Chief Economist Dispatches: when is a recession not a recession?
The Chief Economist’s Dispatches is a new monthly column from our chief economist offering original insights into the major global macro events and themes moving markets.
When is a recession not a recession?
Coronavirus is proving even more forceful than we initially expected, creating a more pronounced and prolonged contraction in the global economy. Our forecasts fall short of what we would describe as the true end of the cycle, but the risks are tilted to the downside and further revisions are likely as containment measures scale up.
No quick rebound
Our mid-February forecasts were predicated on the assumption that the coronavirus would mostly be confined within China. That implied that the hit to global economic activity would largely be restricted to Q1 2020, with activity rebounding sharply thereafter and ultimately regaining the pre-virus trend level in 2021.
But the spread of the virus outside of China, the extreme containment measures being taken, behavioural responses by individuals and companies, supply chain disruptions and the shock to financial markets are combining to create a much larger and more prolonged shock for the global economy.
A larger, longer shock
We now expect global growth to fall well below trend in each of the first three quarters of the year, with technical recessions likely in a number of countries. Indeed with growth falling to 1.7% in our forecasts, 2020 would be the third-weakest year for the global economy since 1980, with only 1982 and 2009 worse.
Thereafter, we assume the spread of the virus slows through Q2, allowing barriers to economic activity and demand to be dismantled by early Q3. On this basis, we project a strong rebound from Q4 onwards, with global growth jumping to 3.9% in 2021. This will be supported by the monetary and fiscal stimulus steps taken already, and those coming down the pipeline.
Table 1 – Global growth forecasts (%)
Source: ASIRI (as at March 2020)
Chinese growth bottoming before developed market growth
For individual countries, the forecast hit to 2020 growth will differ, depending on the incidence of infections, the scale and success of containment measures, and the speed, size, design and space for fiscal and monetary policy responses.
In China, incoming evidence is consistent with the original expectation that Q1 would be the weakest quarter for growth, but the magnitude will be significantly larger.
Indeed, data just released show industrial and retail trade activity falling by more than 10% and 20% respectively in year-on-year terms through January and February. Both are by far the largest drops on record.
Meanwhile, the Q2 rebound will be tempered by the still slow recovery in the services sector and the large hit to external demand from the impact of coronavirus on the rest of the world.
Elsewhere in emerging markets, we also expect growth to weaken significantly. Many countries will avoid technical recessions, particularly those with either low direct exposure to the spread of the virus or high potential growth rates. But large output gaps will open up everywhere (see Chart 1).
Chart 1 – Contribution to global growth forecast revisions by country
Source: ASIRI (as of March 2020)
In the advanced economies, we expect Q2 to be the weakest quarter for growth, with Italy experiencing particularly severe contractions. Activity will in turn decline across the entire Eurozone, compounded by the more recent lockdowns imposed in other countries where infection rates are still growing rapidly.
The Eurozone, Japan and the UK all experience technical recessions in our forecasts. We expect these economies will contract in both Q1 and Q2, before returning to modest growth in Q3. In the US, activity increases in Q1, drops in Q2, and then begins to rise in Q3, and thus a technical recession is avoided.
Policy responses already in train…
Indeed, policy responses to the deepening shock are already kicking in, including the following.
- The People’s Bank of China has been providing targeted support since January and is cutting reserve requirement ratios for banks.
- The US Federal Reserve (Fed) delivered 1.5% in emergency rate cuts, restarted quantitative easing, purchased $500 billion of Treasuries and $200 billion of mortgage-backed securities, and provided liquidity support to keep the funding markets functioning.
- The Bank of England following the Fed with an emergency 0.5% rate cut, accompanied by an expanded targeted lending scheme and a cut to banks’ capital buffer requirements.
- The European Central Bank resisting cutting already-negative rates, but introducing a new support programme to keep money flowing through the financial system.
- The rate-cutting cycle is continuing across a range of smaller advanced and emerging economies.
In addition, fiscal measures are being rolled out, at this stage focused largely on relief to businesses and households suffering short-term income disruptions.
In many cases, these will amount to somewhere between 0.5% and 1% of GDP in 2020, but we think that most governments will eventually do much more.
But policy to be more powerful during the recovery than the shock
Unfortunately, neither monetary nor fiscal policy will be able to fully offset the near-term supply disruptions from containment measures and behavioural responses to the crisis.
Therefore, financial stress is unlikely to abate until there is clear evidence that new cases of the virus are slowing, and the economic aftershocks are better understood.
Nevertheless, provided the disruptions to the global economy last no more than a few more months, monetary and fiscal easing can help banks, companies and households bridge income gaps that might otherwise transform a temporary income and liquidity shock into a more persistent and damaging solvency crisis. Such measures can also help the economy snap back once the virus shock starts to subside. The recent drop in oil prices will also be supportive in time.
Some technical recessions but not yet the end of the cycle
The downturn in the global economy we are now forecasting has many of the hallmarks of a generalised recession. In particular, there will be meaningful, outright declines in activity across a wide range of economies within the first half of the year.
However, our forecasts fall short of what we would describe as the true end of the cycle, largely because the contraction is expected to be comparatively short-lived. For example, National Bureau of Economic Research studies show that, in recessions since the 1960s, the median duration of the decline in industrial activity was 15.5 months, while the median increase in the unemployment rate was 2.6%.
In short, while the size and breadth of the downturn matter, persistence is also crucial. Only then will the default and labour-shedding cycles that generate strong negative feedback loops between activity, the labour market and financial markets be activated.
Risks to our forecasts tilted to the downside
The fact we’re stopping short of calling the end of the current global expansion gives some room for optimism. But uncertainty remains very high. In line with our updated scenario and recession probability analysis, we believe a deeper and more persistent recession is the next most likely scenario after our new baseline.
Key triggers that would cause us to alter our call to a more destructive recession include:
- failure to contain the virus outside of China in Q2
- more draconian and long-lasting containment measures, amplifying behavioural responses of companies and firms
- financial stress and liquidity pressures amplifying the economic shock, with policy responses unable to break the negative feedback cycle; and
- indications that economic and financial stress is leading more firms to default and shed labour.
The downturn in the global economy will have many of the hallmarks of a generalised recession. However, if we’re right about its brevity, a significant corporate default and labour-shedding cycle is avoidable. But uncertainty remains very high – we believe a deeper and more persistent recession is the next most likely scenario after our new baseline.
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