The Big Picture is Shifting Rapidly
These are challenging times in financial markets. Frankly, I nor anyone else has any experience with economic and financial disruptions caused by proclamation from policy makers around the globe. Two weeks ago I did not expect the entire global economy to be closed almost overnight. Normally, policy makers blundering with monetary or fiscal policy cause recessions. Not this time, this is a disease-‐induced problem with enormous economic and financial consequences. What I know, or think I know shifts daily. This is an attempt to help explain with the caveat that understanding will evolve next week and the week after, so I will start with this and send updates often.
In the past two weeks, Covid-‐19 grew from a distant threat to reality. Most Americans did not anticipate this or how long it will remain a threat. The biggest change for me is the acceptance that the damage is not likely to pass in a month or two. It now appears there will be a sharp drop in global activity, followed by a period of significant weakness lasting at least two quarters, followed by a partial recovery. At some point, the expectations of worse outcomes will give way to expecting better outcomes and the panic in markets will cease.
The Economy Will Recover
Perspective is important. After the Great Recession from 2007 to the second quarter of 2009, it took two years, until the second quarter of 2011, for growth to recover to the pre-‐recessionary peak. The market recovery begins before the economic recovery, and the economic recovery begins years before growth and employment recover cycle highs. A few weeks ago, none of us were familiar with social distancing, but apparently it is the only means of suppression of a virus as contagious as this one. It requires an unprecedented disruption to daily activities and the economy. How the economy reacts once these measures are lifted us largely unknown.
Best guess for a timeline:
- Step 1: until this week, economists focused on how long it takes to get to peak infection, when the spread of the virus is “under control.” They thought the economy would return to normal at that point. Markets traded accordingly.
- Step 2: this week, people began thinking about the measures needed to prevent further increases once peak infection is reached. No school, no office work, no movies, no sports, no bars, no restaurants, and no retail beyond groceries and pharmacies, except online. These restrictions will not be dropped all at once just because the number of cases levels off. And certain activities may be permanently altered.
- Step 3: Peak infection, normal life resumes and with it -‐ restarting the economic engine.
Judging from China and a few other Asian countries, step 1 takes months. The CDC estimates the US will reach peak cases in July or August. Steps 2 and 3 are still unknown.
The Federal Reserve and Congress are working hard for answers. I am confident they will find them. Some stimulus measures will have immediate impact and some delayed, but they will all help. The Fed cut the fed funds rate 150bp to 0-‐.25%. Last week, they have provided credit markets with several trillion in various programs providing badly needed liquidity, and transformed their $60bn/mo balance sheet expansion program from not-‐QE (using one short term asset to buy another short term asset) into sort-‐of-‐QE (using a short term asset to buy longer-‐duration assets, but with no pre-‐announced time line or quantity).
The Fed decision to invoke quantitative easing is a signal to markets. And they are not alone, more than half a dozen central banks acted or pledged action in the past 24 hours. Policy makers will not get everything right, but they will react and adapt.
Fiscal policy takes longer to formulate than monetary policy, but US policymakers have set aside politics and gotten to work. They have passed what they term two phases of stimulus and they are currently working on phase three – expected to be north of 1.5 Trillion. Markets have whipsawed. The global drop in stocks is as big as in the first 150 days of 2008-‐09, but in a fraction of the time.
This is a globally synchronous event. Even the global financial crisis hit the world in a staggered fashion. This time, all of the biggest economies are sinking within a few months of each other. There will be significant job losses. I’ve seen estimates Global GDP could drop 10% in the first half of 2020, implying about $8.5 trillion of lost income. A 1% drop in global GDP, by the way, would be the worst ever. The fallout from a 10% drop is hard to imagine. I know that sounds scary, and it is, but it is important to state the economy will recover from whatever is thrown at it. No matter how deep the downturn, there will be a recovery.