A U-shaped recovery after COVID-19

The spread of the COVID-19 virus has dented the global growth outlook. The spread of the COVID-19 into new regions has turned the economic outlook into a V-shaped rather than U-shaped recovery. Therefore, we have lowered our global growth outlook for 2020; see our update, The Coronavirus Crisis: U-shaped rather than L-shaped global recovery . The COVID-19 has hit important service sectors globally, in addition to global value chains, curtailing global growth well into Q2, before we expect it to give way to a recovery in H2 as virus concerns abate. 

As a result, we have seen coordinated G7 policy responses to stand ready and swift individual central bank responses (for example, on Tuesday, the Fed cut its policy rate by 50bp and the Australian central bank cut by 25bp), which will help cushion the hit to the global economy. In our downside scenario where the virus outbreak turns out to be much more serious than expected, the hit to economic growth would be more severe and prolonged, even with a coordinated and forceful monetary and fiscal policy response.

The Fed has acted forcefully and cut rates by 50bp between scheduled meetings, which was a surprise. Although the Fed has already cut rates, we think the situation will deteriorate before it gets better, and hence it is difficult for us to see why it would not cut further (by another 50bp in the coming months). By cutting the Fed funds target range, the Federal Reserve has ensured that monetary policy is now neutral instead of tight. Fed Chair Powell said that the economy is strong but that the virus would weigh on economic activity for some time. Communication from the ECB has centred so far around a 'monitoring, not reacting' approach to the economic slowdown. ECB officials expect a V-shaped recovery, although with higher risk of a U-shaped recovery they appear to be trying to avoid reacting prematurely and therefore from having to backtrack later. Most recently, the ECB's Vice-President, Luis de Guindos, acknowledged the new downside risks but was quite balanced in his views, even highlighting the continually higher PMI and confidence in the euro area. Markets are currently pricing in a 20bp ECB rate cut in 2020 and a 36bp cut by the Fed. 

So far, we have seen only limited data that takes into account COVID-19. Euro area flash PMIs were better than feared, but this was driven partly by a sharp increase in suppliers' delivery times, which is fuelled by a fall in supply, not higher demand, i.e. a 'false positive' growth signal. US ISM manufacturing was also disappointing but, in our view, this is not an indication of COVID-19 yet but rather of a slowdown in service activities.

Germany is set to choose a replacement for CDU leader Annegret Kramp-Karrenbauer (AKK) at a party convention on 25 April . The CDU party has voiced heavy criticism of her leadership following the Thuringia election 'debacle', which initially put AfD in an influential position. Friedrich Merz, an economic liberal and fiscal conservative who narrowly lost against AKK in 2018, could again become one of the frontrunners to take on Merkel's succession. We do not expect a sizeable fiscal boost on the back of this. However, until the new CDU party leader puts a mark on the CDU political party line, we doubt there will be material progress on either the fiscal or EU integration debate. The euro group (euro area finance ministers) agreed to embark on a slightly more expansionary budget in 2020 and 2021 but only if the growth outlook deteriorates.