3 Conditions For A V-Shaped Recovery

A sharp, globally synchronized, COVID-19-related slowdown is underway. Because most governments have been slow to respond, their policy options have narrowed. In order to avoid overwhelming their healthcare systems, they have turned to various degrees of social distancing including its extreme form – countrywide, strict home confinement. Since individuals who stay at home can neither transmit nor acquire the virus, this radical measure is likely to bring about a decline in new cases. China and increasingly Italy, two countries that have implemented mass quarantines (Chart 1), have demonstrated as much.

Chart 1: COVID-19 Cases / mn Population

Source: John Hopkins University, Macro Hive

But the economic costs of social distancing are substantial, since most forms of economic activity involve social interaction. As a result, the global economy is facing a sudden, synchronized decline in demand and supply. In response, governments across the world are providing economic support that could lead to a V shaped recovery provided three conditions are met.

(1) An End to the Panic

The panic gripping consumers and market participants needs to end, which in turn requires bringing the epidemic under control. China and Korea give us a sense of the timeframe involved. China imposed a quarantine in Wuhan at end-January and reached the inflection point of the S curve, where the number of new cases starts falling, two weeks later. For the first time since the beginning of the epidemic, China had no new cases on 18 March. Korea started to roll out its mass testing program in mid-February and reached the S curve inflection point about three weeks later. The decrease in new cases would have to persist long enough to reassure the public. And of course, good government communications could speed up the recovery of confidence. Altogether, the restoration of confidence could take about one and a half to two months from the point of government action.

(2) Government Surveillance and Response

Governments and private sector need to adapt fast to reboot economies without a resurgence of infections. Government surveillance and response capacities must close in on those of countries that have contained the epidemic with limited economic disruption, i.e. Hong Kong, Singapore, Taiwan, and Korea. Testing and contact tracing need to become pervasive, possibly at the cost of some lost privacy, while technologies such as thermal imaging that allows large-scale, non-invasive temperature checks must be fully leveraged. Businesses need to make long-term changes, for instance with temperature checks, frequent cleaning of facilities and reinforced hygiene practices becoming part of the new norm. Citizens need to remain compliant with government guidelines – if necessary through the imposition of fines on trespassers.

Some businesses will do well, for instance telemedicine, big data companies, or home delivery firms. At the same time, activities that involve close social proximity, such as cruises, could take longer to recover. In the long run, business models that could remain negatively affected may well be those exposed to the political shifts likely to be brought about by the epidemic: for instance, pharmaceutical companies and hospitals could feel pressure to lower their prices, and gig economy employers could come under pressure to give sick benefits to workers. In addition, after the dust settles, investment strategies perceived to be responsible for the unprecedented market volatility could face some regulatory tightening.

(3) Global Policy Response

The global policy response needs to prevent illiquidity from turning into insolvency. Large-scale insolvencies would lead to mass layoffs, costly restructurings, and balance sheet repairs that would make for a sluggish recovery. Against these risks, countries are putting together combinations of monetary, fiscal and regulatory easing (Table 1). For these packages to prevent large scale insolvencies, they need to be implemented fast to combat the ongoing rise in unemployment from gaining momentum and further adding to demand weaknesses.

Table 1: Economic Measures in Response to Coronavirus (as of 18th March 2020)

Source: Government Websites, ECB, Fed, BoE, BoJ

The Fed has a special part to play in view of the USD’s global role. While the Fed has lowered the cost and extended the maturities of USD swaps with global central banks, the dollar has continued to strengthen. This suggests the Fed’s USD supply is not reaching the market participants who need it. The Fed needs to step up its supply of USD to a greater range of jurisdictions and borrowers.

The Bottom Line

It is likely that countries will bring their epidemic under control and will manage to regain economic normalcy without restarting the epidemic. It is less clear that the policy response can support a global V-shaped recovery. Central banks are playing a key role in stabilizing markets but, but after a decade of loose policies, will likely have little impact on demand. As far as demand support is concerned, the heavy lifting will have to come from fiscal policy. In this regard, the US and UK appear best positioned while Germany and Japan are lagging. And while France, Italy and Spain have put fiscal packages in place, fiscal policy divergence with Germany could once more expose the Euro area fault lines.