Source: Schroders Economics Group, Markit, 23 March 2020

Where does this leave our forecasts?

We have always argued that the current quarter would see the worst economic news on activity. Our forecasts already feature a significant decline in activity in Q2 with US GDP contracting by 22% quarter-on-quarter (q/q, not annualised) for example, so the latest PMIs should not prompt major revisions.

For us, two factors are key for the path of activity going forward: firstly, the response of governments and the banking system; and secondly, the speed with which lockdowns can be lifted.

Key test for policy and the banking system

First, as the economic storm intensifies it is vital that policy support comes on stream where it is needed. The fall in activity will put severe strain on corporate finances and will result in a significant wave of bankruptcies and layoffs. This is where government support packages will be vital in cushioning the blow and preventing the economy from tipping into a much deeper recession. The danger is particularly acute for smaller companies which do not have the same access to credit as their larger counterparts.

Both the US and UK have recently moved to increase the scope of their support packages in this area with Congress agreeing measures this week, but there are still doubts as to whether the action will be sufficient everywhere.

This period will also be a key test for the banking system which will be expected to continue to extend liquidity. It was notable that in reporting JP Morgan’s results last week CEO Jamie Dimon said that companies were drawing on their credit lines at twice the pace seen in the financial crisis of 2008.

Elsewhere, banks have followed government instructions to cancel dividends and build up capital to meet losses and the European banking sector has lost half its value year-to-date.

With shareholders on the hook there will be no direct bail outs of banks this time. Nonetheless, in extending quantitative easing (QE) to commercial paper and corporate credit, central banks such as the US Federal Reserve, European Central Bank and Bank of England are bearing much of the risk. As, of course, are governments through loan guarantee schemes.

Fading hopes for a V-shape recovery

While the first factor concerns the present, the second looks ahead to how quickly credible exit strategies can be developed for the lifting of the lockdown. This is critical to the shape of the recovery as to whether we get a V or something closer to a U, or even an L. In this respect the sharp bounce back, or V-shape recovery, is in doubt.

Those nations which have been ahead in the process of returning to work have seen the emergence of secondary infections and are having to pursue a gradual lifting of restrictions. Singapore, for example, has seen a sharp jump in secondary infections.

There have also been signs that consumers are reluctant to return to shopping malls and restaurants on fears for their physical and economic health. In China, companies are offering credit and discount vouchers to lure consumers back, whilst communist party officials have been told to be seen out shopping.

It would not be surprising if consumer caution were a feature of the global recovery given the shock to the economy and employment, thus tempering the upswing. Alongside a more cautious consumer we are likely to see slower business spending as ongoing uncertainty will inhibit the willingness to make major investment commitments. Higher savings and lower investment would reinforce slower growth and lower interest rates.

The disadvantage of the suppression strategy is that it does not build up the widespread “herd immunity” which would enable a wholesale return to normal working without the risk of further significant infection. Analysis from the World Health Organisation (WHO) suggests that only 2% to 3% of the population have antibodies which show they have had Covid-19. Studies are ongoing, but a figure closer to 60% would be needed for herd immunity.

Sweden has taken a different approach with fewer restrictions so as to build immunity and Stockholm is expected to achieve this within weeks. Nonetheless, unless their trading partners also recover, Sweden (like China, Korea and Singapore who are also emerging from the crisis), faces the same problem of a lack of global demand.

The pressure to lift the lockdowns more rapidly will now intensify as the economic damage becomes more apparent. However, our current thinking is that the V shape recovery is too optimistic and we are likely to be revising down our forecasts for global growth in 2020 in our next forecast round. The recovery will be weaker and delayed, closer to a U-shape.

The hope would be that with a more gradual lifting of restrictions the world economy should be able to avoid a significant second wave of infection and the double dip recession, or W scenario.

The return of inflation… or deflation?

How will inflation play out? As anyone who has tried to obtain a tin of paint during the lockdown can testify, there are bottlenecks in the system as a result of disruption to supply chains. Moreover, there are fears that the scale of the fiscal and monetary stimulus will result in a significant rise in prices in 2021 as the world economy finally recovers. There are also serious concerns over the supply of food, where labour shortages may slow the harvest due to restrictions on mobility.

At this stage though we see little prospect of inflation. Commodity prices are in retreat and will keep inflation low in coming months. Driven by the collapse in oil prices, the S&P GSCI commodity index is down nearly 50% year-on-year (y/y), close to the decline seen during the GFC when US CPI (consumer price index) inflation turned negative at -2% (see chart 2).

Chart 2: Commodity prices and US inflation

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