News

Bruno Cavalier
Chief Economist at ODDO BHF

How does the coronavirus pandemic look today? This question will determine the economic outlook over the coming weeks and months and probably longer into the future. It hardly needs saying that nobody – not even the top medical experts – has the answer. We can only make assumptions. During the past six months when the virus has been a central concern, knowledge of it has deepened. More is known today about what to do and, more importantly, what not to do to slow its propagation. Testing has been expanded. The treatment protocol for infected persons has improved, contributing to the decrease in fatalities. Promising progress is said to have been made in the search for a vaccine. Whatever the case, this virus continues to hang like a Damocles’ sword over the world economy.

In the space of six months, the world economy has been turned on its head. It was supposed to grow by 3% in 2020. It is now forecast to contract by around 4%, according to the latest consensus forecast, followed by growth of 6% in 2021. Practically all countries will record a contraction in their per capita GDP this year. These annual averages distort the outlook, since the world economy is already recovering. The rebound is going on in China since March and in Europe and the US since May. In many cases, this recovery has surprised by its vigour. Some indicators have returned to or near their pre-pandemic levels, displaying an almost perfectly symmetrical profile, with the plunge followed by a surge (yes, this looks like a V). Here too, beware of optical illusions. The recovery reflects in large part a catch-up after business and travel restrictions were lifted or loosened. Suspended spending was able to go ahead, temporary layoffs were cancelled and business managers’ depression gave way to relief that they could resume their activity. Although these positive developments should not be played down, they tell us little about the solidity of the recovery against the backdrop of still high health-related uncertainty.

Even so, financial markets’ participants appear to have concluded lately that the pandemic shock is well and truly over. While the trauma caused by the sudden shutdown of economies will probably not be repeated identically, the shockwave continues to grow. Policymakers, whose mandate does not include tempering market optimism, are stressing the permanent damages that may be caused by this crisis, especially in the jobs market. The result is a curious situation in which central banks and fiscal authorities are doing everything possible to deliver maximum support in the medium term in the expectation that the crisis will have lasting effects, while this very monetary and fiscal stimulus is encouraging investors to believe that the crisis is temporary, if not already over. Sometimes it is hard to rationalise everything.

Another point open to debate is the relative situation of the US and Europe and their respective outlooks. The lockdown shock was more severe in Europe, resulting in a sharper contraction in real GDP than in the US (this could represent a difference of around three points in 2020). What’s more, the fiscal response may have seemed slower or more wavering on this side of the Atlantic. The US federal deficit is heading towards 20% of GDP this year, around twice as high as in the Eurozone. That said, Europe can claim a few advantages. Firstly – and we keep coming back to this point – there is the health situation. We would not venture to say that the outbreak is totally under control in Europe, but it seems to be doing better than the US. The recovery could lose momentum or grind to a halt if economic agents stay at home, whether they are obliged to do so or simply out of caution. From this perspective, the heated debate about reopening schools in the US is anything but trivial. Secondly, by favouring reduced activity schemes rather than increasing unemployment benefits, European countries are providing longer term support to the jobs market, a crucial factor for domestic demand. If the US Congress does not prolong exceptional aid to the unemployed (which many Republicans disapprove of, claiming, without evidence, that this encourages laziness), disposable income will fall, and consumer spending with it. Lastly, a word should be said about political risk. Since 2015, Europe has often been described as an institutional framework on the verge of break-up. This was the case during the Greek debt crisis, then during the migrants’ crisis, and again after Brexit. For sure, EU member states do not all have the same objectives at the same moment. What’s more, strong Eurosceptic political forces exist in nearly all European countries. In reality, however, integration in Europe has made progress over the past five years. This began through the back door, if we dare say so, thanks to the ECB’s actions. By preventing the fragmentation of financial conditions, monetary policy helped to reinforce the Eurozone. Integration has now made an explicit progress. The recent agreement by EU leaders on a “recovery plan” puts an official stamp on a form of fiscal solidarity between European countries (if only exceptionally). This plan would simply have been unimaginable not long ago. In comparison, uncertainty surrounding the US election and what comes after looks to be a greater source of volatility in the months ahead.

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