World heads into w-shaped depression

Via Capital Economics:

Hard data for May generally revealed sharp improvements in activity, particularly retail spending, albeit not to pre-virus levels. This led us to revise our forecasts for several economies including the US, UK and euro-zone, where we now expect falls in Q2 GDP to be less steep than we initially envisaged. However, renewed coronavirus outbreaks in some parts of the world have added to reasons to expect the recovery to slow in the months ahead. Indeed, timely indicators including restaurant reservations suggest that increased consumer caution is already taking a toll. (See Chart 1.) The previous upward trend in the US seems to have stalled, due partly but not entirely to developments in the affected southern and western states. Meanwhile, even the relatively small and localised outbreak in Australia has seen bookings there nose-dive.

On the demand side:

• While consumer spending has returned faster than we anticipated, we expect the recovery to slow further ahead. May’s retail sales data showed a sharp rebound in most DMs (20). Sales volumes were up by 17% m/m in the US, 17.8% in the euro-zone and 12% in the UK. But given the size of the collapse in March and April, retail sales are still far below their pre-virus levels in most major economies (21).
• The virus appears to have hastened the trend towards online shopping. In the UK, for instance, since February non-store sales have risen by 51.8% and now account for a third of all sales – up from a fifth before the crisis. And in China, this trend has continued even as brick and mortar stores have reopened. Timelier data suggest that the recovery has stalled. Having jumped when restaurants were reopened, bookings have since levelled off in the US and the euro-zone, and have actually slumped in Australia (22). What’s more, the uptick in air travel also seems to have slowed over the past few days (23).
• As a result, we doubt that the current speed of recovery will be maintained. After all, renewed fears about the virus and depressed consumer confidence will weigh on consumption in the months ahead (24). In the US, for instance, after rebounding steadily since mid-April, consumer footfall at retail stores has edged down recently as case numbers have started to pick up and some restrictions have been re-imposed in some states. However, footfall has also fallen in states relatively unaffected by the new rise in cases (25).

On the supply side:

• In general, there is growing evidence that the world economy is picking itself up after a plunge in activity in March and April. In April, global industrial production fell by over 8% compared with March, as doubledigit percentage drops in DMs, Asia and Latin America were mitigated by only a slight decline in emerging Europe and a continued rebound in China (8). The collapse in manufacturing in DMs was largest in transport goods and clothing, while foodstuffs, pharmaceuticals and electronics fared the least badly (9).
• Country data for May show that the global industrial recovery has been underwhelming. Output pulled off only relatively mild rebounds in economies that were hardest hit by lockdowns in April and continued to fall elsewhere (10), leaving output well below pre-virus levels. Taking account of a wider range of timely data, the OECD’s global leading indicator has bottomed out but remains in recession territory (11).
• Finally, our daily Covid Recovery Trackers suggest that activity continued to pick up around most of the world in June (12). Latin America is a notable exception, where the virus is still out of control. Recoveries also seem to have stalled in parts of the US, and not just in the virus hotspot states like California and Texas (13). Overall, though, the surprising strength of these indicators in recent months was one reason why we revised up several of our Q2 GDP growth forecasts. We had expected global GDP to contract by 8% last quarter, but now expect something closer to a still-record decline of 5½% q/q.

And trade:

• April’s 12.1% monthly fall in world trade volumes was by far the largest on record and left the three-month average annual growth rate at -7.9% (26). The euro-zone and the US were the worst hit, with exports falling by over 20% m/m (27). But while trade appeared to hold up slightly better in emerging economies, Latin American and Asian countries outside China also experienced large contractions in exports.
• With most countries in full lockdown, a very sharp fall was inevitable in April. In fact, the damage has been less severe than we might have expected given the scale of the economic collapse. On past form, our forecast for global GDP to decline by 5% this year looks consistent with a contraction of 40% y/y in world trade, but the falls have so far been far smaller (28). Boosted demand for some products, including medical equipment, has helped put a floor under trade flows. In China, for instance, without the support from these products, exports would have fallen by over 10% y/y in May, far greater than the actual 3.3% decline (29).
• There are signs of a tentative recovery. The new export orders component of June’s PMI suggests that the pace of decline in exports slowed (30). And timely data from Korea showed that exports fell by 18.5% y/y in June, a smidgen lower than the 23.6% drop in May. But with global demand weak, the recovery will be slow. Note that Chinese exports fell in May following the initial sharp rebound after lockdowns eased (31).

So, Europe looks OK. The US is headed into a double-dip depression. China is the pick but EMs are headed into disaster.

The key ahead remains the virus which is showing no signs of slowing in the US, is under control in Europe (but no better than that), is effectively eliminated in China and explosively out of control in EMs. Do not look to lockdowns to do the damage. Via Merrill:

One of our core views is that both voluntary and mandated social distancing have significant impacts on the economy. A new academic paper out of the University of Copenhagen and CEBI quantifies the effect of each kind of social distancing on consumer spending during the COVID-19 pandemic. …

Let us start with the facts. The outbreak began at the end of February in Denmark and Sweden. … Since then the two countries have diverged significantly in terms of health care outcomes. As of May 18, Denmark had 95 deaths per million people, while Sweden (363 per million) has had among the highest COVID-19 mortality rates in the world.  This difference points to a large healthcare benefit from lockdown policies. What about the economic costs?

The paper finds that consumer spending dropped by 25% in Sweden and by 29% in Denmark. The 4pp difference between the two declines quantifies the cost of lockdown policies. While 4% of consumer spending is not trivial, it is a small share of the total decrease in consumer spending. Therefore the data indicate that most of the slowdown occurred due to voluntary social distancing rather than lockdown policies.

…If the paper’s results are applicable to other countries, they have important implications for the economic outlook. … Even as restrictions are lifted, consumer spending will likely remain highly impaired, with services getting hit the hardest. Ending lockdowns might also limit the activity of more vulnerable people, further delaying the recovery.

In summary, the economic downturn has been primarily because of the virus, not the policy response.

My own view that the world faced several years of “swoosh shaped” recovery before returning to 2019 output levels is now looking overly optimistic. The risk case of a w-shaped depression is rising fast.

David Llewellyn-Smith
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