March 16, 2020
March 16, 2020 | Adviser News
Economic update: COVID-19
Charles Stodart, Investment Specialist at Zurich Investments
In Australia, there have been 298 cases of COVID-19 (134 in NSW, 62 in QLD, 57 in VIC and 45 in other states) of which 27 have recovered and 5 have died (as of mid-day 16th March 2020; ABC website). Given the experience in other countries, it is well understood that this number may expand significantly and that various levels of containment measures are being actively considered – and implemented.
In Australia, there has been both monetary and fiscal response to COVID-19:
- The Reserve Bank of Australia (RBA) cut rates by 25bp to 0.50% at its 3rd March meeting
- The federal government announced a $17.6bn fiscal stimulus package on 12th March
The impact on economic activity affects both supply (as containment measures reduce factory output, exacerbated by concentrated supply chains, increasingly to China) and demand (as consumers stay at home). Policy response isn’t going to reduce the rate of infection and there is little it can do to boost supply.
On 10th March (before the fiscal package), Capital Economics assessed the impact on GDP within Australia at 1% (ie 2% forecast reduced to 1%); this was based on the assumption that the number of cases stabilize mid-year and that economic activity returns to pre-outbreak levels by year-end.
|Sector||% of GDP||% impact on 2020 GDP Growth|
|Education & Training||5.1||-0.3|
|Accommodation & Food Svcs||2.4||-0.2|
|Arts & Recreation||0.9||-0.2|
|Transport, Postal & W’housing||4.8||-0.1|
The government’s stimulus package, announced 12th March, will see $11bn spent by the end of June 30th 2020, potentially adding 1.5% to GDP growth in the second quarter, which may be enough to avoid a recession. The government stands ready to provide more stimulus in the May budget if required.
|Small business (revs < $50mn)||Payment: $2,500 to $25,000||30/06/20||$6.7bn|
|Welfare recipients (6.6mn)||Payment: $750 cash||$4.8bn|
|Small business (revs < $500mn)||Can deduct extra 50% of asset’s cost in year of purchase||30/06/21||$3.2bn|
|Small business (revs <$500mn)||Can claim tax deduction for spending on assets up to $150k||30/06/20||$0.7bn|
|Apprentice employers||50% wage subsidy||30/09/20||$1.3bn|
|Fee waivers for business||Regions/ communities impacted by COVID-19; tourism, education etc||$1.0bn|
There have been significant policy responses overseas, most notably the US Fed’s decision to cut rates by 50bp* on March 3rd in its first between-meeting move since the GFC, with a further 100bp reduction on Sunday 15th March (reducing the target range for the federal funds rate to 0 – 0.25%).
Historically, the Fed has reserved such drastic rate cut moves for periods when the economic outlook is deteriorating sharply (such as 2001 or 2008). The Fed’s move (and their further pledge that they will keep rates at that level until they are ‘confident that the economy has weathered recent events’) shows how policy makers are bracing for greater economic distress, particularly in regards to credit markets stress and impending cash flow disruptions.
Various stimulus measures have also been announced overseas, though the situation remains highly fluid, especially in countries where the rate of infection is in the early stages and still accelerating.
Morgan Stanley has projected that global GDP growth will be weak at 2.3%Y in 1H20. Recent developments suggest a rising risk of their bear case scenario of 2.1% growth for 2020 materialising (in other words, a full-blown global recession). Other forecasters have been more bearish.
High levels of uncertainty have created major dislocations in financial markets. Increasingly, the sharp tightening of financial conditions everywhere is itself emerging as the key challenge for policy makers. For instance, in the US, financial conditions have tightened by 153bps, the equivalent of more than six 25bps Fed rate hikes, driven by a sharp rise in US high yield credit spreads of ~282bps, which is a key channel of transmission to the real economy. Financial conditions are tightening in a non-linear fashion, which may spill over to the real economy in a non-linear way too.
The level of market concern can be seen in the level of the VIX index (or the fear index on equity markets), which closed at 75.47 on 12th March. The VIX index is at levels last seen (briefly) during the height of the GFC.
Developments in the oil market over 7/8th March have also exacerbated market fears. Saudi Arabia and Russia disagreed on oil production reductions to manage the oil price given its recent decline on COVID-19 concerns. The disagreement resulted in the oil price falling from @$45 on Friday 6th March to $34 on Monday 9th March. Both countries require a higher oil price to manage their budgets, so there may yet be a resolution; however in the short term, oil stocks have been hit and the credit spreads on the more leveraged names have widened sharply. As of 13th March, the oil price stands at $31 (vs $61 on 31st December 2019).
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* basis point (equivalent to 0.01%)
Sources: Zurich Insurance Company Limited, Capital Economics, Morgan Stanley; current prices from Bloomberg
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