Economic recessions are inevitable

"A recession is inevitable"

A recession is inevitable and is part of tackling the health crisis. However, it will have very serious consequences for supply and demand worldwide, comments Marc-Antoine Collard, Chief Economist at Rothschild & Co Asset Management.

A global recession is most likely imminent. Indeed, many countries have been forced to take increasingly stringent measures to slow the spread of COVID-19, from social distancing to strict curfews. According to the OECD, each month with restrictions causes an average loss of two percentage points in annual GDP growth. The ultimate impact depends on the extent and duration of the restrictions, but also on the extent of the damage to demand and value chains. So investors are flying blind to the impact on corporate profits and profitability, even if most still anticipate a sharp but brief economic slump.

Gloomy prospects for Japan

According to the latest business climate surveys, the service sector is declining more than the manufacturing sector, as the restrictions particularly affect sectors such as gastronomy, hotels and tourism. As a result, the overall impact will be more severe as services are a major part of our modern economy. Given the self-inflicted shock, governments have provided emergency aid to their economies. Along with South Korea, Japan is one of the countries that have dealt best with the current health crisis. Nevertheless, the country was probably already in a recession before COVID-19 and is now facing a deterioration in the global environment. In addition, Japan was forced to postpone the Olympic Games that were due to take place in Tokyo in July. Abe's government has therefore announced its intention to launch a stimulus plan worth nearly 10% of GDP, with a third being direct transfers to households and businesses.

Historical increase in the number of unemployed in the USA

In the US, according to most epidemiologists, the Trump administration's chaotic management of the pandemic could lead to the worst health crisis in developed countries. In the meantime, Congress has agreed on a package of 2,000 billion US dollars, or around 10% of GDP. The plan includes income transfers for certain taxpayers as well as an increase in unemployment benefits over a four month period. The labor market has deteriorated dramatically as 3.3 million people have registered as unemployed. In comparison, the increase in the number of unemployed during the financial crisis of 2008/09 was just over 650,000 people. This shows that the speed and extent of the current deterioration in the US labor market is historically unmatched.

USA: Initial claims for unemployment benefits

While the US stimulus package is undoubtedly large, it has to be seen in comparison to the various projects in Europe. In fact, only half of the stimulus package is a direct injection of cash, while the other part is linked to, for example, guarantees or loans to the hardest-hit sectors. In addition, the safety net in the US is weaker compared to social programs in Europe, not to mention a health system that leaves nearly 27 million Americans without insurance. Therefore, the program aims to overcome a system of limited social protection.

Liquidity to avoid debt crisis

Undoubtedly, the question of the financial viability of national debt arises not only for the US, but also for all countries whose budget deficits will quickly worsen due to falling revenues and skyrocketing spending. For now, however, the central banks have decided to do everything possible to allow governments to intervene fully and to ensure the smooth functioning of the financial system.

In fact, the spread of the virus and its economic impact have caused high volatility in the financial markets. Equity indices fell and credit spreads widened, particularly in the high yield area, which put a strain on companies' financial resources. For example, the Fed's unlimited injections of liquidity through extensive emergency credit lines, unlimited QE and repo deals, and expanded dollar swap lines have eased the burden on a large part of the credit market. These include investment grade corporate bonds, money market paper and mortgage Pfandbriefe. Finding ways to restore liquidity and contain key areas of the financial market is critical to avoiding a major debt crisis that would exacerbate the economic downturn and jeopardize economic recovery.

Serious consequences for supply and demand

In the meantime, the oil price has collapsed - adversely affected by a fall in demand and an increase in supply orchestrated by Saudi Arabia. This will support consumer purchasing power. However, the speed of price correction will also increase the financial burden as many producers will go bankrupt. In emerging markets, currencies have depreciated sharply against the US dollar amid massive capital outflows, which will weigh on the private sector's ability to service its US dollar-denominated debt.

Emerging markets: exchange rate vs. US dollar

In short, a recession is inevitable and is part of managing the health crisis. However, it will have very serious consequences for supply and demand worldwide. The economic policy response has certainly been very quick, but it has proven appropriate to the challenge of a severe recession hitting an already weak global economy with only 2% growth in the past twelve months and inconveniently low inflation.

World economic growth

Temporary shock or permanent damage?

Accordingly, the end of the crisis promises to be extremely complex. Budgetary and monetary support measures aimed at promoting part-time unemployment rather than layoffs, postponing business costs (taxes, rents), and avoiding credit restrictions are all factors that will help prevent a presumably temporary shock that causes permanent damage . However, as long as the population is not convinced that the pandemic will calm down, it is rather illusory to hope that they will produce, spend or travel as if nothing had happened. In this regard, reports from China have asked a county in Henan to stay at home after it became known that there were cases of infection because a doctor returning from Wuhan had already passed the virus on to his colleagues. It is unclear whether this is a one-off case. But if there is a renewed increase in cases, especially if mobility increases again, then there is clearly a risk of renewed restrictions.

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