With economic activity disrupted and capital
markets dislocated, investors are debating if Covid-19 will derail the global cycle. In times of sharp
drops in asset markets, pessimistic prognoses are easy to make, but it is at times like this when some
perspective is warranted.
Coming into the year, we had a growing body of evidence that, after
a tough 18 months, the global economy was on the mend. PMIs new orders were improving from October and
headline PMIs troughed then too. Global trade was growing again in December after contracting for six
months. While there was still skepticism then, we thought these data points were lending support to our
thesis of a global recovery taking hold from 1Q20.
The outbreak of Covid-19 has certainly
changed the near-term narrative. It is an untimely shock, considering that the starting point of global
growth was weak, and the recovery was very nascent. The disruptions to economic activity will create a
pronounced impact on global growth in 1Q20.
The question is whether this is an exogenous,
transitory shock or one that fundamentally challenges the cycle. We are in the former camp. Indeed,
throughout this expansion cycle, we have had a series of shocks to the global economy, which have led to
a number of mini-cycles in global growth, but have actually helped to extend the cycle as we did not have
the runway to go into a traditional overheating situation.
Given the uncertainty over the
virus outbreak, we see three possible scenarios for the road ahead:
Scenario #1 – containment
by March: The virus outbreak is contained by end-March and production disruption is limited to 1Q20.
Policy-makers in China and Asia will provide meaningful policy support, with China expanding its fiscal
deficit by 120bp, keeping it high for the second year running. Global growth dips to 2.5%Y in 1Q20 (from
2.9%Y in 4Q19), but recovers meaningfully from 2Q20.
Scenario #2 – escalation in new
geographies, disruption extends into 2Q20: New cases continue to rise in other parts of the world, before
peaking by end-May. The disruption extends into 2Q20, affecting corporate profitability in select
sectors, risking the emergence of corporate credit risks. If the dislocations in asset markets also
persist into 2Q20, the sharp tightening in financial conditions may well become the overwhelming factor
and exacerbate the impact on growth via weaker corporate confidence and capex and cutbacks in hiring
In response, policy-makers around the world will step up easing measures – with
fiscal policy in Asia and Europe and monetary policy in the US doing the heavy lifting. Indeed, our chief
US economist Ellen Zentner expects the Fed to cut rates by 25bp in March and to maintain an explicit
promise to continue if growth damage extends.
Global growth averages just 2.4%Y in 1H20, but
picks up from 3Q20. Scenario #3 – persisting into 3Q, escalating recession risks: The virus
continues to spread into 3Q, encompassing all the large economies. China faces a renewed rise in new
cases as it restarts production. Disruption continues into 3Q. The extended disruption to economic
activity damages corporate profitability and brings about a rise in corporate credit risks and
significant tightening in financial conditions, which exacerbate the slowdown in global growth.
Central banks will embark on a renewed easing cycle, with the potential for a coordinated response. We
expect the global weighted average monetary policy rate to dip to its lowest level since 2012.
The Fed extends the cuts from March-June and becomes more aggressive in 50bp increments to take rates
to close to the lower bound by 3Q20.
The fiscal response across key DM and EM economies also
becomes more aggressive, with China taking up 200bp of fiscal expansion. The cyclically adjusted primary
fiscal deficit for G4 and China widens to 5.1% of GDP in 2020, from 4.1% in 2019. Global growth stays
weak (i.e., below 2.5%Y) between 1Q20-3Q20.
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