William De Vijlder

The measures to stop the spreading of the pandemic have a profound impact on the economy which increasingly shows up in the economic data.Record declines in business sentiment illustrate the necessity of the forceful policy measures which have already been taken.The lifting of the lockdowns will, mechanistically, trigger a rebound in activity but additional stimulus will probably be needed to maintain the momentum.

William De Vijlder, chief economist for BNP Paribas, discusses how the coronavirus outbreak is affecting the global economy, financial markets and policies. He speaks with Matt Miller on “Bloomberg Markets: European Open.”

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.

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.

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.

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.

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.

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.

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.

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.

Recent business surveys such as the purchasing managers’ indices, point towards a broad-based stabilisation in October. This is a welcome development after a prolonged downward trend. However, in a historical perspective, the recent readings are low or, looking at the manufacturing sector, very low. This points to an ongoing subdued growth environment. Going forward, a sideways movement of these surveys should increase the likelihood of a growth acceleration: when the frequency of bad news drops, confidence should eventually rebound, fuelling spending, all the more so given the very accommodative financial and monetary conditions.

Do fluctuations in uncertainty have a symmetric or asymmetric effect on the economy? The question is important considering that since last year, uncertainty has been acting as a headwind to global growth. Moreover, recent news about the US-China trade negotiations and Brexit have raised hope that uncertainty may have peaked and that growth in activity could accelerate. Empirical research shows that an increase in uncertainty has a bigger effect on the economy than a decline, in particular in a subdued growth environment. This would suggest that, should the decline in uncertainty be confirmed, the pick-up in growth would be very gradual.

The US-China trade conflict and Brexit have been acting as a headwind for growth for a considerable time now. Recent developments have raised expectations that these sources of uncertainty may have peaked. Should it turn out to be the case, this could spur spending by unleashing pent-up demand by companies or households. However, in an environment of slowing global growth and, quoting the IMF, a precarious outlook for next year, we probably will see a more limited reaction, with other sources of concern taking over from the previous ones: uncertainty make have peaked in certain areas, but is likely to migrate to other

According to the IMF’s chief economist, the growth outlook is precarious. Although the Fund expects somewhat of a pick-up of growth next year, this is driven by a small group of emerging and developing economies which are currently under stress or underperforming. The modest growth acceleration reflects country-specific factors, rather than the expectation of a broad-based improvement. In the US, the growth slowdown is expected to continue well beyond 2020 and Chinese growth is projected to decline to 5.8% next year. Against this background, the projected slight pick-up in the eurozone, driven by Germany and Italy, and which supposes that external demand regains some momentum, looks challenging.

The slowdown of global growth has gathered pace, forcing the Federal Reserve to cut the federal funds rate on two occasions, whereas the ECB has announced a comprehensive easing package. Nevertheless, the slowdown is expected to continue. Uncertainty is pervasive. Companies question the true state of demand faced with slower growth, trade disputes, Brexit worries, geopolitical risk. Corporate investment suffers and may impact households via slower employment growth. The room to boost growth via monetary policy and, in many countries, fiscal policy has become limited, and this is another factor which could weigh on confidence. Surveys of US corporate executives point towards high concern about recession risk and the US yield curve inversion adds to the unease. However, the picture provided by a broad range of leading indicators is, at least for the time being, less bleak.

The manufacturing purchasing managers’ index of the Institute for Supply Management (ISM) has continued its decline in September, reaching 47.8%. The non-manufacturing ISM has registered a big drop of 3.8 percentage points and is now at 52.6% — a very low print for a non-recessionary period. Against this background, bond yields have declined significantly reflecting increasing worries about recession risk, rising expectations about additional Fed easing and a greater flight to safe havens. The labour market data for September however brought some relief. Nevertheless, we expect the Fed to continue to cut rates. US ISM manufacturing and non-manufacturing indices have both declined lately. In this context, the bond yields decline has intensified the fear of a recession. However, the good figures of the labour market data provided some relief.

Three key factors have characterised the summer months: more signs of slower global growth, more uncertainty and the promise of monetary easing to come. Based on the recent news flow, these themes will in all likelihood continue to dominate the remainder of the year.

Business surveys in the US paint a diverging picture: manufacturing is worsening significantly but services have picked up nicely. Taking a broader perspective, evidence is building of a slowing economy. Less dynamic growth can be observed in engines of growth of the world economy: China and India, although reasons differ. In Europe, Germany is probably already in a technical recession whereas France is resilient. Central banks are back in easing mode but the effectiveness will be hampered by elevated uncertainty, despite the announcement of a new round of trade negotiations between the US and China.