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Catching the COVID-19 knife: preparing for an economic shock and resuscitation


By , David Bailin, Chief Investment Officer , and Steven Wieting, Chief Investment Strategist and Chief Economist

March 16, 2020Posted InEquities, Fixed Income and Investment Strategy

This is, in our view, a true Black Swan set of events. The world economy is facing a health care crisis that will cause a major global disruption in business activity and everyday life. In this extensive Special Report, we want to ensure that you calmly understand the nature of the health issues and likely economic impacts as well as the responses taken and those still needed to adequately address the crisis.

Contained herein is information on many elements of the COVID-19 pandemic and its trajectory. We talk about the varied health care responses of governments in the East and West to the virus, from containment to mitigation to an even more bold experiment in the UK. Our analysis explains why curve flattening is good health care policy with a big economic price tag. We review the untimely nature of the Russia-Saudi oil price war and its impact on credit markets. Our Special Report contains estimates of the expected fall in economic activity in Q2 and Q3 of 2020. And we also review last week’s stock and bond market activity and “What the Markets Are Telling Us” that we may not be hearing. Finally, we talk about the market malfunctions last week that underscored the Fed’s decision to move again in an emergency fashion to ensure market order amidst this extraordinary set of events.

We now expect the US economy to contract 4%-5% in the second quarter, and Eurozone economies to contract 5%-10% in the period. While China will likely soon begin a rebound from a similar negative pace of quarterly decline in 1Q, overall global growth will likely range from 0%-1% for the full year 2020. Corporate profits will likely fall 15% this year.

Beyond the Fed’s strong monetary policy steps noted below, important further fiscal steps are needed to avoid worse outcomes than our new assumptions. Support for small firms and individuals who will not earn incomes during the Covid-19 shutdowns can still avoid a spiral of insolvency and economic contraction after the virus passes. We view the near-term outlook as quite challenged, but our confidence has increased somewhat that policymakers are now awakened to the risks.

On the evening of Sunday 15 March, the US Federal Reserve took a second emergency action in less than a week, slashing interest rates by 125 basis points to 0-0.25%. In addition, the Federal Reserve committed to restore market liquidity with $700 billion in US Treasury and Mortgage Backed Securities Purchases, a cut to zero in US bank reserve requirements, and USD swap line expansion in conjunction with other central banks. We expect other central banks to make announcement tomorrow. The Fed’s actions recognize the severity of the health and economic threats posed by the COVID-19 virus.

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