There are rare moments when the world economy seems to be re-configuring itself beneath our feet. These can be startlingly fast bursts, not obvious to people who are just going about their business but glaringly so to those who interpret the moves of financial markets.
March 2020, it is now abundantly clear, is one of those moments.
Already, it appeared that chunks of the world economy would have to reduce operations or shut down entirely to try to slow the spread of a novel coronavirus, especially in travel-related businesses. Then on top of the virus Russia and Saudi Arabia began an oil price war that sent the price of crude to its biggest plunge in three decades – which could cause widespread bankruptcies in the American energy industry.
The exact scope of the economic damage the world and in particular the United States face is still an open question, and there may yet prove to be significant disruptions without full-scale recession. But recent financial markets, which recorded the steepest single-day drop since 2008, indicated that some very gloomy possibilities were becoming more likely.
Asian markets opened for one week with implausibly large moves in some of the world’s most important measures of economic and financial conditions. The numbers that flashed on traders’ screens in Asia, then eventually in Europe and the United States, seemed to be evidence of a world economy realigning itself.
Let’s ignore for a moment the steep sell – off in stocks – that is an effect, not a cause, of the disruptions remaking the global economic outlook. What in our opinion matters now are bond yields and commodity prices, the two most vivid indicators of a shifting landscape.
These market prices are telling us that a recession is becoming more likely in the United States this year, and that it will probably leave scars on the economy for years to come. Worse, it looks like predictions of a V-shaped downturn with a quick, sharp rebound are probably off base.
In our opinion we’ve reached the tipping point where things are feeding off of each other. We most probably are going to lose a chunk of activity in global markets and then we will most probably grow out of it. That’s the good and most expected news. But are we going to boom out of it like out of the financial crisis of 2008/2009 or crawl out of it? In our opinion crawling is looking far more likely.
President Trump last month endorsed a temporary cut in payroll taxes – after weeks in which his administration appeared largely resistant to large-scale fiscal stimulus. He said that he would announce other economic measures which will be “very major”.
The Federal Reserve is likely to take further actions in our opinion to contain the damage for the economy and financial markets. Not only do futures markets indicate the Fed will cut its short-term interest rate target more in coming weeks, but the yield on 10-year United States Treasury bonds also fell to a mere 0.54%, and the 30-year bond now yields only at 1%. These numbers strongly suggest investors expect the Fed to keep rates near zero – or conceivably below zero at some point – in our opinion for a very long time.
The oil price rout – a barrel of West Texas Intermediate crude, the American standard, closed last month in U.S. trading at 31.13 US-Dollar, down 25% in a single day and around half its level at the start of the year – implies trouble to come in American oil production. Cheaper oil will create benefits for consumers and for oil-consuming industries. But as the shale gas industry has grown and the United States has become a net energy exporter, the balance has changed in how cheaper energy affects the economy.
The pain of cheap oil will tend to be highly concentrated in oil-producing locations, and will have an outsize impact on capital spending. Please also put into consideration that spending on energy is a major driver of demand for heavy industrial equipment. A telling indicator: shares of Halliburton, the leading maker of energy equipment, were down 38% on a single day last month, compared with about 7% for the overall market on that particular day.
The United States has experienced something like this before, in late 2015 and early 2016 when a drop in commodity prices caused an economic slump that was most pronounced in the oil patch and in heavy industry.
In that episode, the overall United States economy kept humming along because consumer spending and service industries were mostly unaffected. What makes the outlook for 2020 seem so different is that the oil price swoon is coming at the same time coronavirus appears likely to wallop those sectors.
The damage in our opinion is still highly uncertain.
But if large gatherings like conferences, concerts, NBA, NFL, Formula One etc. continue to be postponed or partly canceled, and more people decide they will not fly this summer and stay home more generally, it’s likely to cripple the consumer – driven side of the economy.
That means that workers who serve those industries will be in danger of furloughs, lost hours or even layoffs.
Companies affected by the coronavirus spending freeze would, like their counter parts in the energy business, be at risk of default.
Years of aggressive lending practices by businesses could come back to bite them, and a few high-profile bankruptcies could set off a broader reassessment of risk among lenders that means even healthy businesses have trouble rolling over their loans. The downside of the aggressive borrowing by especially corporate America in the last decade is that it makes companies more brittle – less able to withstand the occasional hiccup in demand, or a problem with supplies. It appears to us that 2020 will be a test of their resilience and whether debt loads have truly become excessive.
In effect, plunging energy prices caused by geopolitical machinations are combining with coronavirus to put numerous major industries under pressure in ways that could bounce off one another – through financial markets, to the economy, and back again – in unpredictable ways.
The news isn’t all bad. Lower oil prices really are good news for consumers; lower bond yields will translate into lower mortgage rates; and the big market moves seen over the past weeks will probably get the attention of policy makers and coax a more aggressive response.
In other words, avoiding some of the more dismal possibilities might take some mix of luck and a strong public policy response.
So far, backward – looking data suggests the United States economy is holding up fine. But an economic expansion that would reach its 11th anniversary this summer is in our opinion in danger of premature end. If bond market investors are right, the economy will be haunted by the forces now being unleashed for a long time to come.