Coronavirus & Economic Crisis: 3 Possible Paths Forward

29555

CORONAVIRUS IMPACT

Volatility looks like a mainstay for the coming months. Analysts at the private investment bank JPMorgan Chase & Co. outline three paths forward from here.

Here is a spotlight on how the virus outbreak impacted key economic dynamics that lead to current developments:

A negative supply shock. As the virus spread in Wuhan and other parts of mainland China, containment efforts shut down production and disrupted supply chains.

A negative demand shock. No one wants the virus to spread, so they stop going out and spending money (or policymakers have told them they can’t go out and spend money).

An oil shock. There are two sides to this one. The good news: More supply lowers prices, which increases consumers’ disposable income. The bad news: Energy producers have lower revenues, and are more likely to lose market share, decrease spending, lay off workers, and default on debt.

Updates 15th April:

So where do we go from here? The recent market volatility is an indication that markets don’t really know, even if they are trying to figure it out. JPMorgan Chase & Co. analysts see three broad paths forward.

Path 1: A quick recovery with little lasting damage. In this scenario, the spread of the virus and associated social and economic disruption continue to escalate for a while longer, but peaks in the spring (say, in April or May). The world will likely have to deal with weaker global trade, below-trend Chinese growth for the year, and very weak growth levels in the United States, Europe and Japan throughout the second quarter. But into the summer, the virus will be contained, and the benefits of the fall in oil prices, lower interest rates and possible policy action (like tax cuts and bridge loans) would likely cushion consumer and corporate balance sheets and lead to a swift rebound back toward trend.

In this scenario, equities would likely recover their losses, high yield spreads would tighten, sovereign bond yields would rise, gold could fall, but oil would be at the mercy of the fight for market share (in all three scenarios).

Path 2: Prolonged weakness and a sluggish recovery. Here, the virus persists and reduces consumer spending and economic output well into the summer. The oil shock adds to global demand weakness (from oil producers) and increases credit stresses. Activity in China begins to normalize, but exporters face weak external demand. Global growth is flat in the first half of the year due to the shutdown in China and containment in other regions (think Italy). For context, global growth has not been below 2% since the global financial crisis. Extended disruption brings the risk of damage to corporate profitability and a rise in corporate credit risks, which are exacerbated by lower oil prices. Governments and central banks respond with stimulus, but risk aversion and supply disruption limit the effectiveness.

Markets seem to be pricing something similar to this scenario right now. If this continues, we would expect choppy equity and credit markets, low sovereign yields, and gold prices to remain elevated.

Path 3: Global recession. In the worst-case scenario, virus disruption and the oil price shock cause a sharp downturn in demand and rise in corporate defaults. This leads to a negative spiral of lower capex, weak consumer confidence, and eventually layoffs and rising unemployment in most developed economies. Deflation risk is prominent. Governments lack coordination or willingness to respond with appropriate fiscal measures, and the major central banks pursue more unconventional stimulus measures.

In this scenario, equities and credit would likely sell off more, sovereign yields would head lower still, and gold would likely rally.

At present, financial markets seem to be expecting something similar to Path 2 (prolonged weakness and sluggish recovery). According to market indicators, risk-free Treasury bonds are already pricing in a recession, while risk markets (credit and equities) are between half and three-quarters of the way there. This repricing has been rapid. 

Then, we have to monitor the extent to which the disruption in the most exposed sectors ripples through to other areas of the economy. We can track this by watching unemployment numbers, business confidence surveys, and borrowing activity from both households and corporates.

Only time will tell which path we are on, but it’s our sense that anything better than acute disruption through the first half of the year would be positively received by markets.

As volatility is expected to be a mainstay of the months ahead, the best thing you can do is have a plan to ensure you are on the right path to meet your goals.

1 COMMENT

  1. May Allah protect all humans from this deadly disease.I request every body pray to Allah for every one safe and secure.

LEAVE A REPLY

Please enter your comment!
Please enter your name here