Look for this week to be full of news about governments and central banks signaling their “whatever it takes” willingness to take additional policy measures to fight the contractionary impact of the coronavirus on virtually every economy around the world. Already, the Federal Reserve signaled on Friday readiness to loosen monetary conditions in the United States while Italy announced on Sunday a “shock therapy” of fiscal measures.
As more announcements materialize during the week, it will be crystal clear that the question will not be about the willingness to act but about the effectiveness of those actions. For the most part, the answer will be only partly satisfactory in the short term until two underlying health conditions change. Less obvious will be the need to weigh immediate benefits — partial and as necessary as they are — against the possibility of longer-term unintended consequences associated with the inevitable use of ill-suited policy tools for the task at hand. Those include more borrowing of growth from the future and even greater reliance on activities bolstered by central bank liquidity injections.
An increasing number of sectors and countries are experiencing sudden-stop dynamics as the economic effects of the coronavirus spread more widely around the world. Both demand and supply are being hit hard and in multiple ways. For example, News Corp., the owner of the Wall Street Journal, banned nonessential travel for its employees this weekend; more conferences are being cancelled around the world; airlines are reducing flights; and companies are asking employees to work from home.
It’s a dynamic that builds on itself in the short term, fueled by a “fear virus” and other behavioral traits that engender paralysis and insecurity. It also promotes self-reinforcing vicious economic cycles with adverse social, political and institutional spillover effects, amplified by the considerable risk of pockets of financial market malfunctioning.
The impact of all this will be a repeat internationally of what I called on Friday the “shock number” out of China: The manufacturing purchasing managers’ index for February not only came in well below expectations — 35.7 compared with the consensus estimate of 45.0 — but was also the worst reading on record. Several countries now face a high likelihood of recession, including Germany, Italy, Japan and Singapore, to name just a few, and some of the more financially stressed ones will experience a rise in credit risk and increasing threats of outright credit rationing.
With that, a growing number of companies will again be forced to revise downward their earnings guidance for the year or withdraw it altogether because of the exceptional uncertainties. Some, with limited cash cushions and maturing debt like their sovereign counterparts, will also have to worry about their refunding prospects, with mounting risk of higher defaults for the most exposed sectors.
In light of all this, it should come as no surprise that a growing number of countries will be announcing emergency stimulus measures. Indeed, those already signaled contain important information:
Friday’s rare four-line statement by the Fed pointed to the “evolving risks” facing the U.S. economy and the central bank’s readiness to deploy “tools and act as appropriate to support the economy.” Just like the Fed’s dramatic 180-degree policy turn a year ago from a multiyear path of raising rates to one of immediate cuts during the year, this opens the door for other central banks to loosen financial conditions. If not coordinated, it will be another year of correlated monetary policy stimulus, in which central bankers respond to the same economic conditions but do not cooperate.
Italy’s announcement highlights not just the more targeted policy focus — tax credits for companies suffering large hits to revenue and additional help to the health sector — but also the willingness of a government to act even in the context of prior fiscal constraints and potential tensions with Brussels.
But the considerable willingness of governments and central banks to act should not be confused with effectiveness.
For the reasons I have detailed before, countering an economic sudden stop, such as the one connected with the coronavirus, is a lot harder in the immediate term than resolving a financial sudden stop. It requires not just well-targeted national and local responses but also internationally coordinated, and not just correlated, efforts. (Think, for example, of the April 2009 G-20 meeting in London.) And, given the use of rapidly designed and poorly suited policy tools, it inevitably involves some collateral damage and unintended consequences, especially for longer-term economic well-being and financial stability.
The best that fiscal and monetary policy interventions can realistically hope for in the next few weeks and months is to:
- Support sectors critical to a holistic recovery, medical services in particular.
- Target the most vulnerable, responsive and highly consequential contracting sectors.
- Provide focused relief to corporate and household balance sheets.
- Bolster emergency assistance to countries overwhelmed by this exogenous and external shock.
- Counter pockets of market malfunctioning through timely direct liquidity injections.
- Provide increasing clarity as to what lies ahead for the global economy, national responses and global policy coordination.
These efforts, however, will not be able to engineer in the short term a generalized global and sustained recovery of the three main drivers of economic activity: consumption, investment and trade.
Consumption will be curtailed by households’ lack of confidence to interact in the economy. Weak demand prospects, as well as disrupted supply chains, will limit corporate investment spending. Trade in goods and services will languish as more countries impose restrictions in their quest to protect the health and safety of their citizens.
To decisively turn the corner, the global economy needs evidence of two health accomplishments: success in containing the spread of the virus, particularly when it comes to community transmission; and sustained success in illness recovery and avoidance, with the latter best done through the availability of a new vaccine.
As for financial markets, look for significant price and liquidity swings as traders navigate the tug-of-war between deepening economic and corporate damage on the one hand and central bank liquidity injections, policy announcements and health news on the other. The immediate opportunity for investors will differ depending on whether they favor highly tactical drivers (that is, day trading and exploiting arbitrage opportunities because of indiscriminate behavior in markets) or secular and structural ones (those looking for longer-term portfolio positioning that can withstand the considerable volatility ahead).