Wealth Management: Strategy blog – Whatever it takes – the fiscal variety

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Strategy team - Victor Balfour (Wealth Management)

There seems to be nowhere to hide: equities suffered another day in the red (mid-single digit moves are becoming routine), oil touched an 18-year low, gold is down year-to-date and (until this morning) government bond yields had been rising. Meanwhile, sterling (and the euro), which had seemed immune to market noise, has now fallen nearly 13% against the dollar in little over a week - breaking through its EU-referendum lows though still above its weakest level ever (currently 1.15 vs 1.05 in early '85 when industrial unrest ensued).

As countries grapple with the outbreak, the monetary response has been swift and synchronous, even if somewhat impotent. The inherently political fiscal response has been slower. As governments adjust to the growing economic fallout, stabilising measures have been introduced in a more ad hoc fashion. Policies range from straightforward reliefs - state loans/guarantees, tax deferrals and debt holidays and income subsidies - to more unorthodox measures.

Wednesday may have marked an inflection point: The White House is pushing a $1tn (4.5% of GDP) spending package through Congress, and (absent brinkmanship) is exploring direct cash transfers to individuals (as Hong Kong did several weeks ago). The UK Chancellor announced a new large package of loan guarantees, with further commitments to increase spending as needed. Meanwhile, Germany's commitment to 'schwarze Null' may finally be put on hold, and France has waged 'war' with a large package of measures and intimated that they might consider nationalising large companies. There are even rumours swirling of a eurozone bond issue (i.e. debt mutualised by the 19 EMU member states) - a deeply divisive proposal that Germany had all but dismissed a few years ago.

This is perhaps not surprising. Concerns are mounting that this supply/demand shock could rival the 2008/09 economic crisis. Whether such speculation is prudent or alarmist is a moot point. As yet, the magnitude of the directly stimulatory spending announced is smaller by comparison - perhaps close to 2% of GDP excluding the loan guarantee programmes (for context, the full stimulus package during the GFC amounted to nearly 6% of GDP - see below).

Of course, we can't say with any certainty that this enormous disruption will be as deep or as enduring as 2008/09, during which economies contracted between -4% and -8% over a period of 12 months (on average). Fundamentally, the underlying economy appears in better health and there are fewer systemic risks - as we have outlined before - but a great deal depends on the endemic nature of the virus and crucially the extent of ongoing government restrictions on activity.

We are now starting to see pronounced weakness in the economic data outside China (where some monthly data have shown the biggest-ever falls in spending and output): the ZEW survey in Germany fell sharply, and in the US, Ohio reported more than 48,000 unemployment claims over the past two days, compared to under 2,000 during the same stretch a week prior. A spike in the headline weekly jobless claims seems likely and will signal a rise in the unemployment rate ahead (empirically, a rise of greater than +0.5% in the latter within a six-month period is consistent with an economy in recession and may prove a more timely yardstick than the more heavily lagged GDP release).

With businesses and consumers increasingly immobilised, and markets volatile, there are already signs of corporate distress as meagre cashflow forces even some household names to draw down on credit lines. Arguably the case for much more significant intervention - including tax cuts and direct cash grants - is building, especially given the loose policy setting. The alternative (or simply being too slow to react) could be far more damaging.

The virus is damaging, but clearly so too are the measures - and risks - taken to deal with it…


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