Summary
- The COVID-19 outbreak has quickly morphed into an unprecedented global economic shock. What started out largely focused on China’s highly-integrated supply chains, has turned into a globally transmitted supply and demand shock. As more countries try to clamp down on the virus’ spread with social distancing tactics, an initial sharp drop in travel and tourism is being followed by a reduction in other activities and spending. This is now a question of whether governments and central banks can shore up business and household confidence, in the face of extreme equity and bond market volatility.
- Past virus outbreaks offer only limited insight into current developments. A key distinction with COVID-19 is not the number of impacted countries, but rather the strong behavioral response to limit contagion via large-scale quarantines and interruptions to business operations. We have not seen anything similar in scale in recent history. The result creates far more forecast uncertainty over the next several months.
- Wild swings in global equity markets have echoed and amplified these concerns, further punctuated by an unanticipated sharp drop in oil prices. Weakening global demand was already weighing on oil prices. However, a failed OPEC+ meeting to tighten supplies led to a complete 180-degree tactical move by Saudi Arabia, which has decided to instead flood the market with record levels of supply. This appears to be an attempt to squeeze out marginal producers and strong-arm other OPEC+ members to fall in line.
- Regardless of the rationale, the negative ramifications are borne out in oil-exporting regions, with Canada among those absorbing a significant income shock. The U.S. oil and gas sector will also not be spared, with the potential for amplified financial risks imparted to heavily indebted firms.
- As we’ve noted several times in the past, markets always fear what they cannot measure. Today’s environment is riddled with uncertainty, complicated by a large economic shock from business and household behavioral adjustments.
- When sitting within the nexus of uncertainty, it’s important to not have a knee-jerk reaction on the forecast. We must permit time to evaluate the responses of central banks and governments to mitigate the downside. In doing so, we start with some basic assumptions based on observations. The first of these is that preliminary data indicate China’s aggressive quarantine measures have limited the number of new cases of the virus and contained the economic shock to a relatively short period of roughly three months. However, for that period of containment, the impact to retail sales and industrial production was far greater than ever seen in its historical data.
- This speaks to depth, but not duration. We assume similar outcomes occur among other countries, with Italy, Spain, and France being the latest to implement stringent containment measures. Together, this assumption reduces global growth by 1.3 percentage points and leads to the slowest pace since the global financial crisis, at just 1.7%. However, the recovery phase creates a tailwind to growth in the second half of this year, which lifts our 2021 annual growth by 0.7 percentage points (to 4.0%) relative to our prior forecast in December.
- For the United States and Canada, the impact on activity is expected to follow a similar pattern, with the second quarter bearing the brunt of the economic adjustment. Canada’s greater dependence on global trade and commodity exports implies a more severe economic impact than stateside, made worse by the added negative income shock from the sudden drop in energy prices. However, in advance of the real impacts to either economy, both central banks have responded proactively by lowering rates and shoring up liquidity. In addition, governments have been able to mobilize to ensure appropriate income support measures will be in place to the most heavily impacted businesses and households. Combining the influences still results in a significant downgrade to our 2020 forecast, by 1.4 percentage points for Canada and one percentage point for the U.S. with annual growth of 0.2% and 1.0%, respectively.
Containment is priority number one
| Table 1: Forecast Revisions | ||||||
| Dec QEF | Mar QEF | Change | ||||
| 2020 | 2021 | 2020 | 2021 | 2020 | 2021 | |
| World | 3.0 | 3.3 | 1.7 | 4.0 | -1.3 | 0.6 |
| Advanced | 1.5 | 1.7 | -0.1 | 2.3 | -1.6 | 0.6 |
| U.S. | 2.0 | 1.9 | 1.0 | 2.1 | -1.0 | 0.2 |
| Canada | 1.6 | 1.8 | 0.2 | 2.1 | -1.4 | 0.3 |
| UK | 0.9 | 1.5 | -0.7 | 2.4 | -1.6 | 0.9 |
| Japan | 0.6 | 0.8 | -1.4 | 1.1 | -2.0 | 0.3 |
| Euro Area | 1.2 | 1.5 | -1.6 | 2.5 | -2.9 | 1.0 |
| Germany | 0.5 | 1.4 | -0.5 | 2.1 | -1.0 | 0.7 |
| Emerging Markets | 4.1 | 4.4 | 2.9 | 5.1 | -1.2 | 0.7 |
| China | 5.9 | 5.7 | 4.1 | 7.3 | -1.7 | 1.6 |
| Source: TD Economics | ||||||
- As the virus has spread, attention has rightly turned to the policy response. The first task is to contain the virus. Large scale quarantines in China led to a steep drop in economic activity in February. This was evidenced by double-digit declines in auto sales, exports and plummeting manufacturing activity. China’s manufacturing sentiment indicator plummeted to 35.7, a level that is lower than the global financial crisis experience (38.8). The good news is that the rapid decline in reported new virus cases is prompting Chinese authorities to begin to normalize operations. Absent another large breakout elsewhere in the country, growth is expected to re-emerge in the second quarter of this year.
- Unfortunately, the rest of the world is now in the thick of containment measures and efforts appear to be following a similar playbook. In Italy, France, South Korea and Iran, lockdowns have been mandated across the entire country in varying degrees. Irrespective of the number of confirmed virus infections, surrounding regions are also responding proactively by limiting entry into their countries and pursuing widescale cancelations of group events. Perhaps nothing is more symbolic of this than Ireland’s cancellation of the annual St. Patrick’s Day parade with 21 known coronavirus cases at the time. These responses will impart a large near-term economic shock, but hopefully show success in reducing cases and limiting the duration of the shock.
Policy coordination is priority number two
- Governments and central banks are following a coordinated, risk management framework to setting policy in an attempt to smooth out the economic risk. However, coordination will mean different things to different countries and institutions.
- Central banks are speaking with one voice on the intent to shore up liquidity, credit and confidence, but their actions will differ depending on the starting point. Central banks in Europe, Japan and the UK have far less scope than those in North America to cut interest rates. Instead, they are leaning more heavily on other tools, such as longer-term refinancing options for the most vulnerable sectors of the economy, corporate bond purchases in the event of liquidity strains, and relaxing counter-cyclical capital buffers among banks in order to free up capital for lending. The central banks in Canada and the U.S. are pursuing similar measures, but have the added advantage of lowering interest rates aggressively. The Federal Reserve has swiftly returned rates to the zero lower bound, while Canada conducted an unprecedented combined cut of 100 basis points in 10 short days.
- However, given the nature of this economic shock, the success of central banks being proactive would be met with limited success if government policies don’t address the supply side shock to prevent it from morphing into a widescale demand side one.
- Fiscal policy is a critical component to economic success. Governments within virus-impacted countries are moving quickly to announce financial support to the most vulnerable areas of the economy: small businesses, households and the services sector (tourism and transportation in particular). In many cases, programs set up in the past to deal with natural disasters, such as loan guarantees for businesses and income supports to workers and businesses are being re-activated.
- Among the countries that have announced fiscal stimulus to-date, the amounts vary but some are substantial and greater than 1% of GDP (Table 2). All told, targeted fiscal packages should help to shore up confidence and mitigate the negative income impacts. This should help return activity to normal and allow for make-up growth in the second half of the year.
Greater economic disruption if containment fails
- It’s hard enough being an economist without also having to be an epidemiologist. The main downside risk to the forecast is that the efforts to mitigate the spread of the virus take a greater toll on financial market confidence and carry a longer duration across a broad set of countries. Our baseline forecast is pinned to economic disruptions persisting through April, with the recovery taking hold thereafter. If we’re wrong on the period of disruption, then the economic pain will be more severe and likely accompanied with broad job losses. With uncertainty elevated, the recovery in financial and commodity markets could also be stalled, contributing to greater pullbacks in investment and spending. In this situation, a formal recession would come into scope globally and domestically.
- Canada would be at a clear disadvantage in this scenario. The shock to income from a declining price of oil hits energy-producing countries harder. In addition, across the country, high levels of household debt make spending more vulnerable to income shocks, requiring a more skilled hand at policy responses. Both the history and the recent experience of China suggest that a long or deep global recession is not the most likely scenario, but it will require the actions of policy to deal deftly with the rapidly changing situation.
- And just like any forecast, there could also be some unexpected surprises to the upside in the months ahead. The outlook now incorporates significant monetary and fiscal stimulus. As these measures feed through the economy with lags and linger, it’s quite possible that the recovery stage of the economy later this year proves stronger than expected once the weight of containment measures lifts. Only time will be the ultimate judge of success, for now we remain cautious on the outlook and hope for the best.
| Table 2: Countries' Fiscal Response to COVID-19 | ||
| Country | Fiscal Response | |
| Australia | • Support business investment and provide cash flows assistance for businesses | • Support households with cash handouts and help affected regions and communities |
| A$17.6B | 0.9% of GDP | ||
| Canada | • Credit facility program worth C$10B for SMEs | • Funds for medical research, including funding for vaccine research and clinical trials |
| C$11B | 0.5% of GDP | • Funding for medical gear, public education, surveillance, monitoring, and access to testing | • Increased federal lending to help struggling businesses access credit |
| China | • Allocation for outbreak relief and cutting unnecessary government expenses | • Tax waiver for overtime income earned by medical workers and offering cash and free transport to workers |
| ¥99.5B | 0.1% of GDP | • Reduction in corporate taxes | |
| Euro Area | • €37B directed towards healthcare systems, SMEs and labor markets | • Investments worth €20B by EIB in SMEs |
| €113B | 0.9% of GDP | • European Investment Bank (EIB) and European Commission to do €28B in working capital lending | |
| Germany | • In the form of loans through the German development bank | • Loan terms changed so that the government assumes more risk, while loan applications procedures simplified and speeded up |
| €553B | 15.5% of GDP | • Companies allowed to defer taxpayments | |
| • Announcement of "no upper limit on the amount of loans" | ||
| Hong Kong | • A HK$10,000 one-time cash handout to all permanent residents | • Reduction in corporate and salary taxes and subsidies for utility bills |
| HK$120B | 4.2% of GDP | • Low-interest loans with government guarantees for small businesses | |
| Italy | • Tax credits for companies that reported a 25% drop in revenues | • Suspension of loan payments (including mortgages) from virus-hit companies, resources for health and emergency services |
| €25B | 1.4% of GDP | • Tax cuts and extra cash for the health system | |
| U.K. | • £7 Funding for the self-employed, businesses and vulnerable people | • Government to backstop sick pay for small businesses for two weeks |
| £30B | 1.4% of GDP | • £5 emergency response fund for the public healthcare system | |
| • Additional spending of £18B to support the economy | • Cash grants for small businesses | |
| U.S. | • R&D for vaccines, treatments and diagnostics | • Funding for centers for disease control and prevention |
| $8.3B | 0.04% of GDP | • Medical supplies to boost preparedness and community health care | |
| Source: TD Economics | ||
Canadian Outlook: Unprecedented Times, Unprecedented Measures
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- There seems to be no end to the list of headwinds affecting the Canadian economy. The close of 2019 saw a meagre 0.3% annualized pace of growth, and it now looks like this will give way to a modest contraction at the start of 2020 (Chart 7). If we had been writing this document a month ago, we would have been talking about unusual weather, rail blockades, and other disruptions holding back the economy. Now, with COVID-19 on the landscape, a disappointing start to the year will give way to back-to-back quarterly contractions.
- To make matters worse, now there’s Saudi Arabia’s scorched-earth approach of flooding the market with oil supply when demand is already quite weak. Plummeting prices generate a significant income shock on Canada that is particularly impactful in the second quarter.
- This combination of events is set to disrupt growth over the entire first half of the year. Accordingly, we’ve downgraded our 2020 outlook to just 0.2% (from 1.6% in our December forecast). If realized, this would be the slowest pace since 2015. As discussed in our Chief Economist’s latest client note, only time will tell if virus-containment measures bleeds into the third quarter to take a technical recession into a formal one.
- This forecast hinges on a critical assumption that the worst of the impacts are resolved by mid-year. A recovery thereafter sets up a stronger hand-off into 2021 that results in a 2.1% pace for that year. However, this forecast is subject to a particularly high level of uncertainty given the nature of events and unprecedented mitigation action being taken by governments and businesses.
- The downgrade to this year’s growth occurs via four key channels:
- Travel, tourism and closely connected industries such as restaurants, conferences, sporting activities and so forth. This reflects individuals seeking to avoid infection by cancelling or altering both international and domestic plans, in line with public health guidelines.
- Supply chains. Firms relying on imported parts from other countries that face production disruptions may be unable to find alternative sources of inputs. This carries negative implications for employee incomes, particularly for hourly workers.
- Sentiment – both consumer and business. Recent reports of consumers stockpiling essentials such as toilet paper suggest that fear is taking root, consistent with a significant spending slowdown in the coming months. Given the nature of the outbreak, the biggest impact is likely to be felt in discretionary purchases, particularly spending on in-person services. This is where the prior two supply shock channels intersect with a demand-shock channel.
- The ‘terms of trade’ shock: the incredible drop in commodity prices, particularly for energy, significantly reduces the value of our exports, driving a negative income shock akin to the 2014/2015 experience. The result there? A deepening of the expected second quarter economic contraction, and a blunting of the recovery thereafter. We estimate this shock alone will shave 0.7 percentage points off real GDP during the second quarter, with a further 0.5 p.p. drag on third quarter activity.
- We expect a near-term deterioration in labour markets as the most impacted industries such as travel and tourism adjust staffing levels. However, at this point we believe that fiscal policy to support worker retention will serve to limit the downside.
Monetary + Fiscal Policy Step-Up Measures
- Governor Poloz was first out the gate in Canada, cutting the Bank of Canada’s policy rate by half a point at its March decision. This was in response to the rapid evolution of economic risks presented by COVID-19. Since that decision, a significantly worsened oil price shock also landed on their doorstep. A mere ten days after the first rate-cut decision, Governor Poloz joined his colleagues from the Department of Finance and OSFI in an unprecedented joint action. The Bank of Canada cut its policy rate a further half point, introduced an asset purchase program and a slew of liquidity measures (for further details, please see our recent note), and made clear that it stood ready to do more (Chart 8). For its part, OSFI reduced required capital buffers, a move intended to spur loan availability for the major banks. We expect a further half point cut at the Bank of Canada’s next decision, scheduled for April 15th. However, given the significant downside risks facing the Canadian economy, we would not be surprised to see another inter-meeting rate cut.
- For his part, Finance Minister Morneau has announced a suite of measures designed to mitigate the economic impacts of COVID-19 and other factors on affected industries. We’ve so far seen more than $10bn in direct measures to support healthcare providers and small and medium sized firms, and we expect much more to come. We anticipate that nearly all parts of the Canadian economy will see support, in particular those laid off, and importantly, those who are impacted by the disruption but not able to access government assistance via the usual channels such as EI. While it is too early to know for sure, these measures should help support business and consumer confidence in the coming weeks. However, if unsuccessful in doing so, we would expect additional broad-based measures to stimulate the economy quickly.
The Silver Linings
- Our updated forecast has not been composed entirely of downgrades. A strong housing market is being met by much lower interest rates and an easing of macroprudential regulations. This comes as at a time when demand was already in recovery mode, drawing inventories to 2017 lows (Chart 9).
- The soft start to the year for resale activity appears to have been a weather driven head-fake, with February data showing robust gains in activity and prices. Although soft supply will act as a near-term constraint, the old saying that “the best cure for high prices is high prices” should come into play to lure sellers into the market as we get past the expected pause in activity around the worst of the COVID-19 outbreak.
- Government spending has also been upgraded. This is not solely due to policy responses to COVID-19, but also to stronger-than-anticipated spending plans enumerated in Statistics Canada’s latest capital spending survey. The timing of these outlays may just be a happy coincidence given the significant lags between project announcements and actual spending, but they nevertheless provide much needed support to the economic outlook.
Containment Key To Rapidly Evolving Outlook
- Our economic outlook embeds sizeable downgrades to the 2020 economic outlook, but the damage is expected to be relatively short-lived: although we expect to see two quarters of contraction, the most intense part of the economic hit is concentrated in the second quarter, particularly the latter half of March and early April. Thereafter, we are hoping for some normalization in business operations and a recovery to emerge, albeit one weighed down by renewed and more persistent challenges to the energy sector that will maintain a weight on the economy. As well, some of the lost service activity will not be recaptured, leaving the level of output permanently lower. Our forecast also assumes that job markets are resilient relative to the GDP hit.
- These forecast outcomes rely on an assumption that the worst effects from virus-containment measures are in the rear-view mirror by May. Similarly, oil prices are expected to begin recovering by the third quarter as cooler heads prevail within the OPEC+ oil-price war. Just as important as the containment of the virus will be containment of business and household sentiment. Given the pre-existing risks to the Canadian economy from overindebted consumers, should these assumptions fail to hold, the impact to the economy would unquestionably be deeper and longer. The ability for confidence to rebound quickly is a key underpinning of this forecast.
- Conversely, and equally important to consider, is the strength of the policy responses and their lagged impacts on growth. Just as economic activity will be hard hit in the near-term, a healthy recovery is also part of the outlook, and may be stronger than anticipated if sentiment recovers quickly.
- These forecasts were penned from within the nexus of uncertainty, and we will be monitoring behaviors, data and outcomes in the weeks ahead to determine depth and duration of COVID-19 impacts on the economy.
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