Strategy team: Victor Balfour
Capital markets have just concluded a respectable quarter: stocks, bonds, commodities and property moved higher and, in some cases, reached new highs. Yet it has become clear that economic momentum may be starting to fade, just as a resurgent virus and renewed suppression come into effect.
Business surveys have receded and labour markets – many still insulated from job retention schemes – have started to show some cracks. Some high-profile businesses have announced significant job losses in recent weeks: Shell (9,000 jobs), Disney (28,000 workers), American Airlines (19,000) and Cineworld (45,000).
A retreat from such established companies is clearly a worry, revitalising concerns about the trajectory and shape of this uneven recovery.
Meanwhile, default rates in speculative credit have now more than doubled since the start of the year, and residential and the corporate loan delinquencies – albeit backward looking – have moved sharply higher. Both may still have some way to go.
Yet we are not convinced that these unemployment and credit risks are enough to derail the ongoing recovery.
Learning from the past
But if the short-term glass remains half-full? What of the longer-term prospect? Past crises have shown that the greater the depth of the recession, the more significant the effect on future potential output.
The Great Depression was a good, if tragic, example: US GDP fell by nearly two-fifths and employment by a quarter between 1929 and 1933. Neither the unemployment rate nor output returned to its pre-crisis level for a decade.
Major economic setbacks
Time taken for US GDP to return to starting point (100 = pre-crisis peak)
Undoubtedly, the COVID-19 downturn has been intense – reflecting both a simultaneous supply and demand shock – but in contrast to the Great Depression, on consensus forecasts it could prove relatively short. The ‘average’ recession is typically 9 months long (as in the chart, measured in terms of the time taken to regain the starting level of GDP). The economic fallout from those government-imposed restrictions this spring was likely concentrated over three short months. Current estimates suggest we may have recouped more than half of that lost output since May.
And though the path to a full recovery will be shaped by the persistence of this outbreak – and those stop-start restrictions – perhaps of equal importance is how effectively policymakers can limit long-term economic damage. The timescale to date suggests that perhaps they have a good chance of doing so.
So too do the statements coming from policymakers. There is precedent here. After the Great Depression, FDR’s New Deal in 1933 – a broad package of reforms and infrastructure projects – was instrumental in eventually reviving the US economy. It also incorporated the first (US) attempt at a federal social safety net. Now, the extensive pandemic fiscal relief programmes have not only supported businesses, preserving productive capacity, but they have also reinforced household incomes, in turn, underpinning final private demand – a key component of economic growth. And as we noted yesterday, the IMF (of all people) seems to be urging the US and other governments to embrace such New Deal-like measures now.
Meanwhile, in contrast to the 1930s episode when monetary conditions were famously too tight for too long, monetary interventions in 2020 – beyond headline policy rates - have quickly eased financial conditions, ensuring (so far) the functioning of markets and the provision of liquidity. Global investment grade credit spreads – often quick to respond to distress – widened dramatically back in March, but now are below long-term averages and only modestly wider than the recent lows observed in February.
Crucially there is also no underlying structural impediment: the global economy was not especially vulnerable going into this downturn. In 2008 policymakers were also relatively quick to respond to the challenges of the financial crisis, but the slow subsequent recovery underscored the challenge of an impaired financial system. Weak balance sheets and a seizure in wholesale funding markets undermined banks’ crucial role in intermediating liquidity to the real economy when it was needed most.
This time round no such obvious impediment exists - banks are (mostly) unimpaired, better capitalised and supported by those monetary and fiscal interventions.
We stay cautiously constructive
This period is decidedly different to the initial outbreak in spring – certainly more thought is being given to the economic cost of suppression. Walking this fiscal tightrope does create a policy conflict – withdraw support too fast and you stymie the recovery; too slow, and the fiscal costs mount, while unproductive businesses limp along. The Bank of England’s Chief Economist recently observed that the next stage of the recovery is a “necessary process of adjustment”.
Despite the authorities’ best efforts, some of the damage may well become structural as sectors struggle and corporate restructurings ensue. In some cases, this may simply reflect a deferral of accumulated problems, while other businesses may find their business models challenged by changes in consumer habits and prolonged and uncertain government measures.
Yet, there may also be structural winners. In September, Amazon announced that it was hiring around 130,000 additional employees in North America (having already expanding its global workforce by 175,000 since March). It’s clear that many businesses and workers are proving remarkably resilient and flexible through this crisis, and the recovery, so far, has been quicker than many expected. Despite the obvious risks, we think it is too soon to give up on economic recovery.
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