up a negative scenario with the lockdowns in the eurozone and the US lasting some 3 months. In China, where the lockdown is already over, the greater fall-off in global demand for Chinese products and services is the main driver in the negative scenario.
  • But there is also potential for a positive scenario. Such a scenario could occur if, for instance, universal testing demonstrates that more people than assumed so far have already developed immunity to the virus. In such a situation, public life could recover faster, pulling up the economy in tandem. In this scenario, there could be a growing perception in financial markets that the crisis will be short-lived. Against the backdrop of unprecedented global monetary accommodation, this could, in turn, translate into an accelerated easing of financial conditions (compared to the baseline scenario).
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For the three leading global economies, our growth expectations in the baseline, negative and positive scenarios are as follows.

The new baseline scenario

Most economic outcomes in our baseline scenario depend on the length of the lockdown, the effectiveness of the fiscal and monetary measures taken to prop up the economy during the lockdown and the extent to which economic production can start up once the lockdown has been lifted. These factors jointly will determine both the length and depth of the aftermath of the crisis.

Our current starting point is that the eurozone countries will, on average, emerge from the lockdown after one and a half months, i.e. at the end of April. For the Netherlands, we assume 2 months (including the May holiday) but believe that the economic impact here will be similar to that in other countries as certain sectors seem to be continuing at a more normal level in the Netherlands than in, notably, Southern Europe. Worldwide, the impact on the economy is best reflected in the purchasing manager indices which are nose-diving to all-time historic lows.

Most damaging factor in the US: unemployment

In the US, where the virus has now brought economic activity across the country to a standstill, the lockdown is expected to last two months. Our previous baseline scenario was 1 month. This has sparked an unprecedented wave of unemployment. Last week saw the jobless number soar by 6.6 million, following a similar number the preceding week. We expect a further increase of 7 to 8 million the coming weeks, bringing the total number of unemployed to 17 million. This peak of 18% unemployment is expected in April or May, followed by a rapid drop to about 9.5% by end-2020. For comparison, the number in February was a mere 3.5%.

The expectation that US unemployment will fall rapidly after the peak stems from the fact that employers have designated a very large number of the lay-offs as temporary (i.e. not permanent). Nevertheless, the high level of unemployment will leave deep scars in the US economy for a long time to come.

After the lockdown

In our baseline scenario we assume that the world will slowly but surely copy the Asian recovery model. In other words: intensive testing alongside a system for tracking human movement to identify who may have been in contact with an infected person. This will enable countries to isolate small groups where infection has occurred, so that the rest of society can get on with life. Wearing face masks is also assumed to become widespread practice. This combination of testing, technology and behavioural change should help economic life slowly get back on track.

Larger gatherings such as sports cultural events could then resume by the summer, with restaurants and bars being allowed to re-open after the summer. In this event, tourism could slowly start up again towards the summer, though in a trickle rather than a flood. Total consumption for 2020 is estimated to be some 5% lower than 2019 levels, partly due to increased unemployment.

Policy can soften but not prevent

Governments and monetary authorities have taken more vigorous action than ever, but can only mitigate part of the damage. Discretionary fiscal stimulus is currently running at 6% of GDP in the US and 2.5% in the eurozone. The emergency package that the Eurogroup agreed last Thursday evening (9 April) amounts to EUR 500 billion and will consist of giving countries almost unconditional access to the ESM credit facility within two weeks. In addition, the lending capacity of the European Investment Bank will be raised and an unemployment fund worth EUR 100 billion is being set up by the European Commission. The deal also includes the creation of a recovery fund to help the eurozone economy through the aftermath of the crisis. The size of the fund and the financing conditions are still being worked out. In terms of monetary policy, we expect an ongoing commitment to do “whatever it takes,” including extensive bond-buying and whatever else is necessary to keep markets operating smoothly.

The global fall-off in demand was the main reason for us to revise down our expectations for China once more. We already expected China to post a – by its standards – unusually sharp annualised contraction for the first quarter (figure due in mid-April), but based on the latest macro data we have lowered our forecast even further. A deeper trough in the first quarter could lead to a stronger rebound in the second quarter, also aided by the expected further monetary and budgetary relaxation. That said, the collapse in global growth and world trade will obviously put a strong drag on the recovery in the second quarter. All in all, our growth forecast for full-year 2020 is even lower than before.

Negative scenario: Longer standstill, more chaos and double dip

In our negative scenario the lockdown lasts 3 months in the eurozone (including the Netherlands) and the United States. As well as inflicting deeper damage, this prolonged standstill will lead to a more chaotic exit from the lockdown and even greater second-round effects.

The longer a lockdown lasts, the greater the risk that sections of society start flouting the rules. Such non-compliant behaviour could create persistent hotspots of infection and make any moves back to normality riskier. Wary of this latent threat, companies, households and investors will exercise caution, leading to lower consumption and investments.

In this negative scenario the government and monetary measures will be insufficient to underpin the economy until the recovery gets underway. The result will be even more unemployment and bankruptcies, and a further tightening of financial conditions, leading to a slower post-lockdown recovery and a deeper double dip due to the second-round effects as described above.

Businesses will no doubt try to make the best of things by switching over to online revenue models. The extent to which they succeed in doing so will determine the fall in consumption.

Positive scenario: Immunity and technology enable rapid recovery

In this scenario, large-scale testing shows that we have already developed more immunity than we realised. The probability of this scenario depends strongly on the validity of this research at Oxford University which found that between five and eighty per cent of the population could test positive without displaying symptoms of the virus.

Evidence that a large part of the population has already had the virus would pave the way for a faster return to normality. People can then go back to work, consumers can get out and about, and shops, bars, restaurants and events can reopen for business relatively quickly. Companies will also be more willing to invest, secure in the knowledge that the monetary and fiscal stimulus will at least continue throughout 2020. In this scenario, the recovery for 2021 could be blunted by some stimulus measures being reversed if found to be no longer necessary.