By Lee Heng Guie
IN early 2020, global financial markets and investors’ somewhat cautious optimism was buoyed by the signing of a phase one trade deal between the US and China, coupled with incipient signs of global growth stabilisation and bottoming out. As recently as in January, the International Monetary Fund (IMF) had dismissed fears that the global economy is on the path of recession, and it projected a global growth rebound in 2020, estimated at 3.3% in 2020 and 3.4% in 2021 from an estimated 2.9% in 2019.
Back in 2019, there were periodic fears that the US economy will likely go into recession in 2020 or 2021. The US economy faces the prospects of a slowing growth as the tax cut stimulus had lapsed and also tempered by the damage inflicted by almost a year-long US-China trade spat.
Despite a phase one trade deal signed in January 2020, uncertainty still lingers on the stage two trade negotiations, which was put on the back burner as Donald Trump is preoccupied with the presidential election campaign. There remain valid concerns that the re-election of Trump in November would be dangerous to China as he would step up more pressure on China to get a fair trade.
The Federal Reserve had slashed interest rates three times in 2019 by a cumulative 75 basis points to 1.5%-1.75% to provide insurance against ongoing risks, which was meant to stave off the risk of recession.
About a year ago, the US yield curve inverted (short-term interest rates rise above long-term rates) for the first time in March 2019 and lasted for much of the rest of the year through mid-October.
The yield curve inversion signals danger ahead, and is a reliable predictive power of future recessions; going by past episodes of recessions, it would likely happen in a year or so.
The highly contagious Covid-19 outbreak, which erupted from China, the epicentre, is now spreading fast to major trading countries such as Japan and Korea and is also starting to take its toll on the US and Europe. The odds of the US recession has increased to at least 60%.
It is generally perceived that Covid-19’s economic impact will be short-lived and more damaging in China, at least in 1H20. It will bounce back quickly with the support of massive fiscal and monetary stimulus as consumers release pent-up demand and firms resume production to clear order backlog and demand as well as re-stock inventories.
If the coronavirus outbreak is a global pandemic, it would certainly significantly temper global sentiment and change all of earlier assessments that the virus impact can be manageable. While there are positive developments that new infected cases in China are expected to somewhat stabilise and be contained going into early second quarter, there is heightened fear that new cases are only starting to rise in countries outside China, and the outbreak may go beyond 2H20.
It is now becoming increasingly clear and worrisome that the Covid-19 outbreak has done more economic damage than anticipated. China’s factory output and trade numbers have plummeted more than expected in January-February 2020. Tourism and related services, aviation, transportation and manufacturing (such as smartphones, electronics and electrical, automobile manufacturers), as well as commodities and oil and gas industries are badly affected. The global supply chain disruptions have undermined output everywhere, making China’s major trading partners more vulnerable.
Recessionary risk is real. Covid-19’s inflicted economic consequences are likely to be compounded by unfavourable conditions in most advanced economies and emerging economies, including China, which have already been on a slowing growth trajectory since 2H18.
These economies’ vulnerability has risen and is now less able to absorb shocks, especially when hit by an exogenous shock. The IMF is looking at more dire scenarios where the spread of the virus continues for longer and more globally, and the growth consequences are more protracted.
The US economy has started to feel the rippling effects of the Covid-19-induced supply chain disruptions and demand shocks, with the Fed’s Beige Book reporting the first negative impact of coronavirus on economic activities. There is a real risk that the US consumers’ fundamentals, a strong pillar underpinning the economy, will be hurt if the spread of coronavirus worsens.
Japan’s economy, which had declined by an annualised rate of 6.3% in the fourth quarter of 2019, blamed on a 10% consumption tax hike from 8% previously and the global trade slowdown, and is likely to suffer a technical recession in 1H20.
Growth in the eurozone is slowing or somewhat stagnating to the point of recession. The European manufacturing and trade are more deeply connected to China through the web of supply chains than that with the US.
The next stop on the road to recession is a substantial selloff as well as a wide swing in the stock market as investors worry that the coronavirus would hit the economy badly and have a knock-down impact on corporate earnings and profits of the companies they are investing in.
If the virus’ impact prolongs and worsens, the declining profits or large losses would affect companies’ cash flows to service their debt. As the debt has grown faster than the economy, it is unsustainable. Typically, stock prices fall by about 30%-40% before a severe economic downturn.
The benchmark 10-year Treasury yields saw sharp declines after the Federal Reserve announced an unexpected 50 basis-point cut in its benchmark interest rate to 1%-1.25%, the first time such an emergency move since the 2008-2009 global financial crisis (GFC).
The 10-year Treasury yield tumbled below 1% for the first time ever as investors continued to seek safer assets amid fears that the coronavirus will disrupt global supply chains and tip the economy into a recession. Markets are implicitly expecting a long and deep recession.
Central banks and governments worldwide have cut interest rates and opened up the fiscal spigots to fight the worldwide spread of the coronavirus outbreak. More than US$45 bil budget support has already been pledged or is under consideration to counter the virus impact, encompassing a mix of cash handouts, tax breaks, healthcare prevention, expenditure programmes and projects and transfers.
Global central banks come into this economic shock with far less ammunition globally. With global interest rates generally staying low, and some at negative levels, this means some central banks may not have room to take interest rates much lower. For those that still do, any rate cut may not be effective in lifting economic activity.
The overextended state of central banks’ balance sheets with a combined asset of the Fed, European Central Bank and Bank of Japan collectively stood at US$14.5 tril in November 2019, down slightly from the peak of around US$15 tril in early 2018 and more than 3.5 times the pre-crisis level of US$4 tril, mean that more balance-sheet expansion or quantitative easing (QE) down the road may not guarantee a sustained economic revival.
While it is widely acknowledged that QE was successful in putting a floor under collapsing markets and containing the depths of the global financial crisis in 2008-2009, it failed to achieve traction in sparking vigorous economic recovery and sustainable expansion post GFC, partly due to the lack of meaningful economic and growth reforms. Despite the Bank of Japan having negative interest rates and repeatedly purchasing massive amounts of both stocks and bonds, it is now in its fifth recession since 2008. – March 13, 2020
