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Is a global recession now inevitable and what more can the Fed do?

Mar 17, 2020
With markets seemingly disappointed by emergency central bank policy action, it appears that the global economy is heading for a full-on recession.

While this was not seen as inevitable barely a few days ago, some commentators are even talking about a new depression, even as US National Economic Council Director, Larry Kudlow, bats away any mention of the ‘r’ word, simply saying that the second quarter will be ‘very difficult’.

Official recession definition

The IMF normally defines a global recession as being when growth which has historically been around 3.5% to 4% per year, falls below 2.5%. Although this definition may vary somewhat in the current circumstances, the body has said that the impact of the virus will be ‘significant’ and that growth in 2020 will be lower than in 2019 which printed at 2.9%.

Official forecasts remain more optimistic and as is usual, the word ‘recession’ has been avoided by central bank heads. New ECB President Lagarde said the economic consequences would be a ‘major shock’ while outgoing BoE governor Mark Carney declined to predict a UK recession.

Dire economic data ahead

But we have already seen the impact that the virus is having on some economies. For example, yesterday’s Chinese economic indicators showed a heavier blow than analysts feared from the lock-down following the virus outbreak with industrial output plunging by 13.5% y/y in January and February, while retail sales tumbled 20.5% and fixed-asset investment slumped 24.5%. It seems it is a given that the global economic growth in the first half of the year will be negative, with the second half depending on when peak infection will be reached.

Of course, the hope is that the Fed’s current aggressive policy response can stop this transitory demand and supply shock from turning into an unprecedented financial crisis. Indeed, it is hard to see how much more the Fed can do in the very short-term, while awaiting the upcoming spending package from Congress.

More aggressive measures

The Fed’s balance sheet today stands roughly at 18% of GDP, though it reached around 25% in early 2015 at its peak, so there is potentially more ammunition for asset purchases. Further measures include yield-curve control, similar to the Bank of Japan where the central bank puts a target level for longer yields, the 10-year point in the BoJ’s case. Allowing the Fed to buy a broader range of financial assets, including corporate bonds and stocks, an idea proposed recently by Eric Rosengren could also be in the toolbox, but this is controversial. The Fed is currently only allowed to buy government-backed bonds like US Treasuries and mortgage-backed securities.

Similarly contentious is lowering the policy rate into negative territory, something which Fed Chair Powell again dismissed in his press conference on Sunday night. The Fed is not convinced of the stimulative effects of negative rates and sees notable adverse effects. Not even the BoJ is a fan of negative rates as it increased its stimulus measures yesterday but did not touch short rates.

Interestingly, longer bond yields have not made new lows despite free-falling stock markets and further weakening in the economic outlook. There is still great uncertainty and risk appetite will continue to face headwinds as markets await some kind of co-ordinated fiscal response. It is the current fragmented approach to the crisis by governments which has exacerbated confidence and steers us down the road to a global recession at the moment.

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