The economic shock of COVID-19 is the largest and fastest than that of any other crisis. Every nation around the world is struggling to contain the virus and its economic impacts.
According to the International Monetary Fund, global growth is forecasted at -4.9% in 2020.Other institutions believe it may be slightly less severe at around -4.0%. Despite strong fiscal and monetary policy in effect in response to the pandemic, there is an unlikely chance that a v-shaped recovery will occur due to permanent disruptions the pandemic has caused within the labor and financial markets.
Many long-term implications could result from COVID-19. Before the pandemic, trade tensions between the U.S. and China as well as the backlash from Brexit perpetuated a sentiment of anti-globalization. COVID-19 is now accelerating this trend, witnessed by supply chains being disrupted, food security doubts and more pressure for domestic production of medical equipment. Interest rates will also remain low over the next few years. Governments will have to decide how to finance pandemic support measures and how to address the inequalities between well-paid workers who can just isolate at home and lower-paid workers who have been laid off or have had to work in dangerous conditions.
Since this global recession has been the result of a virus and subsequent government responses rather than usual economic drivers, it has led to significant uncertainty and caution about the future. This forecast is based on the assumption that a second wave of infections will not occur due to countries』 improved response with better protocols and medical support. A vaccine is also predicted to become widely available in 2021.
The severity of COVID-19 appears to have peaked in most developed countries while certain emerging markets continue struggling to contain the virus. Many countries have started to ease containment measures. However, economic activity is still being negatively affected by tighter financial conditions, high unemployment, low commodity prices and several other international factors such as trade disputes.
When placed in lockdown, non-essential businesses are forced to close and restrictions are implemented on travel. Unfortunately, this results in severe supply-side shock as factories and businesses are no longer allowed to operate. Demand also drops as workers lose their income and economic uncertainty grows stronger.
The optimistic assumption is that there will not be a second wave of infections as many countries have peaked in cases in the second quarter and economies will be on track to recover from the third quarter onwards. Of course, the pessimistic forecast would be a resurgence of cases where countries will extend lockdown measures and will experience a much more gradual path to recovery. Government support will also reach its limits as large amounts of debt would result in financial market distress. Consumer confidence would plunge and matters could be indeed much worse.
The success of containment differs across countries, as a result, recovery paths will vary based on the countries』 underlying socio-economic characteristics and how effective their management of the virus spreading.
Given the data to date, there is little evidence of a second wave of infections. Some countries, like the U.S. continue to have many new cases per day but others in Asia and Europe are easing lockdowns as the curve is successfully flattening. The conditions should be closely monitored over the next few months since the virus is highly contagious and lockdowns are the most effective measure thus far. Should a second wave arise, countries will be better positioned to manage the virus with better medical care capacity, treatment and the development of a vaccine for public use hopefully next year.
The U.S was in a strong economic position before the pandemic however, methods to eliminate COVID-19 such as shutdowns of non-essential businesses and travel restrictions have dampened the possibility of a quick rebound, resulting in GDP decreasing at a 5.0% rate in the first quarter. Unfortunately, conditions became much worse in the second quarter as GDP was down 32.9%. In April, the U.S. reached an all-time high of 14.7% unemployment with 21 million Americans unemployed. In May and June, the economy seemed to lightly rebound but spikes in cases continue to prevent the country from reopening and relaxing social distancing measures. TD Canada Trust forecasts Q3 GDP growth will be 28% and Goldman Sachs estimates it will be 25%, much less than its initial estimate of 33%. GDP is not expected to regain its pre-COVID-19 levels within the next two years.
The consumer price index also dropped to 0.3% in the second quarter and is forecasted to be at 0.4% for the year 2020 and 0.9% in 2021 according to TD Canada Trust.
The U.S. currently has a total of 5.6 million cases and over 176,000 deaths and the numbers continue surging. If the U.S. implements better protocols and more effective measures within the medical system, cases could diminish and accelerate the economy’s rebound. Should the infections drastically worsen and as a result, lead to longer stay-at-home or social distancing orders, unemployment will continue to rise and many jobs will be permanently lost.
Response
Lockdowns were implemented relatively late. According to estimates from Columbia University, if the United States imposed social distancing measures one week earlier, about 36,000 fewer people would have died in the coronavirus outbreak. Now, the severity of the pandemic has pushed Congress to implement a series of plans. The cost of the country’s economic-stimulus response accounts for over 12% of GDP. The CARES Act is a bill that was passed in March to support individuals and businesses through loans, grants, tax deductions, etc. Within this bill, the Paycheck Protection Program was established to help small and medium-sized businesses with cash-flow assistance through loans. Although many businesses and workers still benefited from the program, critics have claimed that the program was too slow and failed to give funds to the small businesses that needed them the most. There was also concern over larger companies, politically connected firms and wealthy celebrities getting federal aid. This program ends on August 8, 2020.
Near the end of Q1, the Federal Reserve cut interest rates to near-zero with a target of 0%-0.25% and launched a $700 billion quantitative easing program where they would purchase $500 billion in U.S. Treasurys and $200 billion in mortgage-backed securities. According to the Federal Open Market Committee’s latest economic projections, they expect to keep the federal funds rate anchored to the zero-lower bound through 2022.
Many major retailers such as Hertz, J.C. Penney and Neiman Marcus, filed for bankruptcy, entrepreneurs are becoming more reluctant, with stricter credit standards, etc. all of which will heavily diminish business investment over the next couple years.
There is Light at the End of the Tunnel but Still a Long Journey Ahead
Unemployment seems to be decreasing from the record high in April of 14.7%. In May it went down to 11.1% and 10.2% in July as U.S. employers added 1.8 million jobs. The largest growth was in the leisure and hospitality industry at 529,000jobs. Even with the better-than-expected data, employment remains around 13 million below February levels. According to TD Canada Trust, the unemployment rate is forecasted at 9.2% for the third quarter and 8.5% for 2020.
There is uncertainty around whether Congress will provide a new round of stimulus. The expiry of numerous assistance programs is certainly a threat to the revival of the economy. Moreover, the resurgence of cases coming as a second wave in the U.S. is another risk that could set back the progress being made. The ongoing spike in daily cases in many counties has already forced the government to slow the process of re-opening and many have reintroduced stricter physical distancing measures.
That said, should the U.S. not experience a second wave, recovery would start to take form in the third quarter. Consumer spending and business demand will grow initially but lingering effects of COVID-19 will slow the pace of overall growth. Even when businesses returning to normal operations, consumers may be hesitant and are not likely to resume their past spending habits. Some jobs that were lost due to COVID-19 will likely never return since businesses will be reducing their staff, but new jobs will also be created to offset that loss over time.
Thankfully, economic activity seems to be picking up in select sectors since the big hit in April, like auto sales, traveling, restaurant bookings, hotel occupancy and public transportation.
Japan’s economy was already struggling before the pandemic. In the fourth quarter of 2019, real GDP decreased at an annualized rate of 6.3% from the last quarter, making it the biggest decline since 2014. This outbreak led to a big drop in external demand, along with plunging tourism revenues and weakened domestic demand. GDP shrank an annualized 2.5% in the first quarter and27.8% in the second.
Unemployment increased by only two-tenths of a percentage point to 2.6% in April since February. Not only is this due to their good containment of COVID-19, chief Japan economist at Goldman Sachs claims that Japan’s attitudes and policies toward labor differ from the U.S. Japanese companies prioritize employees』 interests over those of shareholders. They focus on sustainability rather than maximizing profits and growth, thus they can use their retained earnings to prevent laying off workers during difficult times.
The consumer price index dropped to 0.10% in the second quarter and is projected to be 0.2% in 2020 and 1.2% in 2021 according to TD Canada Trust.
It appears that consumers in Japan are capable of spending more since disposable incomes for workers』 households rose 13.4% in May compared to last year. However, consumer expenditure continues to decline. Within the same month, consumer expenditure fell 15.5% from a year earlier. Some are concerned that it will continue to remain low despite the reopening. From the numbers so far, consumer confidence improved in June, suggesting that it was probably previously stagnated due to voluntary restricted travel and closure of recreation establishments.
Response
Japan has done a great job in containing the virus compared to other large countries, with very low rates of infection and death, 61,800 cases and just over 1,170 deaths. They have implemented an effective low-technology and labor-intensive contact tracing system where 469 local public health centers conducted contact tracing early on before the virus was even prevalent in the country.
According to the International Monetary Fund, fiscal stimulus because of COVID-19 in Japan has added up to about 40% of GDP. McKinsey and Company claims it be 21% of their GDP but it is still a significant proportion of GDP nonetheless. The government recently approved a second stimulus package worth around 117 trillion yen. The government implanted a series of measures such as cash handouts of 100,000yen to every resident, expansions of employment adjustment subsidies programs, special loan programs, deferrals of tax, rent fee support, etc.
The Bank of Japan has continued to facilitate monetary policy through unlimited purchases of Japanese government bonds, increased purchases of exchange-traded funds, Japanese real estate investment trusts, corporate bonds and commercial paper, etc. Similar to the U.S., it seems like there will be little to no change in interest rates of -0.1% over the next year or two.
COVID-19 has resulted in a historic collapse of the euro area economy. Many European economies already had issues before the pandemic, for instance, Italy’s high debt, placing the euro area at a disadvantage when combatting the pandemic. GDP fell by an annualized 15.0% in the second quarter of 2020 and unemployment increased 7.8% in June 2020, which is near record lows. According to the European Central Bank, an 8.3% rebound in GDP and a 10.8% peak in unemployment is forecasted for the third quarter since national authorities should be starting to allow businesses across many sectors to restart production and several countries are starting to re-open.TD Canada Trust forecasts euro area GDP to decrease 7.6% in 2020 and a 6.1% rebound in 2021.
Inflation, measured by the Harmonised Index of Consumer Prices (HICP), was at 0.2% in the second quarter and is forecasted at 0.4% in 2020 and 1.1% in 2021 due to stable energy prices and lower prices overall from companies caused by weaker demand.
Consumer expenditure is expected to decline 7.8% in 2020 and recover gradually over the next two years. Vehicle sales, vacations and restaurants have been affected the most due to shutdowns of non-essential businesses and increased job uncertainty.
Given all the uncertainty and increases in corporate debt ratios, business investment is also estimated to collapse for the rest of 2020.
Response
Like the countries mentioned above, monetary and fiscal policy play an essential role in supporting the revival of the euro area economy. In March, the European Central Bank created the Pandemic Emergency Purchase Programme (PPEP), which has now increased to a total of €1.35 trillion aimed to increase lending and lower borrowing costs. The Pandemic Emergency Longer Term Refinancing Operations was also created to support money markets.
The bank has also kept interest rates at historically low levels, increased the amount of money banks can borrow from the central bank and relaxed standards for collateral that banks must give, overall making it easier for households and small to medium-size businesses to obtain financial support.
Many European governments have also implemented a subsidy program for workers so that they can pay their bills and business will in turn benefit because they will not have to hire and train new employees when the crisis settles. The government covers a certain percentage of worker wages, the highest being 90% in the Netherlands for three months. Major countries have the majority of their workforce enrolled in these programs, for instance, almost half of French workers and two-thirds of British employers have participated. This program is proving to be effective since although unemployment is still rising, it is at a much slower rate than the U.S.
Overall, crude oil prices dropped 70% since January through to April. Prices were mainly decreasing because of COVID-19’s effect on China’s oil demand, the country who is the world’s second-largest consumer of oil. Furthermore, the closing of borders and travel ban implementations continued to weigh on prices. On April 20, the WTI Cushing contract for delivery in May dropped to the negatives for the first time at -$37.63/bbl due to low demand, restricted storage capacity, etc.
In June, Brent crude oil spot prices average $40/bbl, increasing by $11/bbl since May and $22/bbl since April. Prices began to rise as global demand for liquid fuels start to increase due to many countries beginning to reopen and as the Organization of the Petroleum Exporting Countries』 producers have also decided to extend their production cuts through July.
The Energy Information Administration (EIA) believes that global oil demand will exceed supply in the second half of 2020. EIA expects prices to reach an average of $41/bbl for the second half of 2020 and $50/bbl for 2021. EIA forecasts the WTI will average about $3/bbl less than Brent in 2020 at $37.55/bbl and $4/bbl in 2021 at $45.70/bbl.
Since the start of 2020 as the pandemic began to spread, the price of gold rapidly increased. The uncertain outlook for the global economy, decreasing interest rates, increased tensions between the U.S. and China and the dollar’s depreciation have encouraged investors to invest in gold. Gold has historically been known for its ability to maintain its long-term value and rise in times of uncertainty. In the first week of August, gold prices reached over $2,000/Oz for its ninth week of consecutive gains. Citi and Goldman Sachs both believe gold could reach $2,300/Oz within the next 12 months.
During times of global crisis, investors tend to gravitate toward safe havens like yen-denominated financial assets. Not only is the yen currently stronger against the U.S. dollar, but it has also appreciated more than other Asian countries. Furthermore, should the economic status of the U.S. worsen, investors may dump their dollar-denominated assets for yen or euro-denominated assets. However, this could dampen Japanese exports for their high value and constrain Japanese manufacturers.
The U.S. Dollar could continue to depreciate for many reasons. Since global trade is mainly conducted in USD and trade is being negatively affected by the pandemic. Also, the Federal Reserve cutting interest rates no longer supports the U.S. dollar and from a structural perspective, the country’s economy is not well suited to respond to the virus, making measures less effective in comparison to other places. The upcoming election will also contribute to this depreciation.
The EUR/USD gains near the end of the second quarter going into the third, is more so due to the depreciation of the USD rather than a strengthening EUR. But in general, Europe has succeeded in containing the virus for the most part and the economy is beginning to recover as it starts to reopen. （Analyst：Annie Zhang）
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