Market Insights | March 27, 2020
Flattening the Curves
Todd Mattina, PhD
Senior Vice President, Chief Economist, Team Co-Lead
Mackenzie Multi-Asset Strategies Team
Summary
• Stopping the pandemic spread while minimizing the steep economic cost is the key policy challenge
• Policymakers have acted quickly with strong measures to backstop the economy and credit markets
• P
olicy stimulus should strive to prevent a further deterioration in demand and unemployment, but policymakers cannot offset
the negative supply-side impact of a prolonged economic lockdown
• The macro outlook depends on the duration of social distancing to contain the epidemic
• L
ong horizon investors should continue periodic portfolio rebalancing and ensure adequate liquidity to avoid selling assets at
distressed prices
Stopping the spread of the COVID-19 epidemic will come at a steep economic cost. Medical experts argue that “flattening
the infection curve” through stringent social distancing can save lives and avoid overwhelming the healthcare system. However,
these measures also steepen the recession curve with the economy in lockdown (Figure 1). This sudden stop in economic activity
is leading many US forecasters to expect a sharp contraction in GDP during April to June with estimates ranging between 12%
and 25%.1
Figure 1. Flattening the Infection Curve Steepens the Recession Curve
Containment policies flatten the medical curve, but steepen the recession curve
New cases
With containment policies
Without containment policies
Medical containment measures
Make the medical crisis less bad
Time
Make the economic crisis worse
Severity of
recession
Source: https://voxeu.org/content/economics-time-covid-19-0
Policymakers have acted quickly to implement measures of unprecedented size and scope to “flatten the recession
curve”. Major central banks have moved quickly with larger measures in many cases than during the Global Financial Crisis
in 2008 so that the expected economic slowdown does not become a financial crisis. Central banks have eased rates, injected
liquidity in money markets, launched new lending facilities to unlock credit markets and expanded Quantitative Easing (QE) to
tackle illiquidity (Figure 2). Governments have also announced fiscal packages of unprecedented size, including tax deferrals, cash
transfers to households and backstops for business credit. The US stimulus package of about US $2 trillion amounts to about 10%
of GDP. Germany is considering a package of a roughly similar magnitude. In Canada, the announced measures of $82 billion
are more modest at just over 3% of GDP. Critically, global policymakers are striving to avoid a temporary cash squeeze leading
to business insolvencies and higher unemployment. Failure to prevent insolvencies from a temporary and deliberately induced
economic slowdown would likely lead to a much slower recovery when the epidemic is resolved.
Figure 2. Total Assets of the US Federal Reserve Surpass Previous Peak
(in billions of US dollars)
$6,000
$5,254
$3,000
Previous peak was
just over $4,500
$0
2008 2010 2012 2014 2016 2018 2020
Source: Total Assets of the US Federal Reserve as of March 25, 2020. Data provided via Bloomberg.
The policy toolkit has been largely borrowed from measures taken during the Global Financial Crisis, but the current crisis
is different in important ways. The Great Recession in 2009 stemmed from sharp deleveraging by the private sector following
a confidence crisis and financial sector failure, which led to a sharp decline in aggregate demand and a recession. The priority in
that crisis was to boost aggregate demand by rebooting credit markets and providing liquidity. The current economic downturn
is primarily a supply-driven shock as policymakers deliberately induced a sharp slowdown to contain the COVID-19 outbreak. The
crisis also resulted in a large decline in aggregate demand, pushing expected inflation even lower (Figure 3).
Policymakers should compensate for the decline in demand but not try to over-compensate for the decline in aggregate
supply. Monetary and fiscal policy can play key roles by preventing a further deterioration in demand causing higher unemployment.2
Policies can also backstop credit markets and the financial system to avoid bankruptcies simply due to the short-term liquidity
crunch rather than long-term insolvency. In contrast, lower central bank rates and cash transfers from the government cannot
offset the large loss in production and incomes due to business closures and quarantined workforces. However, we believe
policymakers cannot restore demand to its pre-crisis level while the economy remains in lockdown as the economy would be
unable to meet that higher level of demand.
Figure 3. Decline in Market Pricing of 10-year US Average Inflation
(breakeven US inflation rate based on 10-year TIPS)
2.5%
2.0%
1.5%
1.0%
0.5%
Mar. 17 Mar. 18 Mar. 19 Mar. 20
Source: Market data provided via Bloomberg as of March 25, 2020
Looking ahead, the macro outlook depends mainly on the duration of the economic lockdown to contain the pandemic
spread. President Trump indicated that the US economy could return to work as early as Easter. Several European countries
have only partially shut down economic activity. In Canada, the federal and provincial governments appear to be preparing for a
prolonged shutdown. While the duration of the lockdown is uncertain and likely to differ across countries, the global economy is
expected to experience a contraction in the second quarter that extends into the third quarter. Based on the early experience of
China, the recovery appears to be U- or even L-shaped after the prolonged lockdown of Hubei in early 2020 (Figure 4). Once the
epidemic is behind us in North America, the speed of the economic bounce will depend critically on our success in preventing
business failures during the temporary liquidity squeeze so that unemployed workers can quickly return to work, allowing income
and production to normalize. The next few months could include both upside and downside surprises, ranging from new medical
innovations to treat the virus to potential secondary waves of infection.
Figure 4. Economic Activity Indicators in China
Job offers: Hubei Province, other selected Provinces and China, one month prior to and after Lunar New Year Day, December 28, 2019
- March 23, 2020 (December 28, 2019 = 100, jobs data as of 8:00 Beijing time March 24, 2020)
120
100
80
60
Beijing
Guangdong
40 Hubei
Shanghai
20 Tianjin
All china
Lunar New Year Day
0
Dec. 28 Jan. 25 Mar. 23 Apr. 04
Source: DeepMacro
For long horizon investors, cheaper equity valuations following the sell-off point to higher long-term expected returns.
Attempting to time asset mix allocations tactically based on views about the epidemic outlook is inherently difficult. However,
following a disciplined investment process can help investors:
• Investment horizon: The intrinsic valuation of risk assets like equities is lined to long-term fundamentals, such as earnings
growth and real interest rates. We believe, cheaper stock valuations today after the sell-off imply a higher long-term average
expected return.
• Portfolio rebalancing: For investors with a long-term asset mix, periodic rebalancing to target has historically helped to reduce
total fund drawdowns in periods of market stress and contributed to a faster rebound in portfolio value. Generally, rebalancing
can also help to ensure the factors driving portfolio risk and return remain aligned with the target long-term asset mix.
• Liquidity: Maintaining sufficient allocations to liquid high-quality assets is critical to cover short-term financial commitments
and avoid sales of distressed assets at inopportune times to raise cash.
1
oldman Sachs is predicting a contraction in real GDP by 24% in 2020 Q2. Oxford, JP Morgan and other forecasters are forecasting declines of about 12% to 14%. Top
G
Economists See Some Echoes of Depression in U.S. Sudden Stop, Bloomberg (March 22, 2020).
2
Paul Krugman expressed a similar view on March 22, 2020: https://twitter.com/paulkrugman/status/1241690862448529408
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