Global economy on the rebound, but plenty of potholes still seen

The global economy looks to be rebounding from the shortest and deepest economic shock in history, economists say.

But markets and investors are not out of the woods just yet. Concerns remain over just how short-lived the current rebound will be, how consumer behavior will change as economies reopen and the course of the COVID-19 virus itself.

Developed market economies began to reopen in May and June, albeit with a number of cities and towns forced to revert to lockdowns as infection rates rose. A number of emerging markets remain deep in lockdown, with daily cases continuing to rise.

The coronavirus pandemic and subsequent lockdowns across the globe led to a bottoming out in global stock markets in March and April. The MSCI ACWI lost 32.06% year-to-date through March 23. Since then, global equities have rebounded to a -4.73% return through July 9, and up 40.22% from that March low point.

While economists agree markets are largely through the worst of the coronavirus-induced recession, they’re still trying to figure out just what this recovery looks like, with V-, U- and W-shaped recoveries still under debate.

“I don’t think we have a letter of the alphabet — I’ve even been through the Greek alphabet,” said Karen Ward, London-based managing director, chief market strategist for Europe, the Middle East and Africa at J.P. Morgan Asset Management. “I think it will be a little more stop-start, more jagged.”

Assuming a second wave of infections doesn’t hit markets, the recovery might look like a “swoosh” or check mark, said Megan Greene, global chief economist and senior fellow at the Mossavar-Rahmani Center for Business and Government at Harvard Kennedy School, Cambridge, Mass. Any bounce back to good-looking data has to be put into context, that it’s “growth off a really low base.”

Ms. Greene does not see a V-shaped recovery due to the “asynchronous way that the virus is affecting emerging markets to developed markets — to have a V-shaped recovery you need everyone rebounding at the same time,” she said.

In June, the International Monetary Fund revised global GDP forecasts downward for 2020 to -4.9%. In April, the IMF had projected a 3% contraction. The IMF’s January, pre-COVID-19 global growth forecast, was for 3.3% expansion.

Group of 20 GDP fell 3.4% in the first quarter, compared with a 1.5% drop in the first quarter of 2009 — the height of the global financial crisis, according to the Organization for Cooperation and Economic Development. And economists think second-quarter GDP will be even worse.

But third-quarter data is expected to look pretty good — although that projection comes with a warning not to get too complacent.

“What we’re seeing at the moment is an economic recovery in play — most of that has been driven by the pent-up demand that grew during lockdown,” said Seema Shah, London-based chief strategist at Principal Global Investors LLC. “We’re seeing a surge in activity, which is a good thing, and also policy stimulus is helping.”

Sources are largely cautious about the recovery, which will be “slow and protracted. The path is at least positive. Q3 will be a strong one. … (For) Q4 we have a few more concerns. You could see a lot of that recovery losing momentum, and demand could have been satiated,” Ms. Shah said.

Sources also cited the fourth quarter as one that will not be so positive for markets given the potential for a second wave over the winter plus other risks related to Brexit and the November U.S. presidential election.

BNY Mellon Investment Management’s most likely scenario is that the world gets back to a pre-crisis level of spending in mid-2021.

“Broadly speaking, we’ve got a little bit more V-like” vs. the early days of the crisis, said Shamik Dhar, chief economist in London. A V-shaped recovery carries a 50% probability, up from 35% in a projection made in March. A U-shaped recovery — redefined from a W shape in early March — where gross domestic product spending returns to pre-crisis levels in the second half of 2022, carries a 30% probability, down from 35% previously. An L-shaped recovery, where a second wave hits in the third and fourth quarters this year and there is a permanent hit to output, sits at 15%, down from 20%; and an “inflationary” scenario, where growth in the U.S. recovers more strongly than expected, inflation picks up and the Federal Reserve is forced to tighten monetary policy faster than expected, sits at 5%, down from 10%.

There are three reasons for the upward revision to a V-shaped recovery: the data; the economic background and policy; and the course of the disease itself. “Of those, the most important we think is the course of the disease. It will ultimately decide which economic course we end up on,” Mr. Dhar said.

And 2021 is set to bring a fresh rebound in GDP. The IMF expects global growth of 5.4% next year, revised slightly downward from the previous forecast of 5.8% made in April. That compares with its pre-COVID-19 January forecast for 2021 of 3.4%.

“2021 will see good recoveries,” said Amlan Roy, global chief retirement strategist, senior managing director at State Street Global Advisors in London. But it’s the structural changes to society that concern Mr. Roy. “The impairment of schools, societal things, is something which will guide how future behavior works. We will need to be brave,” he said. “This crisis is affecting 7.94 billion consumers — it’s shuttering in 7.94 billion consumers from their natural consumption. And 4.2-odd billion people are shuttered out — (told) ‘don’t come back into work,’” he said.

The change in consumer behavior is weighing heavily on economists’ minds.

“I am quite concerned that there are many cuts, in terms of employment, to come,” said Dambisa Moyo, global economist and author, based in New York. She is worried some companies may use the pandemic as an opportunity to become more digitized, as they have “seen they can be efficient with a fraction of the staff (and) in a more devolved manner,” she said. Ms. Moyo serves on a number of corporate boards.

The impact of the pandemic “is no longer something that can be captured by the VIX or the MOVE indexes — this is aggregated uncertainty of … companies getting affected on a variety of dimensions,” Mr. Roy said.

While the coronavirus pandemic appears to be top of investors’ minds, there are a number of “big, short-to-medium-term relevant (issues) lurking beneath the surface, but (that) are still challenging,” said Eric Lascelles, chief economist at RBC Global Asset Management Inc. in Toronto. While these issues are big, Mr. Lascelles said they “still pale into insignificance vs. the clout of COVID-19.”

One of those issues is the U.S. election in November.

“It is very much nearing and the better market is suggesting (Democratic candidate Joe) Biden has a good chance at it,” Mr. Lascelles said, also noting the potential for a “Democratic sweep” in Congress. “There’s a real risk to financial markets (of a) less-favorable tax and regulatory regime in four months. It’s a mounting risk worth considering,” he said.

“I think it’s going to be a tumultuous U.S. election season,” said Mike Pyle, managing director and global chief investment strategist at the BlackRock Investment Institute, New York. There’s a “divergent outcome of policy” depending on which candidate is victorious, Mr. Pyle said.

Economists elsewhere in the world are also concerned about the presidential election.

“For 2020 as a whole, we are moderately more pessimistic about global GDP than consensus, as fiscal stimulus will not likely keep up with (second-quarter) levels and unemployment begins to hurt spending later this year,” said John Vail, chief global strategist and managing director at Nikko Asset Management in Tokyo. “In particular, we believe that the U.S. election will cause great uncertainty and thus weak spending by most individuals and corporations.”

London-based economists are also thinking about the Nov. 3 vote.

“We’re seeing more come through now in research and discussions (regarding the) likelihood of a Democratic clean sweep,” said John Roe, an economist and head of multiasset funds at Legal & General Investment Management in London. “If we do get a clean sweep, it is likely some of the corporate tax cuts of the Trump era would be reversed, which would weigh on equity markets.”

However, BlueBay Asset Management LLP is debating the implications of the election. “But it’s hard to start thinking about positioning portfolios for that,” said David Riley, chief strategist in London. “We’re not even at the point where we have the (candidate) debates — the campaign hasn’t really intensified yet. It will be a big deal.”

The second area to watch is Brexit, with the U.K.’s transition period set to end Dec. 31.

“Most would concede that as time passes, Brexit risks are mounting. We’re assuming a harder Brexit than (we were at) the start of the year. We can’t completely exclude the potential for a no-deal,” Mr. Lascelles said.

BlueBay has a “bearish bias on U.K. assets and sterling,” with Mr. Riley allocating a one-third probability to a no-deal scenario.

In that case, the U.K. would be subject to European Union tariffs, which would be “damaging for the EU, more for the U.K. — it would meaningfully weaken the recovery for the U.K. in 2021.”

That’s not Mr. Riley’s base case, though. He thinks a deal will be reached: “Not a good deal, but not a cliff edge. There’s a lot to play for, but I think the focus will start to increase … as we come out of the summer.”

Much of the post-coronavirus outlook is also based on the actions of central banks and governments. Over recent months, major central banks have injected trillions of dollars into the global economy, while governments have put in place schemes designed to keep households and businesses afloat.

The big question for economists is what major central banks choose to do next — if anything.

“I think it continues to be the case that the Fed is pretty strongly disinclined to move into negative territory,” BlackRock’s Mr. Pyle said. “The big conversation in the U.S. is the degree to which, either explicitly or implicitly, a form of yield-curve control would be the principal” response.
BNY Mellon puts about a one-fifth probability on the Fed moving to negative rates. “But that will only happen if there’s another shock, and only” in the firm’s W/U or L scenarios, which carry a total 45% probability. “There’s probably a bigger chance that the market thinks the Fed will be forced into negative interest rates, but it will fight that and use other methods like yield-curve control or more (quantitative easing),” Mr. Dhar said.

In the U.K., there was “reticence to go to negative rates. … I think that’s dampened a lot,” LGIM’s Mr. Roe said.

Central bank actions have avoided the crisis morphing “into something more systemic — they did a great job,” said Michael Herzum, head of macro and strategy at Union Investment Institutional GmbH in Frankfurt. Mr. Herzum expects to see more quantitative easing and forward guidance.

And central banks and governments have more firepower at their fingertips. “In the sort of traditional economics playbook, and traditional paradigm, the answer would be no,” they have no further ammunition, Ms. Moyo said. “But very crucially we’re now in … a new world order and anything is possible. We’ve seen the (Bank of England), Fed and (European Central Bank) buying corporate bonds. We’ve seen massive bailouts. Do they have room? Yes.”

BlueBay’s Mr. Riley agreed, adding that there is “no limit on how big (central banks) could grow their balance sheets” and noting that the Bank of Japan’s and Swiss National Bank’s balance sheets are bigger than their countries’ GDPs, at more than 100% for Japan and 125% for Switzerland.

Conversely, the Fed’s balance sheet is around 30% of GDP and the ECB’s about 40%. “On that basis, the Fed and the ECB could buy a lot more assets if they wanted to. But they may well have to extend the range of assets,” Mr. Riley said.

On the government side, PGI’s Ms. Shah said a key concern is whether they will “be willing or able to continue rolling out these fiscal support packages.”

But this fiscal side of policy “is where it’s mainly at right now. The monetary side has worked and is a blunt tool — the fiscal side is the bigger question: Is it sustainable, what are the long-term consequences?” Mr. Lascelles said.