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. The U.S. oil and gas sector will 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.
| 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 | ||||||
- 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 a 0.7 percentage point (to 4.0%) relative to our prior forecast in December.
- For the United States, the impact on activity is expected to follow a similar pattern, with the second quarter bearing the brunt of the economic adjustment. However, in advance of the real impact to the economy, the Federal Reserve has 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 of one percentage point, with annual growth of 1.0%.
| 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 | ||
U.S. Outlook: Sideswiped by COVID-19
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- The economic outlook has been sideswiped by the COVID-19 pandemic. Financial markets are in a tailspin as investors try to assess the economic damage. The Fed has stepped in to provide what support it can by cutting interest rates to the floor, expanding asset purchases, and announcing a host of other liquidity measures aimed at restoring market functioning.
- As a result of the sudden stop in economic activity in March and April, we expect growth in the first quarter will be held close to 1% annualized and the second quarter to contract by 3.2%, the biggest drop since the recession (Chart 4).
- Travel and tourism will be hit hardest, with related leisure and hospitality sectors also feeling the pain as sporting and cultural events, conferences and gatherings are cancelled. The hit to revenue will hold back spending at many businesses, with the oil patch likely to see significant retrenchment. Supply chains will also be impacted by global manufacturing shutdowns, but these impacts will be overshadowed by the hit to demand.
- Assuming containment measures are successful in stemming the number of new cases, activity is expected to normalize, and the economy to bounce back in the third quarter. Still, real GDP growth is expected to average just 1.0% for 2020 as a whole, a full percentage point below our previous forecast. The rebound in activity will show up in average growth for 2021, which we now forecast at 2.1%, two tenths faster than our previous forecast. However, a large amount of foregone spending on services will not be recouped.
- There is a high degree of uncertainty about how widely the virus will spread domestically, and how long the pandemic will go on. Our forecast assumes a two-month disruption to economic activity due to quarantines and shutdowns. The risk is that the outbreak lasts longer, and exacts a larger toll on the outlook.
An unprecedented shock to household spending will hit in the second quarter
- The consumer came into the COVID-19 shock on a solid footing with strong job growth and a record-low unemployment rate. However, as a result of social distancing, spending is forecast to drop over 4% (annualized) in the second quarter of this year. Once fears of infection subside, spending should be expected to rebound, with growth averaging roughly 3.5% in the second half of the year.
- Lower interest rates and a relatively warm winter saw new home construction roar to life early in the year. However, residential investment is likely to fall in the second quarter, in part as warm weather pulled activity forward, but also as activity is stalled due to the coronavirus. There is also likely to be some short-term hit to the resale housing market in the spring as potential homebuyers hold off on purchases and sellers pull listings. Eventually, lower mortgage rates will support demand in the housing sector, giving support to prices and construction.
A short-lived boost from Phase One trade deal
- Before the coronavirus headlines emerged in January, the big economic story was the Phase One trade deal signed with China (see report). The deal lowered tariffs, and just as important, reduced a key source of business uncertainty.
- Unfortunately, businesses didn’t get much of a chance to enjoy it before they had to worry about the impact of virus-related factory shutdowns on global supply chains. The Beige Book and other confidence surveys showed that closures of Chinese factories were a significant concern for American companies. With the virus morphing into a global pandemic, supply constraints will remain an issue, both in terms of the availability of intermediate inputs and in terms of workers who may be unable to come to work due to containment measures.
- Business investment was already expected to be held back by the production shutdown at Boeing in the first half of the year. We expect production there to resume in the second half of the year, which, combined with improved business sentiment should result in a rebound in equipment investment in the second half of the year. The downside risk to this is that the extreme challenges faced by the airline sector continue to weigh on demand for airplanes and restrain production over the medium term.
- In the meantime, the collapse in oil prices is likely to decimate investment in the energy sector. This in large part shows up in structures investment (oil shafts and wells), which we now expect to see sizeable declines in over much of the year.
- The high degree of indebtedness in the nonfinancial sector (Chart 5) could amplify the downside risk to the economy in the event of larger-than-expected weakness in corporate profits. As many industries see their revenues hit, high debt loads could necessitate greater cost-cutting and layoffs than would have otherwise been the case, and is a downside risk to our forecast.
Fed cuts will help, but fiscal support required
- The Federal Reserve acted decisively in the face to the COVID-19 shock and has cut the federal funds rate by 150 basis-point rates to near-zero, with two unscheduled interest rate announcements in March.
- To these traditional policy measures, it has added an additional $700 billion in asset purchases and announced an array of liquidity measures. These are aimed at shoring up confidence in Treasury and mortgage-backed securities (MBS) markets and encouraging the continued flow of credit to households and businesses.
- Our forecasts for Treasury yields are in line with near-zero rates remaining in place for some time (Chart 6). This will trickle through to lower borrowing rates for consumers and businesses. While lower rates will not cure the virus or counteract containment measures, they will help improve debt affordability and should support a rise in spending as life returns to normal.
- As Chair Powell has pointed out, monetary policy is only part of the response to the virus. Indeed, with the Fed having exhausted its traditional policy tools, the time is now for fiscal policy to step into the fray. Washington’s first response was an $8.3 billion in emergency spending to combat coronavirus, assisting with local and state responses. The House of Representatives has passed a bill to provide free virus testing and paid sick leave with reimbursement to businesses via a temporary tax credit. This should help mitigate both layoffs in the near-term, and the spread of the virus by incenting individuals to stay at home when ill. Additional initiatives are likely in the weeks ahead, and present an upside risk to our current forecast.
- On the other hand, the failure of government to provide adequate income supports would increase the risk of credit events among businesses, worsening job losses and increasing the likelihood of an extended economic downturn.
Forecast Tables |
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| U.S. Economic Outlook |
| Interest Rate Outlook |
| Foreign Exchange Outlook |
| Commodity Price Outlook |
| Global Economic Outlook |
| Economic Indicators: G7 and Europe |
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