Global markets collapsed again on Monday, dismissive of the U.S. Federal Reserve’s dramatic weekend rate cut and huge new round of quantitative easing, as the near-term economic carnage from the new coronavirus outbreak is coming into sharp relief.
For the third time in less than a week, trading on the New York Stock Exchange was briefly suspended after the market plunged almost 12 percent upon opening, and it closed even lower, down almost 13 percent in one of its worst days ever, while stock markets across Europe and Asia posted sharp declines and crude oil cratered. Even though U.S. President Donald Trump finally has interest rates close to zero, the move to loosen monetary policy has done little to assuage nervous investors.
“It’s started to dawn on people—we’ve seen the demonstration of the president’s understanding of the problem, which was worrisome—that there is nothing between us and the worst-case scenario,” said Austan Goolsbee, a professor of economics at the University of Chicago’s Booth School of Business.
Trump acknowledged that the outbreak, and its attendant disruptions, could last into the summer and could lead to a recession. “People are talking about July, August … could be longer than that,” he said. He announced fresh recommendations to limit gatherings and social outings but stopped short of ordering any closures or any domestic travel ban. He said he grades his response to the virus outbreak as “10 out of 10.”
Goldman Sachs said over the weekend that the United States could see economic contraction of 5 percent in the second quarter, a sharp reversal that would likely qualify as a recession. Manufacturing data from New York state just showed the biggest monthly drop on record. Trump’s former top economic advisor Kevin Hassett said Monday that chances of a recession are nearly 100 percent, with big job losses on the horizon. Treasury Secretary Steven Mnuchin, in contrast, over the weekend was still dismissing fears of a recession even as the market plunges and economic indicators go south.
“A 5 percent contraction is way too optimistic,” said Goolsbee, who as President Barack Obama’s former chief economic advisor helped to navigate the financial crash and Great Recession of a decade ago. “Rich country economies are dominated by services, and that is what drops precipitously with social distancing. So the economic impact on Italy, the rest of Europe, now on the United States is going to be bigger even than it was in China for the same size outbreak.”
And that’s scary, because the latest economic data from China, where the outbreak (and the economic shutdown) first began, is especially dire, with double-digit declines in factory output and retail sales. Forecasters now expect the world’s second-largest economy to shrink in the first quarter, the worst performance since the days of Mao Zedong.
To deal with the economic fallout of the pandemic (and the measures to contain it), policymakers will first have to stem the spread of the disease and then turn to other tools, especially massive fiscal stimulus. That’s one reason that even steep interest rate cuts by the Fed and other central banks have failed to cheer markets.
That’s not to say that the Fed’s drastic action was unneeded—it injects liquidity into the financial markets and prompted other central banks to lower rates as well, which could grease a recovery down the road. More immediately, by firing off all the monetary policy ammunition and leaving rates close to zero in the United States and below zero in Europe and Japan, the way is now open for aggressive fiscal stimulus, according to Adam Posen, the president of the Peterson Institute for International Economics.
“This removes any excuses for fiscal policymakers to keep inactive,” Posen said in an email. “Borrowing costs are going to be essentially zero for sovereign rich country debt for the foreseeable future.”
Some countries in Europe, such as the United Kingdom, France, and Italy, have already announced multibillion-dollar stimulus plans to help workers and small businesses in the near term, though additional measures will likely be needed as the pain from closed factories, canceled trips, and national lockdowns percolates through the global economy. Since last week, the United States has been mulling short-term plans for paid sick leave, possible tax cuts, and the like—but is still struggling to get enough testing kits or other medical equipment, enforce social distancing, or even have a consistent message from policymakers about how serious the threat is and how it should be handled. The White House is trying to put together a big rescue package that reportedly includes a big payroll tax cut and targeted aid for vulnerable industries, support for paid leave, and loans for small businesses.
“Whenever you’re in a crisis, I think stimulus can’t work until you tone down the public panic about the virus,” Goolsbee said. “It’s not like a regular business cycle; anything to slow the spread of the virus is the greatest economic stimulus you could have, and it’s now clear that U.S. government policy is not doing that.”
As the virus outbreak continues—with new cases and deaths still rising rapidly in outbreak epicenters such as Spain and Italy, with France announcing on Monday a two-week nationwide shutdown, and with state and local closures in the United States–the near-term economic damage is becoming increasingly evident. The G-7 countries said Monday the outbreak poses “major risks” for the global economy and vowed to take any actions necessary.
The big question: Will the pain will be a single, concentrated punch while the outbreak peaks, to be replaced by heady economic growth later in the year, as many forecasters still expect, or will the slowdown persist? A temporary hit would leave the potential for a strong economic rebound, as Trump insisted—assuming that the slowdown doesn’t leave a trail of permanent damage in its wake.
“One of the challenges that a policymaker faces is to try to prevent the temporary negative things from becoming permanent. There are going to be lots of people and companies that could go bankrupt, and the more of that there is, the more lasting this will be, and the harder it will be to see a V-shaped recovery,” Goolsbee said.
Greg Mankiw, former President George W. Bush’s chief economic advisor, wrote much the same prognosis and recommendations late last week, before the Fed even took action. He called a recession “likely” and called for immediate actions not to jumpstart demand throughout the economy but to allow people to get through the next few months. “There are times to worry about the growing government debt. This is not one of them,” he wrote.
That’s why the focus everywhere is now on different combinations of fiscal stimulus that can tide people over through the worst. France, which is now beginning to copy Italy and Spain by starting a national lockdown, announced a huge economic backstop to ensure that no French companies go bankrupt, with French President Emmanuel Macron comparing the fight against the virus to a state of war. The U.K. just announced a 30 billion pound ($37 billion) package of its own, while Italy, which already put forward a 28 billion euro ($31 billion) rescue plan, is going back to the well for billions more.
In Washington, lawmakers are reconvening this week to take up legislation that would provide paid sick leave, more loans for cash-strapped small businesses, and perhaps some additional tax cuts. Also gathering momentum are proposals for direct cash payments to Americans to act as a financial lifeline in the short term.
Another measure that is gaining traction is targeted aid for certain sectors that are taking a massive hit as a result of the outbreak. The global airline business, which was already on track to lose more than $100 billion this year, now is at risk of a wave of bankruptcies by the end of May. U.S. carriers have all slashed their capacity, and many have already announced pay cuts or layoffs; European airlines are equally hard-hit. The pain is only set to increase: The European Union is banning travel from countries outside the 26-nation Schengen free-movement area.
And that near-shutdown of the airline business shows up clearly in the unprecedented glut in the global oil market, exacerbated by a price and production war between Saudi Arabia and Russia. Crude oil prices plunged 12 percent in London and 9 percent in New York to under $30 a barrel—far too low for many U.S. producers to make money even to service their huge piles of debt.
The oil outlook is likely to get even worse as the full scope of the economic disruption spreads from Europe to the United States: IHS Markit, the big energy consultancy, said in a release that the collapse in demand for oil combined with extra production by Saudi Arabia and Russia could produce “the most extreme global oil supply surplus ever recorded.” That’s terrifying news for U.S. oil producers, which have been pumping with abandon in recent years: IHS estimates that falling prices and growing crude surpluses could knock off 2 million to 4 million barrels a day of U.S. oil production. That would have huge ripple effects on employment and spending throughout the entire U.S. oil patch.
And cash flow woes for heavily leveraged oil producers could bleed into the corporate debt market, which is more bloated than ever before. Any downgrades to corporate debt will automatically trigger lots of sales, because big institutional investors can only hold higher-quality bonds. And that cycle could be accelerated if other big investors, needing cash, start liquidating their riskier holdings while they can; some on Wall Street are talking about a 2008-style bond debacle.
“Over a short period, this is likely to be far nastier than a typical recession,” Goolsbee said.
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