William De Vijlder

Group Chief Economist BNP Paribas

Drop in data confirms need for strong policy reaction

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Crise économique

Faced with a sudden stop, policy switches to a ‘whatever it takes’ mode

Recent activity and demand data for China show the huge impact of the coronavirus epidemic. German business expectations have seen an unprecedented monthly drop in March . The drop in the price of oil acts as an additional drag on growth and a source of increased credit risk. The strengthening of the dollar is a source of concern for issuers with foreign currency debt in dollar. Despite swift action of the major central banks and the announcement of increasingly important fiscal policy support in various countries, equity markets have barely reacted: lack of visibility dominates.

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Interview CNN du 9 mars

How will the coronavirus impact global growth

Richard Quest will ask William De Vijlder three main questions : How will the coronavirus affect global growth ? What have been the recent actions of central banks ? What governments should do in terms of fiscal policy ?

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Coronavirus + stock exchange

Addressing the economic consequences of the coronavirus: waiting for the fiscal policy impulse

Wall Street has entered a bear market, having declined more than 20% from its high. Equity markets globally have seen huge declines this week and corporate bond spreads have widened significantly.Despite the positive news from China, the combination of an uninterrupted international propagation of the coronavirus has dealt a blow to expectations about the growth outlook for the next several months. The oil shock has made matters worse.Central banks have reacted. After the Fed rate cut last week, the Bank of England cut rates as well and the ECB also took several measures to support activity.The instrument of choice at the present juncture is fiscal stimulus of a sufficient size. Both in the US and the eurozone, we are still waiting for this impulse.

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Coronavirus

The importance of monetary policy in addressing the economic consequences of the coronavirus

The Federal Reserve created a surprise this week by, quite unusually, going for an inter-meeting cut of the federal funds rate of 50 basis points. At first glance, the very nature of an epidemic makes monetary policy ill-equipped to address the consequences. The drop in demand and the disruption of supply are not related to the level of interest rates. Nevertheless, monetary policy has an important role to play in the current environment by seeking to avoid a deterioration of the financial and monetary conditions. This is a defensive move, the alternative being to run the risk that the tightening of these conditions acts as an additional brake on activity. It seems this has played a role in the decision of the FOMC and it now puts the onus on the ECB to act at its meeting next week.

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Incertitude

Financial markets and the coronavirus: what price for uncertainty?

In theory, and all other things being equal, an increase in uncertainty results in a fall in the price of risky assets and an increase in the price of safe haven assets. In a way, this can be considered as the “price of uncertainty”. The reality is rather more complex. Greater uncertainty also affects growth prospects, which in their turn influence asset valuations.

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Effet domino

The coronavirus: international propagation and tail risks

The international propagation of the coronavirus forces a rethink of the consequences for the global economy. Coming after the outbreak in China, the marginal impact on the global economy of the spreading of the epidemic should, a priori, be rather limited. Yet, financial markets have reacted very negatively. This jump in risk aversion reflects concern that the economic consequences may have been underestimated thus far as well as increased focus on tail risk. This ‘financial accelerator’ phenomenon may in turn contribute to the worsening of the growth outlook.

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US inflation

The Federal Reserve’s strategy review: towards a target range for inflation?

As part of the Federal Reserve’s strategy review, the introduction of a target range for inflation is being discussed. Such a range could provide flexibility in the conduct of monetary policy. It could also take into account past shortfalls in inflation. Introducing a range when inflation is below target runs the risk of being perceived as not being bothered by the inflation shortfall. This would call for an asymmetric range but this increases the risk of market turbulence when a tightening cycle starts.

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Marchés financiers

The strange relationship between markets and uncertainty

Economic sciences teach us that financial markets fear uncertainty as it introduces volatility in prices of financial assets. Based on the reaction of markets since the beginning of the year, one could conclude that economic textbooks need to be rewritten. In spite of a high level of commercial and geopolitical uncertainty, markets have recently set new records.

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The coronavirus: putting a number on the economic consequences

Putting a number on the consequences of the coronavirus is a huge challenge. On some of the topics we have a satisfactory level of visibility of the order of magnitude: international spillover effects of the demand shock, repercussions of the global increase in uncertainty. The visibility is much lower concerning the effects of the supply disruption. This is even more the case for the impact on China. In the near term, data surprises –the difference between the consensus forecast and the outcome- should be higher than normal. However, provided that the peak of the epidemic is reached quickly, visibility should improve quickly and hence support confidence.

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Economic growth

The coronavirus and the profile for global growth in 2020: V, U or L?

From an economic perspective, the coronavirus epidemic represents a combination of a demand, a supply and an uncertainty shock. The weight of China in world economy, its contribution to global GDP growth and its role in global value chains imply that the international repercussions are more far-reaching than during the SARS crisis in 2003.We have to brace for poor data in February and March, so the real test is whether April sees a pick-up in business surveys. Absence thereof would fuel concerns that the impact is more lasting in nature which would put us in a U-type scenario. An L-type scenario looks unlikely as yet whereas a V-type recovery would supposes a swift decline in new cases.

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Analyse données économiques

Global: how many swallows make a spring?

Recent survey data have picked up, in particular in the manufacturing sector and in terms of export orders. The European Commission noted a marked increase of economic sentiment in the European Union, the eurozone, Germany and France in January, after substantial weakness in Q4. Although economists expect a pick-up in growth in the US as the year progresses, the dispersion is very wide. This means that the median forecast will inspire less confidence than if the level of disagreement amongst forecasters would be lower.

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BCE

ECB: reviewing strategy whilst waiting for inflation

The ECB remains cautious in its assessment of the economic situation characterised by risks still tilted to the downside, although less than before thanks to the US-China trade deal
The message is slightly better on underlying inflation where some signs of a moderate increase are noted
Between now and year-end, the strategy review, which has now been launched, will grab a lot of attention, with markets wondering how it could influence monetary policy
The review is also important from the perspective of climate change: will monetary policy operations take it on board as a risk factor or will ambition even be higher?

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Import Export

The US-China trade: few reasons to be cheerful

The US-China trade deal has brought relief. It avoids new tariff increases by the US with the risk of further escalation. The deal should be welcomed in China, given its ongoing growth slowdown, but also in the US where companies had increasingly expressed their concern about the trade confrontation. The rest of the world will monitor closely the extent of trade diversion which could follow from the agreement. Attention will now shift to the phase 2 negotiations, which could very well mean that trade uncertainty will intensify at some stage.

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Question marks

Markets and geopolitical uncertainty: (ir)rational complacency?

There is a considerable gap between what are considered to be the geopolitical ramifications of the escalating tensions between the US and Iran since the start of the year and the subdued reaction of markets. The market reaction probably reflects the investors’ view that the probability-weighted impact on growth should be very limited because the risk of a major escalation is considered to be small and/or because of an expectation that the impact of higher oil prices on the economy is limited. What also may play a role in the market reaction thus far is that, leaving the geopolitical uncertainty aside, the economic environment is considered to be conducive to taking risk: stabilisation of survey data, reduction in trade-related uncertainty and accommodative monetary policy.

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Economie mondiale

2019: a difficult year, ending on a hopeful note

2019 has been dominated by uncertainty, in particular about trade tensions and hard Brexit risk, as well as mounting concern about the slowdown of the global economy. This has led to additional policy easing by the ECB whereas the Federal Reserve has reversed course by cutting the federal funds rate on several occasions. This has further reduced the remaining policy leeway of central banks, a subject that will be analysed in the context of the strategic reviews by the Fed and the ECB. It has also led to increased calls for fiscal stimulus. Equity markets have delivered surprisingly strong returns with investors preferring to look at the role of lower interest rates, rather than at the weakening of the profits outlook. The year ended on a hopeful note with the improvement of certain business surveys.

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Zone euro

Eurozone: very low interest rates for how long?

Danish monetary policy is closely linked to ECB policy so the recent statement of Denmark’s central bank governor that he expects interest rates to remain around current negative levels in the next five to ten years is not without importance for the Eurozone. Forward guidance by ECB implies that policy will only be adjusted when justified by economic conditions. The inability to be clearer in terms of time frame illustrates the complexities of inflation dynamics. Past wage increases will gradually filter through in a pick-up in inflation although low inflation, well-anchored inflation expectations and intense competition in certain sectors may very well moderate this transmission. It thus seems clear that the current policy will remain in place for a considerable time. How long ’considerable’ turns out to be will depend on the data. The eurozone clearly needs more growth.

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Global economy

Global economy: stabilisation, stability, opacity

Based on business surveys, the cyclical environment, globally, seems to have stabilised. A similar picture emerges for the eurozone and China, whereas in the US it is mixed. ‘Stability’ characterises the monetary policy outlook. After the announcements in September, the ECB can afford to wait before making a judgment of the effectiveness of its policy stance. For the Federal Reserve, it seems that the bar for envisaging a change in the federal funds rate is high, even more so when it’s about considering a rate hike. Stabilisation of economic data and a stable, very accommodative monetary stance provide reasons for being hopeful, but this supposes that uncertainty doesn’t increase again. In this respect, unfortunately, the situation remains very opaque. Shifting to a higher gear in terms of growth then becomes more complex.

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Eurozone

Eurozone: QE and market instability risks

The ECB’s monetary policy meeting account illustrates the dilemma it is facing: inflation is subdued and risks to growth are tilted to the downside, yet the financial stability implications of the very accommodative policy need to be closely monitored. These implications are covered in sobering detail in the ECB’s Financial Stability Review. A possible side effect of very low to negative interest rates is that borrowing and spending become more procyclical. Quantitative easing (QE), by modifying the risk structure of investment portfolios (less government bonds and more exposure to assets with a higher risk), will probably increase the sensitivity of portfolio returns to the business cycle.

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Eurozone

Eurozone: which role for automatic fiscal stabilisers?

Automatic fiscal stabilisers help cushion the impact of economic shocks on GDP via changes in government revenues (because of progressive taxes) and expenditures (unemployment insurance). The limited remaining monetary policy leeway in the eurozone is fueling interest in the effectiveness of the automatic stabilisers. European Commission research confirms that, to some degree, automatic stabilisers iron out the impact of negative shocks on GDP. Whether that is enough is another matter. It warrants a debate on the role of discretionary fiscal policy in case of a recession.

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Financial Markets

What drives the recent rise in bond yields and equity markets?

In recent weeks, equity markets performed well. Focussing on the US, it is hard to argue that this reflects an improvement in the earnings outlook or a perspective of more rate cuts than hitherto expected. This would imply that a decline in the required risk premium was the key driver. US treasury yields also increased significantly, which probably reflects to a large degree an increase in the term premium. The decline in the equity risk premium and the increase in the bond term premium were driven by a common factor, namely a reduction in economic tail risk on the back of progress in the trade negotiations between the US and China and a stabilisation of certain survey data.
The reduced likelihood of very negative economic developments, which has boosted equity markets, has also reduced the attraction of bonds as a hedge against equity risk. As a consequence, bond yields have moved up in sync with equity markets.

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William De Vijlder

About William De Vijlder

Group Chief
Economist
BNP Paribas
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