Key Calls April 2020 - Capital Economics

Worst global recession since WWII

We warned in February that the effects of the coronavirus on the global economy could be worse than those of the Global Financial Crisis. Our current projection is for a 4.5% contraction in world GDP this year, which is larger than most forecasters expect and comfortably the steepest decline since WWII. Once lockdowns have eased, activity should rebound quite strongly, but persistent weakness of demand is likely to mean that GDP takes a long time to return fully to its pre-virus path. Central banks are at or very close to their limits and fiscal support will be ramped up further. This might imply a danger of future inflation. But we think that the disinflationary effects of weaker demand will outweigh any boost from supply shortages, at least over our forecast horizon.

Global Markets & Asset Allocation

Recovery in markets likely to keep favouring those hit hardest

Across developed and emerging economies, those stock markets and currencies that had fallen the most after fears emerged about the coronavirus outbreak have generally bounced back more strongly since such concerns have eased. Provided that the virus is contained in most major economies, we think that this pattern will continue between now and the end of this year and suspect that equities in parts of the emerging world will be the best performers in those circumstances. Nonetheless, we doubt that risky assets in general will make up all of the ground that they have lost.

United States

Virus disruption to only partially reverse in second half of 2020

As a result of the coronavirus containment measures, we anticipate an unprecedented 40% annualised decline in second-quarter GDP. Even allowing for a recovery in the second half of the year, we estimate that GDP growth for this year will be -5.0%. We do expect the recovery to continue into next year, with GDP growth of 6.5% in 2021 and 3.3% in 2022. Nevertheless, even by the end of 2022, our forecasts imply that the level of real GDP will still be 2% lower than its pre-virus trend. We also anticipate some permanent scarring in the labour market, with the unemployment rate still at 5% at end-2022.


Virus effects and oil price slump will cause some long-lasting damage

The severe restrictions on activity are set to cause a dramatic 45% annualised drop in GDP in the second quarter. The recovery is set to be fairly slow and we expect an 8% fall in GDP for 2020 as a whole. This suggests that policymakers will still need to do more to support economic growth, and we expect the Bank of Canada to expand its asset purchases again before long.


On the brink of a sharp slump

The euro-zone is on the brink of a huge economic slump due to the measures taken to control the spread of COVID-19. The timing and depth of the downturn are highly uncertain, but we have pencilled in a decline in GDP of nearly 20% in the second quarter. We think that the subsequent recovery will be very quick by past standards, but that output and employment will not return to their pre-crisis trends. In the absence of a joint fiscal response, national governments will also be left with much higher debt ratios. The ECB’s expanded asset purchases should prevent a re-run of the debt crisis this year, but QE might still have to be stepped up again. And further down the line, much higher debt loads will leave Italy more vulnerable to losses of investor confidence.

Nordic & Swiss

Lockdowns causing carnage

Movement restrictions in the Swiss and Nordic economies have already caused carnage in labour markets. The early signs are that the economic damage will be worse than expected by consensus and local governments. Our forecast for oil prices to remain subdued means that this is particularly true in Norway. Although central banks’ focus so far has been on firefighting, their attention will turn to supporting the recovery as restrictions are lifted gradually. Against this backdrop, both the Riksbank and the Norges Bank look set to join the SNB in the sub-zero rate club by year-end.


Economy will struggle to get back to full health

It will take the economy a few years to recover from an unprecedented hit to GDP of around 25% triggered by the coronavirus lockdown. Despite the unparalleled speed and size of the monetary and fiscal stimulus, the unemployment rate will probably still leap from 4% to 9% and many businesses will go bust. By the end of 2022, the economy may be 5% smaller than it would have been if the virus never existed and the cumulative loss since the end of 2019 may add up to a huge 20% of GDP.


BoJ to lower policy rate

Our forecast that Japan’s GDP will shrink by 7% this year in the wake of the coronavirus outbreak is far more pessimistic than the analyst consensus. We think that the Bank of Japan will provide some modest support to the economy by lowering its policy rate to -0.2% in April, but fiscal policy is doing the heavy lifting. The government has responded by announcing a fiscal support package with vastly inflated headline numbers but we think that more fiscal support will be required.

Australia & New Zealand

RBNZ to slash rates into negative territory

The recent sharp fall in the number of new coronavirus cases in both Australia and New Zealand suggests that the restrictions imposed to stem the outbreak will be gradually eased over the coming months. Even so, GDP growth this year will be weaker than most anticipate. We agree with the analyst consensus that the RBA probably won’t cut interest rates any further. But we are firmly non-consensus in expecting the RBNZ to slash rates into negative territory in the second half of the year.


Slow road to recovery

China’s economy is starting to recover but the road ahead is long. The initial acceleration of activity as lockdown measures were eased is already running into constraints of weak demand. China’s state-led industrial and financial sectors give it some advantages in sustaining employment and keeping credit flowing, but the economy is at least a year from returning to its pre-virus path. The fairly restrained initial policy response will be jettisoned along the way, with interest rates likely to drop to near zero and fiscal support to be significantly expanded.


Slowest growth in four decades

Strict containment measures in response to the coronavirus outbreak in India will have severe economic repercussions, and we now expect the economy to grow by just 1% in 2020. That’s the weakest pace of annual growth in four decades. And while the RBI has emphatically responded with aggressive monetary loosening, large-scale fiscal stimulus is also needed to prevent the drastic economic slowdown from morphing into an outright contraction in annual output or a depression.

Emerging Asia

Massive recession underway and a difficult recovery ahead

With exports collapsing and countries across the region implementing draconian restrictions on travel and commerce, economic activity in Emerging Asia will contractsharply this year. Parts of South East Asia and Hong Kong are likely to be the worst affected economies. Even if the virus is eventually brought under control, weak demand and impaired balance sheets mean that recoveries will be gradual. Most economies are unlikely to regain their pre-crisis level of output until the middle of next year and will still be 2-4% smaller at the end of 2022 than if the crisis hadn’t happened.

Emerging Europe

Sharp contraction followed by a patchy recovery

Emerging Europe will experience its largest peak-to-trough fall in GDP this year since the global financial crisis. But one crumb of comfort is that banking systems are generally better placed to weather the fallout from an economic downturn than they were in 2008, which should support a faster recovery. The authorities in Poland and the Czech Republic have been successful in slowing the spread of the virus and the aggressive policy support suggests that their recoveries will be stronger than those in Russia and Turkey, where virus outbreaks are escalating and policy support has been more limited. In Turkey, this will be exacerbated by the sharp tightening of external financing conditions which could trigger a wave of bank defaults.

Latin America

Output tumbling, limited policy response

GDP in Latin America as a whole will fall this year at a steeper pace than it did during the 2008/09 global financial crisis or at the start of the region’s debt crisis in the early 1980s. Central banks are likely to cut interest rates further. However, weak balance sheets across the region and lacklustre policy responses in Brazil and Mexico suggests that Latin America’s recovery from the coronavirus crisis will be weaker than elsewhere in the emerging world. Fiscal problems will mount, with Brazil’s debt trajectory likely to get worse and Argentina getting closer to a disorderly default.

Sub-Saharan Africa

South Africa in freefall, debt risks growing

The economic effects of the coronavirus will push the region’s largest economies, notably South Africa, into deep recessions this year. A lack of testing means that the spread of the virus across the region remains unclear. But outbreaks in Africa’s poorer economies could prove difficult or impossible to control, which could make the economic damage much more protracted. The fiscal costs of the crisis make sovereign debt restructurings likely in many countries.

Middle East & North Africa

Gulf economies hit hard and recoveries will be slow

Efforts to contain the coronavirus mean that the economies of the Middle East and North Africa will suffer their steepest downturn this year since the early 1980s. Egypt, Morocco and Tunisia are particularly vulnerable to draconian social distancing measures and travel restrictions. Dubai also looks exposed and the scale of the downturn and the expected delay to the World Expo may cause fresh debt problems. Meanwhile, lower oil production and the collapse in oil prices will weigh on the Gulf economies. We expect dollar pegs to remain intact but there is limited scope for a fiscal response meaning that, once the virus is brought under control, recoveries are likely to be slow going.


Weak demand to weigh on all commodity prices

Despite the unprecedented output cuts pledged by OPEC and its allies, the hit to demand from virus containment measures will mean that the oil market will remain oversupplied for much of this year. That said, we do expect prices to start to pick up later this year in tandem with somewhat stronger global economic activity. Industrial metals demand will also suffer as a result of the economic downturn created by coronavirus, but there will be some support for prices from supply disruptions and stimulus spending on infrastructure in China. By contrast, we think that the price of gold could rise further in the near term on the back of safe-haven buying.

UK Commercial Property

Retail rents to fall furthest, industrial more resilient

Due to containment measures, it is increasingly likely that investment activity will slump to very low levels in Q2, though a recovery is expected in the second half of the year. We expect rents to decline this year, with retail seeing the steepest falls and industrial most resilient. Despite lower interest rates and bond yields, property yields are expected to rise and all-property capital values could fall by as much 10% y/y in 2020.

European Commercial Property

CEE markets most vulnerable

With European economic activity to be hit hard this year, we think that prime rents will drop, with the largest falls in the retail sector. Yields are also expected to rise in the near term, with CEE markets most vulnerable. However, if the virus is brought under control in coming months, we expect rental growth to bounce back. And the low interest rate environment will support property valuations, meaning prime office and industrial yields should continue their downward trend in many markets.

US Commercial Property

All-property capital values to fall by nearly 10% as activity slumps

Investment and leasing activity is set to fall, for both practical and economic reasons. Reduced occupier demand will cause rents to decline, particularly in the retail sector, while continued uncertainty will increase investors’ risk premium for holding real estate. We expect a combination of lower rental values and higher yields to push all-property capital values nearly 10% lower this year. This will be far smaller than the peak-to-trough fall in US REIT prices.

UK Housing

Housing transactions to collapse

The coronavirus lockdown will sharply cut housing transactions in Q2 – by perhaps 70% q/q, although transactions should partially bounce back in the second half of the year. We expect housing starts to fall in line with housing sales, as housebuilders pull back on construction in response to sharply falling revenues. Meanwhile, we expect the virus to trigger a fairly modest fall in house prices, as low interest rates, forbearance and government support help to keep the number of forced sellers low.

US Housing

Home sales to fall to record lows, but prices shouldn’t crash  

Disruption from the coronavirus will push home sales to record lows in the second quarter, but pent-up demand from the spring buying season and record low mortgage rates will help activity bounce back in the second half of the year. Widespread forbearance will prevent a house price crash, with a drop of around 4% likely.

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