One Quarter Or Two?

The crystal ball has rarely been more clouded. An investor’s standard assessments of potential growth and rate dynamics have been overwhelmed by three unanswerable questions: How long will the economic shock from the coronavirus last? Will government measures make a difference? What damage will the crisis leave behind?

The answers depend on a combination of epidemiology, economics and politics. Awkwardly, only one of these is an actual science, so the fear-and-greed that normally drive financial markets have been displaced by fear-and-confusion.

The first question around the length of the disruption is also least predictable, but there is some hope in recent headlines from Asia. Reports suggest that China may be returning to work after losing a quarter of normal economic activity. There is skepticism around the official numbers from Beijing, but the patterns in Japan and Korea offer promise, too–success that is perhaps the product of testing and monitoring measures learned during the 2003 SARS epidemic.

Yes, China has more government levers to shut down cities, but most “social distancing” now rippling across the world comes from a combination of political decisions taken by democratic governments and a rising sense of community solidarity and responsibility. Yes, the damage in developing countries with poor public health infrastructure will be much worse, but the vigorous response currently underway should deliver results.

Warmer summer weather may or may not slow the spread, but the third quarter should at least bring a better understanding of the disease, improved testing procedures and more ventilators. Even if a vaccine may be years away under current approval protocols, we are likely to develop tools that track and manage the risks from the virus much sooner. This should allow a slow return to more normal activity even if new cases pick up again in the fall.

Meanwhile, have governments done enough to cushion the loss of economic activity on a global scale? China’s response to what was then a more contained crisis involved substantial injections of financial liquidity, but new government spending may be on the way.

The U.S. Federal Reserve has mobilized its 2008 financial crisis playbook with rapid rate cuts and massive credit facilities to keep dollars flowing for primary dealers, money market funds and other central banks. Congress is working on a third massive stimulus bill even as the president’s signature is still fresh on the second package. The European Central Bank has promised EUR 750 billion in bond purchases, and the European Union has suspended fiscal rules to allow governments to respond. Even Germany seems resigned to deficit spending to support growth.

These are trillions of dollars that will help even if the timing is tricky. Over the next few weeks, nothing will come soon enough. Yet, if the virus is truly under control later this year, the monetary measures deliver their effect just as life returns to normal.

This brings us to the third question about the damage the shock will bring. We can now officially set aside tired debates about whether there will be a recession this year. There will. The IMF started 2020 predicting an acceleration to 3.3% from 2.9% last year, but forecasts have been coming down and will surely fall below the 2.5% growth threshold it defines as recessionary. It will bring unemployment, defaults and bankruptcies. The most vulnerable industries–aviation, tourism, retail–may get emergency funding to tide them through. Still, the damage will be real.

We can probably assume first-quarter growth will fall near zero when all the revisions account for the damage from China and the sudden collapse in global activity in March. The second quarter number will certainly be negative and could have two digits, although more precise forecasts are pure speculation.

"These are trillions of dollars that will help even if the timing is tricky. Over the next few weeks, nothing will come soon enough."

At the same time, talk of a deeper global depression looks like so much fear-mongering, given our likely ability to track and manage the virus in the months ahead and a massive government response that would make John Maynard Keynes proud.

So the central question for anyone trying to price anything at all into these markets is will global growth turn negative for one quarter or two?

As markets track the news of mounting coronavirus cases, government action and lasting damage, they’ll focus on whether the third quarter will show early signs of normalization or if it takes longer for activity to resume. Will there be containment setbacks that postpone a full return to normal? Will confidence take even longer to reappear if there are fears of a relapse?

Markets won’t recover until there are answers to these questions, but they may begin to stabilize if investors can agree on the right questions to ask.