News

Bruno Cavalier
Chief Economist at ODDO BHF

• Less than a month ago, the outlook for the world economy in 2020 appeared bright. The US and China had buried the hatchet for a while in their tariff war, removing a disruptive factor for trade and industrial production. Central banks reacted promptly to the weakening of economic conditions in 2019, and they planned to continue offering the maximum support possible with accommodative policies. Leading indicators had returned to an upward trajectory in the manufacturing sector. In short, the world economy was poised to emerge from the weakening phase that had begun two years earlier. Global growth had bottomed out at an annualised pace of around 3%. This appeared to be a floor. The future could only be better. 
• And then, on 20 January, the coronavirus epidemic, which surfaced in the Hubei region of China, began to hit the headlines in the global press. This risk was not on any radar screens. One classification that has become somewhat notorious draws a distinction between two types of contingencies: “known unknowns” and “unknown unknowns”. The first of these can be reasonably well anticipated and evaluated; the second cannot. The fact that this new risk has emerged in China is a particular source of stress. Firstly, this country is not known for the transparency of its information, even in normal times. Secondly, it is a vital link in the functioning of the global economy. Isolating China from the rest of the world is what Trump dreamt of achieving by raising tariff barriers and forcing a rethink of the global production chain. The virus has managed to do this in a few days. We can only hope that it is temporary.
• Just as it was poised to celebrate the New Year, a period synonymous with frenetic spending and travel, China finds itself confined. Many countries have reduced or suspended their air, sea or rail links. A large party of the Chinese economy is at a standstill. More than ten working days have already been lost. The economy can only gradually be put back on the rails, since the authorities need to balance health considerations (stem the epidemic) with economic objectives (recreate normal working, travel, production and spending conditions). No-one has a reliable and exhaustive measure today of the macroeconomic disruption, but all anecdotal reports point to a severe shock for manufacturing, transport, property transactions, etc. 
• To assess the damage, three things should be kept in mind:

1. First, economic conditions prior to the shock. At the start of 2020, the global industrial cycle was fragile but seemed to be going into remission. However, disruption to the production chain and trade in intermediate goods raises fears of a fresh erosion of business confidence, first and foremost in China and Asia, but also elsewhere. Highly industrialised and exporter countries such as Japan or Germany and industries such as the automotive sector appear very exposed on the face of it. 
2. Second, the shock itself. We will make no secret that this is the most speculative point. The general pattern is that the sharp plunge in activity will be short-lived and followed by a brisk recovery. This is the famous V-shaped profile seen during the SARS shock in 2003 or after September 11. But how far will activity fall? A rough estimate is that Chinese growth, which was on a trend of 1.5% q/q before the virus, could well fall to zero or even lower in Q1. In view of the weight of China and its repercussions, world growth could drop from 0.75% q/q (3% annualised) to 0.25% (1% annualised). The expected recovery in global growth, and specifically European growth, has been postponed by a few months.
3. Third, counter-shock measures. In China, the virus has not destroyed demand, but it has created huge supply disruptions. A stimulus plan would not serve much purpose in the near term. The priority is to ensure that companies and banks do not run out of liquidity. The immediate response is to come on the monetary side. At a later stage, to boost the economic recovery, a fiscal stimulus remains a possibility. In the rest of the world, the shock from the virus has accentuated the accommodative bias of central banks, justifying more than ever a more active use of fiscal policy in countries that can afford it.

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