In this note I list my top three risks of V (fast) and U (slow) shaped recoveries. On balance, V seems more probable, mainly due to the US electoral calendar.
Top 3 Risks of V-shaped Recovery
Risk #1: The November elections generate ‘whatever it takes’ policy support. The scale of monetary and fiscal relief is unprecedented. Yet the administration has other levers it could use, for instance a broader debt moratorium or central bank digital money to ensure the economy is recovering ahead of the elections.
Risk #2: A cure or a vaccine is identified. In view of the unprecedented global resources and of recent progresses in AI and biotechnologies, a credible cure or vaccine could emerge by year end. In any event, the current drip of positive, if early stage, market-supportive news will probably continue.
This article is only available to Macro Hive subscribers. Sign-up to receive world-class macro analysis with a daily curated newsletter, podcast, original content from award-winning researchers, cross market strategy, equity insights, trade ideas, crypto flow frameworks, academic paper summaries, explanation and analysis of market-moving events, community investor chat room, and more.
In this note I list my top three risks of V (fast) and U (slow) shaped recoveries. On balance, V seems more probable, mainly due to the US electoral calendar.
Top 3 Risks of V-shaped Recovery
Risk #1: The November elections generate ‘whatever it takes’ policy support. The scale of monetary and fiscal relief is unprecedented. Yet the administration has other levers it could use, for instance a broader debt moratorium or central bank digital money to ensure the economy is recovering ahead of the elections.
Risk #2: A cure or a vaccine is identified. In view of the unprecedented global resources and of recent progresses in AI and biotechnologies, a credible cure or vaccine could emerge by year end. In any event, the current drip of positive, if early stage, market-supportive news will probably continue.
Risk #3: Lockdown fatigue leads to de facto reopening of economies. A bottom-up move towards economic normalcy is possible: the August 1969 Woodstock festival gathered 300,000 participants in the midst of the 1968-69 H3N2 epidemic, aka “Hong Kong flu”, that was just as contagious and deadly as COVID-19. Americans’ greater risk aversion this time around could in part reflect media influence. But mortality and hospitalisation rates are falling, possibly because most states’ delayed response to COVID-19 suggests the most vulnerable could have already been hit. In addition, the much-feared shortage of medical capacity has not happened. And data on excess deaths from all causes (one of the more reliable indicators of COVID-19 prevalence) does not show that countries without lockdowns, for instance Sweden, have been hit more than countries with strict lockdowns, for instance Italy. In addition, excess deaths are falling across the world. As Americans realise that, for the most part, they can move about without getting severely ill, they are likely to become less risk averse. Indeed, in the US, mobility data has improved ahead of the gradual lifting of stay home orders.
Top 3 Risks of U-shaped Recovery
Risk #1: Policy relief does not hit its intended targets. By contrast with European countries that have targeted employment directly through subsidies, the targeting of US relief has been diffuse. Out of $3tn each of budget and currently planned Fed support, only $0.7tn consists of transfers and tax cuts for households. In addition, only $0.8tn of the support to the corporate sector is conditional on worker retention. Furthermore, funds are disbursed slowly: states’ antiquated IT systems cannot handle mass unemployment insurance claims; SMEs are losing interest in the complex Payroll Protection Program; and the Fed has only disbursed $4bn of the $2tn it intends to lend to the nonfinancial sector. The risk is that the unprecedented support will fail to reach its intended beneficiaries in time to prevent employer bankruptcies and a further round of layoffs.
Risk #2: Economic restructuring picks up pace. With the coronavirus shock, adjustments previously underway could quicken: for instance, rationalisation of shale oil, of brick and mortar retail, of commercial real estate and of cash flow negative firms. In addition, remote working is likely to make firms realise that many of their in-house capabilities can be outsourced at a time when a collapse in revenues is pushing them to cut costs. Simultaneously, unemployment benefits that exceed wages and inefficient labour and product market regulations could delay the required adjustments. If these trends become dominant, it is unclear how big the government stimulus would have to be to offset them.
Risk #3: A new sovereign crisis in Europe. The economic collapse brought by COVID-19 is likely to once more expose the Euro area fault-lines, including weak banking systems, over-leveraged governments and weak competitiveness – with Italy the poster child of these weaknesses. While France and Germany have agreed on the establishment of a €500bn recovery fund, smaller fiscally conservative countries remain opposed. As differences in countries’ responses and budget deficits become clearer, divergence between core and periphery countries could deepen, with political establishments becoming less committed to the European project. In Italy, for instance, Euroscepticism has grown even among traditional supporters of the EU. In addition, the 2021 German elections as well as forthcoming CDU leadership change could see the emergence of a German government less open to concessions to other Euro area countries.
Why I Remain a V Shaper
Overall, the risks of a V-shaped recovery seem to me greater than those of a U-shaped one. When it comes to getting re-elected, politicians’ resourcefulness tends to surprise on the upside. Also, the best minds and deepest pocketed public and private actors in the world are working on cures and vaccines, which is bound to produce some results. Finally, a combination of cabin fever and economic realism is likely to drag Americans out of their homes and make them realise that, for most, actual risks are limited.
Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)