That said, no-one should underestimate the severity of the crisis:
1) Isolating populations is essential to stem the epidemic but comes at significant economic cost. Christine Lagarde and the ECB consider a 5% contraction in euro zone GDP in 2020 is now an unfortunately plausible hypothesis. It seems likely this scenario of a European recession is now priced in. But what will happen to markets when the USA also announces it is quarantining its population?
2) In just a few days, governments all over the planet have announced unprecedented support packages and central banks have come in all guns blazing. In Europe, the aim was to repeat Mario Draghi's “whatever it takes” trick. From Emmanuel Macron’s “whatever it costs” to Lagarde’s “there are no limits to our commitment to the euro”, it is the no-limits message that comes through. However, this tidal wave of massive announcements may well induce a degree of anxiety in some watchers. Not everyone can be Mario Draghi, particularly as the hero of 2012 was able to count on a surprise factor that is now much diminished. In any event, the fact is these extensive plans have not as yet prompted any significant recovery in stock markets, which is embarrassing.
3) The last few weeks have seen the emergence of some worrying market phenomena, notably temporary liquidity problems with US Treasuries linked partly to the ongoing dash for cash. Rates have tightened in this climate of mistrust toward sovereign debt, as massive spending announcements may raise doubts among some, as mentioned in point 2.
4) Finally, the worst of the health crisis is yet to come. Saturation of hospital systems in Europe and soon the USA prevents severely ill patients getting high-quality treatment. Specialists think this could sadly result in a heavy death toll over coming months. The coming trauma for populations will have its consequences, even if these are hard to quantify with any degree of exactitude at the moment.
For all that, we need to bear in mind the following:
1) China and South Korea have mastered this epidemic in three months. We are not in a total impasse: the health crisis will have an end.
2) The measures to shore up the economy may not be enough to stabilise the markets but are nevertheless solid support factors. They should permit a rapid restart of our economies as most of the productive base will be preserved. The numbers in the stimulus packages are impressive: EUR 45 billion in France, EUR 20 billion in Spain, around EUR 25 billion in Italy and around GBP 34 billion in the UK. On top of this are the state guarantees of corporate bank loans, totalling around EUR 300 billion in France for example. In the USA, the total package of measures is worth around USD 1,300 billion.
3) Central banks are determined to pull out all the stops to ensure the smooth running of markets and adequate funding for the economy. As for the Fed, it is engaged on all fronts: rapid rate cuts, intervention in Treasury bond and corporate debt markets, measures to underpin the liquidity of US money market funds. The ECB was also quick out of the blocks, with massive purchases of sovereign and corporate debt to come in a much more flexible framework than previously. Greece, for instance, has been included in the system and the debt purchase programmes are not conditional on austerity measures. Can European and US central banks afford these commitments? The answer is probably yes, as the dollar and euro are two reserve currencies with no serious rival other than the yuan and are backed by powerful economies. This gives some room for manoeuvre when it comes to printing money, which in turn allows increased fiscal spending and makes the measures set out in point 2 sustainable.
4) Finally, we must not forget the spectacular slump in the oil price - the second key factor in the current situation. The low price per barrel, result of the rivalry between Russian, Saudi and US producers who are locked in war for market share as demand slows with people shut up at home, should last months and is a decisive support factor for the global economy.
Financial markets care little right now about these last four points but this is unlikely to last. It is probably time to start moving gradually back into risky assets.
Article completed on 19 March 2020 by Florent Delorme, macroanalyst at M&G Investments.
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