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3 Things to Watch Amid Painful GDP Contractions


As the world ramps up its response to the coronavirus crisis, with lockdowns and business closures gathering pace, we have estimated the potential peak-to-trough impact to global GDP. Our main views are:

  1. GDP contractions around 15% peak-to-trough are likely in most economies.
  2. Fiscal and monetary policy responses will be key, but business closures may limit the impact.
  3. Closely watch unemployment, supply chain constraints and behavioral changes for clues on the strength of the eventual rebound.

Travel and leisure sectors could take -80% hits

We have put together our projections by applying sector-level impact estimates to each nation’s economic composition. We believe sectors tied to travel and leisure will be particularly hard hit (Figure 1). Elsewhere, growing restrictions on non-essential work will likely mean most sectors will face some negative impact, particularly where activity cannot be conducted remotely. Based on announced policies as of 3/31/2020, the majority of the United States will be restricted to essential activity for a minimum of six weeks.

We expect sectors such as construction and manufacturing will face both labor constraints and potential supply chain disruptions, although we believe the impact will be less severe declines than with restaurants, for example.

Figure 1: A sector-by-sector impact of the crisis

GDP sector

Peak to trough impact*

Agriculture, forest, and fishing

-10%

Industrial

-14%

Manufacturing

-20%

Construction

-25%

Wholesale and retail trade

-21%

Transport

-30%

Accommodation and food service activities

-80%

Information and communication

-10%

Financial and insurance activities

-10%

Real estate activities

-16%

Human health and social work activities

0%

Public Administration

0%

Professional, scientific, and technical activities, administrative and support service activities

-10%

Education

-10%

Arts, entertainment and recreation, other service activities

-80%

Source: Insight Investment estimates, March 2020 | *Not Annualized. 

Our views on the hardest-hit sectors are largely supported by high frequency data. For example, OpenTable suggests that sit-down restaurant activity has fallen by more than 90% in the United States, Germany, and Ireland. It also expects more regions to follow suit.

Similarly, U.S. cinema box office receipts in the week ended March 16 were less than $1 million, the lowest weekly level since data collection began in 1981, and down over 99% from the 2019 average. Functionally, the entire industry has closed. Similarly, TSA data shows a greater-than-90% decline in air traffic. As more industries are forced to close worldwide, activity would be expected to fall further.

At this early stage, we need to emphasize these forecasts have unavoidably wide margins of error as we cannot yet know how successful each nation’s lockdown strategies will be or how long the authorities will pursue them.

Figure 2: The hardest-hit sectors are following similar paths across countries

restaurant sales, % change
 

Labor markets are under pressure as a result

In the United States, Google searches for “unemployment” have risen fourteen-fold compared to a month ago. In the United Kingdom, the factor is three and in France, 14. There has been little change in Germany, however, which has a unique labor market stabilization mechanism. In the United States, we have seen a 15-fold increase in initial jobless claims in the third week of March to a record 3.3 million.

Policy response will be a key factor – but business closures limit the stimulus impact

The implementation of fiscal policy in each country will be the key determinant of the extent labor market issues will be contained and in determining the strength of the eventual economic recovery.

Unlike in a typical recession, fiscal and monetary policy is limited in its ability to mitigate the economic contraction. Even where an element of “helicopter money” is being considered (such as the United States), discretionary consumption is limited by social distancing policies and business closures.

These measures are therefore more aimed toward providing enough liquidity to businesses, individuals, and markets to ride-out the downturn and facilitate a sharp rebound in activity.

Double-digit GDP growth declines are likely

The varying nature of each nation’s service sector and trade balances will likely lead to somewhat different economic outcomes. However, we expect double-digit declines in GDP peak-to-trough, with the United States falling slightly less due to a smaller restaurant sector and trade deficit. Due to unknowns around the duration and effectiveness of containment measures, there is much higher uncertainty to these forecasts than during normal economic times.

Figure 3: Insight’s peak-to-trough GDP forecasts

Region

Estimated peak-to-trough GDP Impact

United States

-12.5%

United Kingdom

-15%

European Union

-15%

Australia

-15%

China

-15%

Hong Kong

-12.5%

Japan

-15%

Source: Insight Investment estimates, March 2020.

Policy response will be substantial

Monetary policy will likely be highly accommodative for over 12 months while fiscal policy will need to be loose to ensure firms and individuals have the necessary liquidity to withstand the downturn.

Should authorities be able to contain the virus, this stimulus will likely set the scene for growth to run well-above trend. In most regions, we expect it will take more than 12 months to return to pre-virus levels of activity.

Three things to watch for the eventual rebound


  1. Unemployment: While helicopter money combined with standard safety net benefits can help displaced workers, they will need to return to the labor market to maintain consumption eventually. But how quickly workers are rehired at restaurants, hotels or (for example) airports, is a key question. The greater the initial rise in unemployment or corporate bankruptcy filings, the greater the risk of lingering unemployment is to the economy.

  2. Supply chain constraints: These will likely delay the return to full capacity. In China this has been a multi-week process even as virus restrictions are removed. In all likelihood, not all countries will remove restrictions concurrently. With the global nature of the supply chain, production may not return as quickly as demand, prolonging the recovering in output.

  3. Behavioral changes: The key question here is, how long will it take (if ever) for consumers to be as willing to eat out, go to large sporting events, fly and/or travel as before? These preferences can be quickly tracked via real-time data like film tickets, restaurant reservations, as well as information on weekly oil demand and number of flights. But the potential longer-term psychological behavioral impact of this event also needs to be considered. Will businesses and individuals want to maintain less leverage or hold more liquidity, which could increase the savings rate, lower consumption, or defer business investment? These changes may take more time to grow clear.

As these lockdown policies are phased out, we would expect economic activity to begin to bounce back with the recovery likely to begin in the second half of this year. While there should be a large bounce back, it will not be immediate. For instance, it will take time for hotels to re-occupy rooms, restaurants to build inventory, or airlines to schedule flights. As such, it will take some time for the economy to return to its pre-crisis levels, particularly as lockdown measures may be phased out incrementally.

Imagine the economy like traffic on the highway. The coronavirus has been a multiple car pile-up, which has brought traffic to a stand-still. As we’ve all experienced, it takes a lot longer for traffic to get back to normal speed than it did to halt it. Jams take some time to unclog themselves, and that will be the case. Given this, we expect it will take the economy more than 12 months to return to peak pre-crisis levels of output. 

Here, the role of fiscal and monetary stimulus is incredibly important in greasing the tracks to ensure that the economic damage of the virus does not linger too long beyond the lockdown policies. As you can see below, there has been unprecedented action by policymakers to support growth with a direct fiscal stimulus in excess of 6.5% of GDP. The United States is engaged in a hybrid policy of limiting the rise in unemployment, by subsidizing some employers’ payroll, and mitigating the impact of unemployment by increasing cash payments. Doing these two things successfully is critical for laying the groundwork for a strong recovery.

Public health policy has essentially frozen “economic time” in many sectors (restaurants, malls, hotels, etc. closed). However, “financial time” continues to march on (rent, mortgages, credit card bills, etc. continue to accrue). Absent a response, this mismatch would lead to erosion in savings in the corporate and consumer sectors as they tap into reserves to make essential payments. We would see a sharp rise in unemployment, business closures, delinquencies, and defaults. The policy response needs to bridge this mismatch until economic time resumes minimizing the erosion so that the economy can more quickly rebound.

We believe policymakers have taken significant steps to greatly reduce second-round damage from the virus, particularly for the consumer and investment grade corporate sectors. However, small and medium-sized businesses may need more assistance than has been announced so far. Importantly, we believe the speed and size of the response thus far speaks to policymakers’ willingness to do whatever it takes. If it turns out small businesses need $577 billion, not $377 billion, members of Congress are unlikely to say “we did what we could” and let there be mass failure. At this stage, we believe policymakers have largely bought into the mantra “in for a penny in for a pound” and will provide the necessary assistance, which means corporate and personal defaults will be a fraction of what they would otherwise have been.

Winston Churchill once said, “You can always count on the Americans to do the right thing after they have tried everything else.” The same Congress which has failed to pass a budget on time in every year since 1997 managed to pass a $2 trillion support package within eight days of the first draft. While these policies will not arrest the downturn (no amount of stimulus can make consumers go to restaurants that have been closed for public health), they will greatly reduce the collateral damage and lay the groundwork for a sustained recovery. While this recovery will take time given the magnitude of the shock, the promise of continued policy support, should it prove necessary, will give investors the ability to better look through near-term volatility. Positioning for recovery will require careful security selection focusing on attractively valued securities with the balance sheet, structure, and policy support to benefit from as the economy eventually recovers.

coronavirus fiscal and monetary policy responses

Source: Federal Reserve Bank, Insight Investment as of March 26, 2020

 

CRN: 2020-0406-8182 R

The opinions of this piece are that of Insight Investment and not necessarily that of AAM.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

Please note: any forecasts or opinions are Insight Investment's own as of the date of this communication and may change.

Information herein may contain, include or is based upon forward-looking statements within the meaning of the federal securities laws, specifically Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements include all statements, other than statements of historical fact, that address future activities, events or developments, including without limitation, business or investment strategy or measures to implement strategy, competitive strengths, goals expansion and growth of our business, plans, prospects and references to future or success. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Words such as ‘anticipate,’ ‘estimate,’ ‘expect,’ ‘project,’ ‘intend,’ ‘plan,’ ‘believe,’ and other similar words are intended to identify these forward-looking statements. Forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks and uncertainties. Many such factors will be important in determining our actual future results or outcomes. Consequently, no forward-looking statement can be guaranteed. Our actual results or outcomes may vary materially. Given these uncertainties, you should not place undue reliance on these forward-looking statements.


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