COVID-19’s macro-economic impact

For the first time in a century a pandemic has swept the globe leading to the lockdown of over 3 billion people, causing wide-ranging, detrimental impacts upon stock, commodity and bond markets, upending economies and inflicting punishing levels of unemployment upon nations from East to West.

That damage has been done to markets is clear, but how much damage? And, to what extent can the various government stimulus packages repair that damage? We’ll explore a variety of answers to these questions in this article.

Historical context

Before we proceed however, it’s important to look at the current financial market impact of COVID-19 in light of other historical slumps.

Perhaps the most eye-opening of statements on the historicity of the current slump comes from the Bank of England which in early May stated that Britain is facing its worst recession in 300 years, with unemployment hitting 9% and the economy shrinking by 14% during 2020 as a whole. Gross domestic product is expected to fall by 15% to 25% during the April-June quarter.

On the face of it, this appears to be an unparalleled decline in economic output. Yet, the National Institute of Economic and Social Research (NIESR) has compared these figures to those immediately following the 1918-1921 ‘Spanish’ influenza pandemic. In the third quarter of 1921, economic output recovered by 12-15%. Could we see a similar recovery in output in the third quarter of 2020?

We’re facing a serious disruption in the economic life of the economy then, but history suggests that there may be some cause for optimism (or at the least grounds to reject boundless pessimism).

Stock markets take stock

As it became clear that the regionalised COVID-19 epidemic was becoming a global pandemic, the stock markets saw immediate falls. On Monday 24^th February, the Dow Jones and S&P 500 posted their sharpest daily declines since 2018, with the Dow falling 3.5%. The S&P 500 ended the day 3.3% lower, whilst the NASDAQ dropped 3.7%. Reflecting the global nature of the crisis, other major stock markets were equally hit; the FTSE 100 share index closed 3.3% lower, Milan’s stock market plunged by nearly 6%, Japan’s Nikkei 225 declined 4.41% (more than 20% lower than its 52-week closing high).

Further turbulence in the following weeks saw the yields on 10-year and 30-year U.S. Treasury securities fall to record lows. By the end of March, the OECD estimates that stock markets had declined over 30 percent.

The commodity crash

With a rapid and massive contraction in economic activity caused by lockdown, a collapse in oil prices (and other commodities/natural resources) seemed somewhat inevitable. Yet the scale of collapse is something that will be recorded in history books. It was a crash which was precipitated by a disagreement.

OPEC member nations had tentatively agreed on the 5^th March to curtail their collective oil production by 1 million barrels per day. Unfortunately, the cartel’s biggest oil producing rival, Russia, refused to co-operate with the production cuts.

The result?

On 8^th March, Saudi Arabia reneged on its previous agreed production cuts and set about increasing production and selling it to customers in Asia, the US and Europe at a discount of $6-8 a barrel.

As the laws of supply and demand would dictate, a collapse in oil prices was bound to follow…

What followed was remarkable decline in value for what economists commonly refer to as the ‘master resource’. Brent Crude, which is used to price two-thirds of the world’s crude oil supplies, experienced its largest drop in price since the outbreak of the first Gulf War.

For traders committed to certain oil futures, worse was to come.

On 20^th April, thanks to a combination of unmodulated oil supply, a lack of storage capacity and exceptionally low demand, the futures price of West Texas Intermediate (WTI) crude to be delivered in May went negative – the first time that crude oil had reached a negative value.

With national economies still at reduced levels of activity and output, instability in oil markets is set to persist…

Industry hibernation

Aside from the oil industry, multiple others have experienced pain as a result of the COVID-19 induced economic recession. Indeed, some industries such as aviation and tourism are facing a period of hibernation, whilst others such as hospitality are facing the prospect of fundamentally altered trading conditions.

Just how bad could the impact be on the most vulnerable industries?

Aviation – According to an analysis by the International Transport Association global airlines could lose upwards of $113 billion in sales as a result of the pandemic and its associated lockdowns, travel restrictions and quarantines.
Retail – Retail, especially brick and mortar retailers, has experienced declines in consumer spend across nearly every category. The worst affected retail categories include apparel and footwear, home and furniture, electronics, and health and beauty. Aside from declining consumer demand, retailers are also facing challenges such as obstructed logistics, and constrained/shut down suppliers.
Sports – Major sporting events across the planet have been postponed and cancelled. Everything from the Summer 2020 Olympics to the 2020 UEFA European Championship have been pushed to next summer, impacting related industries such as entertainment, betting, and advertising.
Entertainment – For similar reasons as sports, the entertainment industry has been severely impacted by COVID-19 and faces an uncertain future so long as the virus remains present. Concerts, music festivals, movie theatres and galleries have all been curtailed by the pandemic. Whilst they may return soon, they’re likely to offer a very different experience to consumers than they did BC (Before COVID).

Central banks to the rescue

From the onset of the pandemic in early March market volatility reached levels not seen since 2008. However, lessons appear to have been learned from this previous crash, with policymakers quickly responding with co-ordinated action by central banks with interest rates slashed, huge new injections of liquidity and the re-emergence of quantitative easing.

Governments and policymakers of all stripes have embraced the spirit of Keynes. This is evidenced in the scale, scope and ambition of the stimulus packages that have been agreed to date:

The US Federal Reserve has agreed new measures worth around $4 trillion (approximately 20% of GDP).
The UK Treasury has committed to a stimulus package in excess of 15% of GDP.
Other European nations such as Spain and Germany have agreed stimulus packages of 20% and 8% respectively.

Naturally, stimulus packages require borrowing. In this case, a lot of it. Here in the UK government borrowing is set to rise more steeply than it did during the Great Financial Crisis of 2008 with the debt to national output (GDP) ratio likely to rise to 120% by year end.

Aside from these stimulus packages, expect to see a variety of other policy instruments employed. If the recession becomes prolonged and/or increasingly severe, central banks such as the Bank of England could well take interest rates negative.

But that all lies in the future. What happens next could well hinge on the development of an effective vaccine and/or the dissipation of the virus…

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