What's next for the global economy? Eight working assumptions

The ground beneath us is moving. There are unprecedented levels of uncertainty. Economies are responding to substantial supply-side and demand-side shocks, the scale (and kind) of which we have precious little experience with. Markets are behaving in ways they’ve rarely done, and yet we’re caught in a position where central banks can do almost nothing to solve the largest—although not the only—underlying problem: a global public health crisis. Plummeting oil prices, in our view, are likely to exacerbate all of these problems in a significant way.

At this point, economic forecasting can feel like a futile endeavor: The parameters are changing so quickly that even typically forward-looking macroeconomic data is out of date before it’s published. As a result, we have almost no visibility into how global economies are reacting to COVID-19. At this point, the macroeconomic strategy team is operating with several important assumptions that we carry with moderate to high levels of conviction. It’s important to note that these assumptions are fluid in nature and are likely to evolve over the coming weeks, but they form the pillars of our current thinking about the global economy:

  1. The global economy is likely to grow at a rate that’s consistent with a global recession, with China, Japan, and Germany—the world’s second, third, and fourth largest economies—being the most at risk of experiencing two or more quarters of back-to-back negative growth. If the global economy does indeed slip into a recession, it would be a culmination of four factors: (i) an already weakened economy as a result of protracted trade tensions, (ii) the supply- and demand-side shocks arising from COVID-19, (iii) signs of trouble in the credit markets, and (iv) economic weakness created by substantially lower oil prices.
  2. We believe the United States is also facing a sizable recession risk, and we expect U.S. growth to contract for at least one quarter. Crucially, we think there’s a chance that the magnitude of demand destruction could be significant—what would typically take place over the course of two quarters could materialize in three months. Whether we’ll see a second quarter of contraction and, therefore, slip into a formal recession will depend on when the virus outbreak peaks out. In our view, we’ve moved from a supply-side-driven economic shock, which markets were likely capable of looking through, to a supply- and demand-side shock, which is far more problematic.  
  3. The risk of a credit crisis is rising. Monday’s oil price decline1 increased the likelihood of issues arising in the credit markets, given that the high-yield segment is particularly energy intensive. In our view, three ways in which the financial markets have evolved in recent years have heightened our concerns on this front: (i) liquidity is more electronic than it has been in the past, (ii) the market has moved from collateralized debt obligations to leveraged loans (a similar product with similar liquidity problems), and (iii) the rise of the exchange-traded fund market.
  4. U.S. interest rates could be 75bps lower before the end of March. In our view, the U.S. Federal Reserve (Fed) could announce another 50 basis points (bps) intermeeting interest-rate cut and might well lower rates again when it meets on March 18. The Fed will also likely need to be ready to ramp up its liquidity operations to meet the demands of the market; it’s highly likely that the entire U.S. yield curve will continue to trade below 1.0% for the foreseeable future. At this juncture, we could also see central banks turning to unconventional monetary policies such as yield curve control. While years of economic training might have led us to believe that temporary equity buying programs (e.g., Bank of Japan) would be off the table, it might be unwise to write that off completely.
  5. There’s global coordination among central banks, but the European Central Bank is lagging, and that’s led to a strengthening in the euro,1 further tightening global financial conditions. As we’ve mentioned in previous commentaries, while monetary policy can buy policymakers some time, provide some support to financial markets, and lower some monthly debt costs for households and businesses, it won’t prevent recessions.
  6. Fiscal stimulus is substantially lagging monetary policy, and crucially, at this point, could be insufficient to prevent recessions in key global economies, including the United States. Fiscal packages announced so far seem focused on public health infrastructure, which is no doubt important, but we’ve yet to see measures that are aimed at cushioning the drop-off in demand, particularly in the United States. Given the long lead time between fiscal stimulus implementation and real economic impact, measures of this nature—assuming they’ll be introduced in the coming weeks—are more likely to influence the strength of the recovery as opposed to arresting the rate of the slowdown in consumer demand.
  7. There’s a large deflationary shock coming, driven by demand destruction, a strong trade-weighted U.S. dollar, and the oil price shock. We believe central bank inflation targets are seriously at risk in this environment, as inflation expectations become unanchored from official targets.
  8. We expect a sizable depreciation in the Canadian dollar, as the Canadian economy entered this environment in a position that made it extremely vulnerable to a demand-side shock. In our view, the USD/CAD currency pair could hit the 1.39 level in the near term. Interestingly, the market has priced in fewer interest-rate cuts in Canada than in the United States, meaning there’s scope for more dovish surprises from the Bank of Canada. The drop in Western Canada Select prices,2 while slightly more resilient than Brent, spells further problems.

 

 

1 Bloomberg, March 9, 2020. 2 Western Canada Select is a grade of crude oil that’s produced in Canada. Its price is typically used as a benchmark for crude oil produced in the country.

Investing involves risks, including the potential loss of principal. Financial markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. These risks are magnified for investments made in emerging markets. Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a portfolio’s investments. The information provided does not take into account the suitability, investment objectives, financial situation, or particular needs of any specific person. You should consider the suitability of any type of investment for your circumstances and, if necessary, seek professional advice.This material, intended for the exclusiveuse by the recipients who are allowable to receive this document under the applicable laws and regulations of the relevant jurisdictions, was produced by, and the opinions expressed are those of, Manulife Investment Management as of the date of this publication, and are subject to change based on market and other conditions. The information and/or analysis contained in this material have been compiled or arrived at from sources believed to be reliable, but Manulife Investment Management does not make any representation as to their accuracy, correctness, usefulness, or completeness and does not accept liability for any loss arising from the use of the information and/or analysis contained.The information in this material may contain projections or other forward-looking statements regarding future events, targets, management discipline, or other expectations, and is only as current as of the date indicated. The information in this document, including statements concerning financial market trends, are based oncurrent market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. Manulife Investment Management disclaims any responsibility to update such information.Neither Manulife Investment Management or its affiliates, nor any of their directors, officers or employees shall assume any liability or responsibility for any direct or indirect loss or damage or any other consequence of any person acting or not acting in reliance on the information contained herein.All overviews and commentary are intended to be general in nature and for current interest. While helpful, these overviews are no substitute for professional tax, investment or legal advice. Clients should seek professional advice for their particular situation. Neither Manulife, Manulife Investment Management, nor any of their affiliates or representatives is providing tax, investment or legal advice. Past performance does not guarantee future results. This material was prepared solely for informational purposes, does not constitute a recommendation, professional advice, an offer or an invitation by or on behalf of Manulife Investment Management to any person to buy or sell any security or adopt any investment strategy, and is no indication of trading intent in any fund or account managed by Manulife Investment Management. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Diversification or asset allocation does not guarantee a profit norprotect against loss in any market.Unless otherwise specified, all data is sourced from Manulife Investment Management.Manulife Investment ManagementManulife Investment Management is the global wealth and asset management segment of Manulife Financial Corporation. We draw on more than 150 years of financial stewardship to partner with clients across our institutional, retail, and retirement businesses globally. Our specialist approach to money management includes the highly differentiated strategies of our fixed-income, specialized equity, multi-asset solutions, and private markets teams—along with access to specialized, unaffiliated asset managers from around the world through our multimanager model.These materials have not been reviewed by, are not registered with any securities or other regulatory authority, and may, where appropriate, be distributed by the following Manulife entities in their respective jurisdictions. Additional information about Manulife Investment Management may be found at www.manulifeam.com.Australia: Hancock Natural Resource Group Australasia Pty Limited, Manulife Investment Management (Hong Kong) Limited.Brazil:Hancock Asset Management Brasil Ltda.Canada: Manulife Investment Management Limited, Manulife Investment ManagementDistributors Inc., Manulife Investment Management (North America) Limited, Manulife Investment Management Private Markets (Canada) Corp. China: Manulife Overseas Investment Fund Management (Shanghai) Limited Company. European Economic Area and United Kingdom: Manulife Investment Management (Europe) Ltd. which is authorised and regulated by the Financial Conduct Authority, Manulife Investment Management(Ireland) Ltd. which is authorised and regulated by the Central Bank of IrelandHong Kong: Manulife Investment Management (Hong Kong) Limited. Indonesia: PT Manulife Aset Manajemen Indonesia. Japan: Manulife Asset Management (Japan) Limited. Malaysia: Manulife Investment Management (M) Berhad (formerly known as Manulife Asset Management Services Berhad) 200801033087 (834424-U) Philippines: Manulife Asset Management and Trust Corporation. Singapore: Manulife Investment Management (Singapore) Pte. Ltd. (Company Registration No. 200709952G) Switzerland:Manulife IM (Switzerland) LLC. Taiwan: Manulife Investment Management (Taiwan) Co. Ltd. Thailand: Manulife Asset Management (Thailand) Company Limited. United States: John Hancock Investment Management LLC, Manulife Investment Management (US) LLC, Manulife Investment ManagementPrivate Markets (US) LLC and Hancock Natural Resource Group, Inc. Vietnam: Manulife Investment Fund Management (Vietnam) Company Limited. Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.

511282

Frances Donald

Frances Donald, 

Global Chief Economist and Strategist, Multi-Asset Solutions Team

Manulife Investment Management

Read bio