What will be coming next?
This commentary is intended for professional investors only within the meaning of MiFID II.
Although it is difficult to assess the current economic impacts of a global lockdown, economists are now starting to forecast growth in order to estimate the degree of contraction of the activity.
One thing is certain, a global recession for the year 2020 will succeed to the major health crisis the world is experiencing. The questions will now lean towards the gravity of the recession and the form of the expected recovery.
Unlike previous crisis, governments and central banks reacted quickly and strongly, like the ECB, with a € 750 billion asset buy-back program, and the Fed, with a no size limit “Quantitative Easing”.
Debates will soon open regarding the cost of this situation, the debt sustainability and on the treatment of these exceptional deficits.
The markets have obviously understood the challenge that the world is facing. All asset classes have been impacted and allocating assets has been made more complex, while the lack of liquidity has sometimes complicated the work of the portfolio managers.
We will have to gradually refine our economic forecasts to be able to adjust the valuation of asset classes of which some parameters have radically changed.
HISTORICAL CRISIS… HISTORICAL RECOVERY PLANS
The global economy is on hold and no one knows how long this situation will last.
However, economists are trying to adapt their growth forecasts to this new highly uncertain environment, and the shock looming ahead of us now seems unprecedented.
Some US investment banks are forecasting -25% to -30% annualized growth in Q21, a drop two to three times greater than the worst drop recorded in American history.
We definitely can imagine Europe experiencing an equivalent shock of 20%.
These figures are impressive, with effects undoubtedly even greater in the most affected industries such as casinos (-95% of revenues), sports (-80%) or even hotels (-75%). The global recession is no longer a possibility today but is almost a certainty. Moderate at first, in their responses, Authorities seemed to take the issue very seriously since last week. What are these responses?
1. Monetary responses
Central banks have put in place measures that remind us 2008’s most difficult moments:
- The ECB has set up a €750 billion asset programme; this programme, known as the Pandemic Emergency Purchase Programme (PEPP), could increase if necessary, despite the reluctance of Germany and the netherlands. It could also deviate from the "capital key" and adjust its own constraints if necessary. If we add to this the possibility for countries to call on the OMT2 (with fewer constraints than before), the ECB's action seems credible to us and it is a powerful signal regarding the action capacity for any country under "fiscal stress"3.
- The Fed lowered its rates to -0.25%4 (i.e. a 150bps drop since the beginning of the month) and first announced that it would resume its "quantitative easing" programme by buying $700 billion worth of US government bonds and then make this programme "open ended", i.e. without any size limit. The Fed also reinstated various lending mechanism programmes to reduce the risks to the economy (CPFF (commercial papers), PDCF (primary dealers), etc.). Finally, and perhaps most importantly, the Fed has provided almost infinite swap lines to all central banks in order to meet the exponential demand for dollars4.
- Other main central banks have taken similar action, by lowering their rates and/or increasing their asset buyback programmes (England, Switzerland, Japan, etc.).
Generally speaking, after a period of uncertainty, these announcements show that the monetary authorities will do everything possible to ensure the system’s survival: provision of liquidity and easing of financing conditions for banks, governments and, indirectly, companies.
2. Budgetary responses:
Governments have announced budgetary measures never seen before; while the lack of a coordinated European response is regrettable, all European countries have said they are prepared to do everything possible to support economies and provide multiple aids to firms. And the same is true on the other side of the Atlantic or the Channel. While these announcements have not yet been finalized or definitive, they at least seem to show that governments have grasped the magnitude of the challenge affecting our economies. Let's look back at some of these announcements:
- United States: Since March 13, The American government has taken multiple measures to fight the future growth decline: Declaration of the state of emergency ($50Bn), delays for paying taxes ($300Bn in credit), and above all, lately, an agreement would have been reached at the senate regarding a massive fiscal stimulus plan, according to a white house adviser. This plan should be signed by the house of Representatives quickly and the latest information suggests $2000Bn (or 10% of GDP) for supporting both households and businesses. We are very close to what is called "helicopter money", especially considering that the Treasury may issue 50-year bonds (never seen before) to finance this stimulus, and that the Fed will probably be the main buyer.
- Germany: So far unthinkable, Germans have recently announced major measures. Finance Minister Olaf Scholz said he was planning a crisis budget of €150 billion, or about 4.4% of German GDP.
- France: It is very difficult to put a figure on all the measures announced, but they are very substantial: a €45 billion recovery plan, deadlines for social security contributions, tax cuts, guarantees for SME loans, etc.
It is likely that other stimulus packages will emerge in the coming weeks, with a mantra that seems to be shared by most of our governments: "whatever it takes". It is impossible for us to know what the future of this crisis will be, but these different actions will have long-term impacts for all financial markets, impacts that we must keep in mind to be able to correctly analyse the current state of these markets.
1 Source: Bureau of Economic Analysis, March 2020 ex: Goldman Sachs -24%, BofAML -25%, Morgan Stanley -30%
2 OMT: Opérations Monétaires sur Titres
3 Source ECB, March 2020
4 Source Fed, March 2020
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