(Bloomberg) -- The coronavirus is delivering a one-two punch to
the world economy, laying it low for months to come and forcing
investors to reprice equities and bonds to account for lower company earnings.
From one side, the epidemic is hammering the capacity to produce goods as
swathes of Chinese factories remain shuttered and workers
housebound. That’s stopping production of goods there and
depriving companies elsewhere of the materials they need for their own businesses.
That supply shock was initially viewed as a short-term disruption,
easily reversed once the virus was brought under control.
Hence the initial predictions that global growth would follow
a V-shaped trajectory, sliding in the first quarter and rebounding in subsequent weeks.
Those early bets for 2020 are now in tatters because demand is
slumping too. With the virus no longer contained to China,
increasingly worried consumers everywhere are reluctant
to shop, travel or eat out. As a result, companies are
likely not only to send workers home, but to cease hiring
or investing -- worsening the hit to spending.
How the two shocks will reverberate has sparked some debate
among economists, with Harvard University Professor Kenneth
Rogoff writing this week that a 1970s style supply-shortage-induced
inflation jolt can’t be ruled out. Others contend another round of weakening inflation is pending.
The bottom line for central banks and governments is that
there’s likely to be even more pressure to deliver economic fixes.
“A classic recession involves a shortfall of demand
relative to supply,” David Wilcox, a former Federal Reserve
official now at the Peterson Institute for International Economics,
said in a report this week. “In that more ordinary situation,
economic policy makers know how to help fill in the missing demand.
But this case is more complicated because it involves negative hits to both supply and demand.”
Worst Since 2009
The supply-cum-demand blows explain why the world economy is
sliding toward its weakest expansion since the 2009 recession,
with policy makers’ inflation targets becoming all
the more unreachable. Companies including Hyatt Hotels Corp.
and United Airlines Holdings Inc. have withdrawn their earnings
outlooks, while manufacturers from Samsung Electronics Co. to
Toyota Motor Corp. are battling to get production back online.
Those body blows explain why the Federal Reserve’s biggest cut
to interest rates since 2008, in an emergency move
Tuesday, initially failed to spur the equity market.
Rogoff’s warning on product shortages notwithstanding,
traders are now pricing inflation over the coming 10 years
at just 1.48%, down from 1.80% at the start of 2020, Treasury securities show.
For central banks, the worry is that rate cuts won’t
reopen factories or return workers to work. Even to
support demand when the virus passes they likely need
to be more inventive -- combining rate cuts with targeted
programs to cushion confidence and keep credit flowing.
Another reason for that is most central banks are already
short of ammunition after past rate reductions.With the
Fed’s first move flopping, governments are under mounting
pressure to do more. In the U.S., the House of Representatives
passed a $7.8 billion emergency-spending bill to fund a
response to the outbreak -- helping deliver a rebound in
stocks lacking in the immediate aftermath of the Fed.“We’re
only in the early innings of this crisis,” said former U.S. Treasury Secretary Lawrence Summers.
Some economists argue that what’s happened is mostly a
supply side shock, others have highlighted the wallop to
demand as well, to the degree that the distinction matters.
Supply shocks are inherently tougher for policy makers to
address, because of the difficulty of quickly restoring the
production, transport or communication networks or natural-resource
inputs affected by the surprise hit.
They most often involve fiscal authorities, who have up to
now taken the back seat, leaving central bankers at the
wheel. The U.S., Japan, Italy and South Korea are among
those that have moved to assemble packages to address the
virus, though in most cases they’re tied to the health-care
industry and treatment and prevention specifically, not the broader economy.
Rates ‘Hopeless’
“Certainly, rate cuts will not help re-stock emptying
grocery shelves,” said Seema Shah, chief strategist at Principal
Global Investors. “Monetary policy is hopeless when supply simply cannot feed demand,” she said.
On the demand side, where central bankers are the natural
first-responders, the nature of the shock this time can make
a broad-brush monetary response less effective.
While lower borrowing costs can help give households
greater spending power, that aid is limited if millions are
shut up at home due to anti-virus measures -- or simply because of fears of catching the disease.
That may help explain the People’s Bank of China’s
preference to use targeted credit measures rather than
large-scale interest-rate cuts since the virus erupted
early this year. Among their steps, Chinese regulators
have let banks run up larger totals of
non-performing loans, and loosened guidelines for bond sales.
The Fed too may need to get more expansive in its moves,
Credit Suisse Group AG analysts argue. Zoltan Pozsar and
James Sweeney said Tuesday that disruptions to the global
supply chain could in turn cause payment failures, tightening financial conditions.
“The supply chain is a payment chain in reverse,”
the duo wrote. They urged “open-ended liquidity support through its balance sheet.”
The European Commission is also watching for potential
turbulence in the case of a prolonged epidemic.
“Cascading effects could stem from liquidity shortages
in firms that have to stop production, amplified and
spread out by financial markets,” a commission briefing note seen by Bloomberg said.
Last week saw the deepest slide in global equities since
the credit crisis, a rapid turnaround from the record
high of the MSCI All Country World Index just as recently
as Feb. 12. It remains about 8% down on that peak after a
2.7% gain Wednesday, spurred by the U.S. spending move
along with relief among some investors that the moderate
Democratic candidate for president, Joe Biden, did well
in the Super Tuesday primaries. Still, the risk remains
of further market disruptions.
“While the Fed’s insurance cuts did serve its purpose
into late 2019, the continued lowering of rates may have
limited support for markets at present,” said Jingyi Pan,
market strategist at IG Asia Pte in Singapore.
It all puts the onus on policy makers to contemplate greater
inventiveness. Government spending may not be able to contain
the virus spread, but it can help replace free-falling consumer
demand. Chetan Ahya, chief economist at Morgan Stanley projects
fiscal deficits for the four major advanced economies plus China
to rise to at least 4.7% of gross domestic product this year,
the most since 2011 and up from 4.1% last year.
“COVID-19 is a particularly pernicious economic shock,
as it is both a supply and demand-side shock,” said Mark
Zandi, chief economist for Moody’s Analytics.