Our round-up of major economies; featuring charts and commentary.
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The United States went into the COVID crisis in better economic shape than most. There were no serious internal imbalances and the uncertainty around the external situation had reduced following the phase one trade deal with China. As such, most expected the US to be better-placed to deal with the economic fall-out of COVID. To some extent that remains the case. However, we have lowered our growth forecast for 2020 and think there is increased uncertainty around the recovery. Those changes reflect two things: 1) the larger-than-anticipated impact of the stay-athome orders in place in March and April; 2) the resurgence in COVID cases in June following the rapid easing of restrictions. While the fiscal and monetary policy response has been effective in helping households and businesses bridge the initial period of lockdown, that support is set to expire in the coming months. We believe it will need to be extended and expanded to ensure a robust recovery follows. Adding further uncertainty is the upcoming presidential and congressional election, which could see a material change in economic policy should the Democrats take control.
Figure 1. US
There is still considerable uncertainty about both the ongoing control of the virus and also regarding the nature and extent of economic recovery as economies slowly re-open. In medical terms, the lockdowns have been successful in most European nations, severely slowing the transmission of the disease and preventing a far worse health crisis. The resulting slump in economic activity seems to have reached a trough in April and May has witnessed the first signs of a rebound which should continue in June and the second half of the year. The experience varies a little by country, but the broad pattern is the same: GDP declines in Q2 will be enormous, but Q3 should see a strong recovery. The many monetary and fiscal policy measures that have been adopted will remain in place for some time, although the focus will shift from support to stimulus. The euro zone has stumbled a little in terms of a coordinated fiscal response, but some progress has now been made. The ECB, as ever, stands ready to support where necessary.
Figure 2. Euro zone
GDP growth numbers for 2020 and 2021 will probably be unique from a historical perspective, seeing both the largest annual decline (2020) and biggest annual increase (2021) ever. The UK lockdown began slightly later than elsewhere in Europe, so the output drop in Q1 was fractionally less than elsewhere. But the collapse in Q2 will be comparable and may well approach 20 per cent. The steep and unprecedented fall will, in substantial part, reverse in Q3 as activities resume while restrictions are gradually eased. Even so, it will not be until well into next year – and perhaps considerably later – that activity will return to pre-COVID levels. Policy stimulus is set to remain in place for some time, although there will be some pressure to rein back on fiscal policy support packages as soon as possible. The extent of lasting damage to businesses and households (unemployment) will only become apparent with time. The UK also faces the additional uncertainty related to the end-year Brexit transition deadline which has the capacity to add another unwelcome shock.
Figure 3. UK
China is “first in, first out” with respect to the COVID-19 shock. The 10 per cent quarterly contraction in Q1 fully reversed in Q2, but the weakness in the rest of the world, and continuing problems with full reopening, mean that GDP will slow from there, and not resume its pre-crisis trajectory. That said, we revise our expectations for output growth for the full year 2020 to around two per cent y/y, with Q4/Q4 up around five per cent. There are two-sided risks, but this is due more to the virus and the global situation, rather than things under Beijing’s control: fiscal and monetary policy are loosened but not to the degree they were in 2009 or 2016. The PBOC is in a rate-cutting cycle, but a gradual one, as inflation has come down and PPI has moved deeper into negative territory. Rather, the central bank’s focus is on ensuring adequate liquidity via RRR-cuts and other measures to absorb heavy local government bond and corporate issuance. The FX is stable with a weakening bias.
Figure 4. China
Already almost in a recession due to a tax hike in Q4 2019, Japan hit bottom in Q2 2020, with GDP about eight per cent lower than the year before. A drawn-out recovery looms, as monetary policy is constrained with the entire yield curve out to 10 years at zero or below. However, thanks to Fed swap lines the BoJ has been able to stem the strong yen, though the path of least resistance is still appreciation until global growth picks up; there is disinflationary pressure but not yet outright deflation. So far, the government has expanded fiscal policy by more than 10 per cent, with handouts to businesses large and small as well as individuals. A slew of subsidies and potentially forgiveable loans add to the support – and distortions – in the economy. Deficits cannot grow faster than the economy forever, yet as long as inflation stays positive, and growth returns to positive territory (someday) then negative real rates means that a larger debt 'burden' makes debt dynamics more sustainable!
Figure 5. Japan
Growth is expected to rebound strongly in Q3, albeit from a low base, as the economy starts to reopen. Focus will now turn to the pace and breadth of the recovery. The recently extended government support package has lessened the shock to household incomes and laid the foundations for recovery. Going forward, expectations are for an initial period of rapid jobs growth and higher spending thanks to pent-up demand, followed by a more gradual pace of recovery as confidence is restored. If supply recovers quicker than demand, significant downward pressure on inflation may result. The new Bank of Canada Governor, Tiff Macklem, has reiterated that the inflation target remains in place. With policy rates at the effective lower bound, further monetary stimulus has been delivered via QE: the bank has committed to buy at least $5 billion of Canadian government bonds a week until recovery is assured. As the bank is reluctant to impose negative rates, any requirement for additional easing is likely to come from adjustments to the QE programme.