Fast and furious: policymakers react to - COVID-19 - Ninety One
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Investment Institute
Viewpoint / April 2020
Fast and furious:
policymakers react to
COVID-19
Previously Investec
Asset Management
Central banks have done a lot, says Russell Silberston. But is it enough?
Since its first appearance in Wuhan, Hubei, China toward the end of December 2019, the
coronavirus (COVID-19) has spread rapidly across the world, causing widespread strains on society
and economies.
Nassim Nicholas Taleb, in his 2007 best seller ‘The Black Swan1’ described three attributes of low
probability but large impact events. Firstly, it is an outlier, with nothing in the past that can
convincingly point to its possibility. Secondly, it carries an extreme impact, and lastly, an ex-post
Russell Silberston narrative makes it both explainable and predictable.
Investment Strategist –
Macro-economic and
Using Taleb’s definition, the global COVID-19 pandemic, currently placing more than 20% of the
Policy Research global population under restrictions2 to their daily lives is not a ‘black swan’ in the strict sense. In
2006, the UK financial authorities carried out a ‘Market Wide Pandemic Exercise’ that ‘highlighted a
number of important challenges that would face the financial sector in the event of a flu pandemic.3’
And in 2011, the UK Department of Health published a ‘UK Influenza Pandemic Preparedness Strategy
20114’ in which they stated that “given known patterns of spread of infection, up to 50% of the
population could experience symptoms of pandemic influenza during one or more pandemic waves
lasting 15 weeks.” So off the radar certainly, but hardly impossible to conceive.
However, the current episode certainly ticks two of Taleb’s boxes. There can be little doubt that
the economic and social impact are likely to be extreme. And it seems probable that once the worst
passes, the narrative in financial markets and society will be more geared to understanding what
happened.
While events are fast moving and unfolding rapidly, it is important to differentiate between problems
with the financial plumbing and the wider economic damage caused by the dislocation brought
about by placing restrictions on 20% of the population. Financial markets operate on a different time
scale to policymakers, as the former move quickly to discount future news and anticipate evolving
credit conditions in real time. Policymakers, on the other hand, take a more considered view and so
The value of investments, and any income generated from them, can fall as well as rise.
For professional investors and financial advisors only. Not for distribution to the public or within a country where distribution would be contrary
to applicable law or regulations.
1Fast and furious: policymakers react forcefully to COVID-19
are rarely able to react with the urgency that financial markets scream for. This can
often lead to a ‘sudden stop’ as a vicious cycle of higher cash demands sees funding
markets dry up, forcing up volatility and margin requirements, which in turn pushes up
liquidity requirements further. The circle is only broken once central banks offer
enough liquidity for everybody, thus reducing demand, volatility and margin. Four
weeks into the current period of extreme volatility, the speed and scale of
policymaker intervention suggests the plumbing is being repaired rapidly. The
economic fallout, however, is only just starting and the scale of the dislocation is likely
to be unrivalled in history, with the possible exception of the Great Depression.
However, in an inversion of the usual rules of economic forecast making, the near-
term outlook is highly uncertain, but in the medium term, economies are likely to
bounce back strongly as normality returns and the amount of policy stimulus in the
system gains traction.
Monetary policy addresses the need for liquidity
Market liquidity is easy to define in principal; it is the ability to buy or sell an asset with
minimal cost. However, economic history teaches us that it is not constant but rather
varies widely. It is thus hard to pin down in practice. It is best considered by focusing
on both its supply and its demand. Supply is the ability of investment banks and
dealers to warehouse stock and quote competitive two-way prices. The demand for
liquidity is dominated by asset owners and investment managers, whose asset base is
a function of global saving and global borrowing.
The supply of liquidity is influenced by two broad interconnected factors; ease of
funding and confidence. In recent weeks, both have tightened markedly. Given the
breadth of potential future outcomes from here, the COVID-19 virus has made
near-term forecasting impossible, which in turn has seen precautionary credit lines
drawn down, liquidity buffers raised and risk management departments request lower
exposure. Despite post global financial crisis (GFC) regulation requiring much higher
liquidity buffers, the shock saw money market rates rocket and bid-offer prices widen
significantly. Equally, asset owners and investment managers face similar pressures;
they need to have enough liquidity for pending outflows, margin calls and cash
money to invest in compelling assets. With both the supply and demand for liquidity
therefore in disequilibrium, only monetary policy can pump in enough cash to ease
the pain. And in recent weeks the scale and speed of the reaction has
been unprecedented.
Figure 1: Pace of US Federal Reserve balance sheet expansion (US$ millions)
$3,000,000
$2,500,000
$2,000,000
$1,500,000
$1,000,000
$500,000
$0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Weeks
GFC week 0 = 10-Sep-2008 COVID-19 week 0 = 11-Mar-2020
Source: Bloomberg, NY Fed Statement issued Monday as at 27 March 2020
2Fast and furious: policymakers react forcefully to COVID-19
The US Federal Reserve (Fed), for example, is on track to add US$2 trillion within four
weeks of the market dislocation taking hold, a significantly faster pace than seen
during the GFC. In an effort to ease shortage of US dollars outside of the United
States, they have activated swap lines with major central banks, lending US$80 billion
into the eurozone and US$130 billion into Japan.
The European Central Bank (ECB) has also been aggressive by launching a
€870 billion quantitative easing programme, lending cash at -0.75% and easing bank
capital requirements — a trio of measures that could add nearly €3 trillion of liquidity
to markets. Given their balance sheet assets stood at €4.7 trillion at the end of 2019,
this package marks a significant offset to the liquidity and economic headwinds.
The corporate bond market has grown massively in recent years, as finance
managers take advantage of low interest rates to refinance existing debt,
fund share buybacks and undertake mergers and acquisitions. Much of this
debt has ended up with long-term investors, serviced by investment managers. Given
that many of these buy-side firms offer same day liquidity on their pooled funds, the
demand for liquidity has increased in line with the growing borrowing. The magnitude
of the increase in corporate debt can be seen below, based on data for credit to
non-financial corporations, supplied by the Bank for International Settlements.
Figure 2: Outstanding non-financial companies (US$ billions)
25000
20000
15000
10000
5000
0
Mar-1990
Jun-1991
Sep-1992
Dec-1993
Mar-1995
Jun-1996
Sep-1997
Dec-1998
Mar-2000
Jun-2001
Sep-2002
Dec-2003
Mar-2005
Jun-2006
Sep-2007
Dec-2008
Mar-2010
Jun-2011
Sep-2012
Dec-2013
Mar-2015
Jun-2016
Sep-2017
Dec-2018
China: PNFC debt Japan: PNFC debt Eurozone: PNFC debt US: PNFC debt
Source: Bank for International Settlements & Ninety One calculations as at 30 September 2019
With US$16 trillion outstanding and market liquidity non-existent, the Fed has
resurrected its GFC playbook by operating a number of special purpose vehicles,
capitalised by the US Treasury and leveraged up to ten times in order to support both
primary and secondary corporate bonds and money market instruments. With initial
capital of US$50 billion, this gave the Fed US$500 billion of buying capacity. But the
recent adoption of the US Phase Three emergency legislation onto the statute book,
the Treasury has earmarked an additional US$150 billion of capital across three of
these special purpose vehicles, giving the Fed potential buying power of US$3.6
trillion (3*150bn*8x leverage). It can be no surprise, therefore, that corporate bond
spreads have begun to normalise for illiquidity, if not yet for the economic fallout.
Including quantitative easing as well, as at 31 March 2020 we tracked a total of
US$7.6 trillion in market specific measures from the US that are aimed at improving
liquidity and price discovery.
3Fast and furious: policymakers react forcefully to COVID-19
A possible path for macro data in the coming months
The expenditure measure of gross domestic product (GDP) is the simple sum of
household and government spending, business investment, exports less imports and
an adjustment for inventories. It generally grows around a trend, with only recessions
seeing a material deviation from this trend. The trend itself also moves, but this a
function of slowing moving factors such as population growth and the productive
capacity of the economy. It is easy to forecast in the short term, but much harder in
the long term. The COVID-19 crisis, however, turns forecasting ability on its head; it is
going to be exceptionally hard to calibrate the near-term economic path, but in the
medium term, we can have a high degree of confidence of a reversion to trend growth.
One way to think about the coming economic slump is to consider the contributions
of each expenditure item listed above. Taking the UK, for example, household
consumption comprised the vast majority of the average 0.4% quarterly GDP growth
in recent years, with a 5-year rolling growth rate of 0.4%, while business investment
grew 0.1% and net trade detracted 0.1%. The consumer, as is the case in several large
economies, is the lynchpin of GDP. Using the latest data on consumer trends,
published by the Office for National Statistics, we can see the breakdown of this
spending by category for 2018, and from that begin to pencil in a possible economic
impact, as in Figure 3.
Figure 3: Potential lockdown impact on consumer trends spending
Estimate of Weighted
£m % of total lockdown impact impact Note
Rent, inputted
Housing 347,462 25.88% None 0%
rent & utility bill
Transport 183,896 13.70% 80% reduction -10.96%
Misc goods and services 173,740 12.94% 80% reduction -10.35%
Recreation and culture 149,854 11.16% 50% reduction -5.58%
Restaurants and hotels 126,692 9.44% 90% reduction -8.49%
Food and drink 104,378 7. 77% None 0%
Clothing and footwear 67,499 5.03% 50% reduction -2.51%
Furnishing and maintenance 65,576 4.88% 50% reduction -2.44%
Alcohol and tobacco 44,434 3.31% None 0%
Education 31,190 2.32% 10% reduction -0.23%
Health 26,528 1.98% None 0%
Communication 21,528 1.60% None 0%
Sum 1,342,777 100.00% -40.57%
Source: ONS Table 02.KN, Consumer Trends, UK July to September 2019, released 20 December 2019
4Fast and furious: policymakers react forcefully to COVID-19
As will become immediately obvious, it is possible that UK consumer spending could
fall 40% on an annualised basis, or 10% of GDP over three months. If the lockdown
lasts six months, the impact could be 20%. Assuming similar spending patterns in
other major economies, we can expect to see massive and immediate collapses in
economic growth. There is little to no precedent to compare this period to any other
in economic history, other than, perhaps, the Great Depression in the United States,
where industrial production fell a cumulative 70% and unemployment rose from 2.1%
in December 1929 to 25.2% in December 1932.
Fortunately, policymakers are well aware of their economic history and are doing all
they can to ensure that the short-term disruption does not lead to a wholesale
destruction of capital and employment. The fiscal response has been fast and
aggressive, with US direct fiscal loosening, for example already standing at US$1.5
trillion, and with another US$500 billion shoring up the Fed’s efforts to stabilise
financial markets. This already exceeds the US$1.7 trillion enacted across three
stimulus packages during the GFC and yet members of Congress are debating
further measures.
In the United Kingdom, the Chancellor of the Exchequer has been quick to underwrite
80% of employee pay, up to £2,550 per month, reverse engineered through the Pay
as You Earn (PAYE) employee tax system. We are currently tracking fiscal spending at
£500 billion, or 21% of GDP.
The eurozone, unfortunately, has displayed its structural weakness, with no cross
border fiscal policy to accompany the impressive actions of the European Central
Bank. But at a country level, the response has been more impressive, with widespread
loan guarantees, tax deferrals and mortgage guarantees. In aggregate, the range of
packages sums to a little over €2 trillion, or 17% of eurozone growth.
Asia, the first region to be hit with the virus, has seen a much more subdued policy
response to the crisis, with China and Japan implementing combined monetary and
fiscal easing of 3% and 5% of their GDP respectively. In the case of China, the
authority’s ability to direct banks to lend can be seen as the ideal model to overcome
the dislocation in western markets.
The combined monetary and fiscal responses of the major economic block can be
seen below.
Figure 4: Summary of key stimulus measures to date (US$ million)
1,559
2,251
USD billions
7,719
4,337
936 (total)
404 (total)
231 (total)
US EZ UK China Japan
Monetary Fiscal
Source: Bloomberg. Federal Reserve websites and press releases, ECB website and press
releases, UK Government website, speech transcripts and March 2020 Budget. ML ‘China
Economic Watch’ as at 31 March 2020.
5Fast and furious: policymakers react forcefully to COVID-19
Figure 5: Summary of key stimulus measures to date (% of region’s GDP)
13.0%
17.2%
40.5%
21.2%
33.1%
15.2% 4.7% (total) 3.2% (total)
US Eurozone UK Japan China
Monetary Fiscal
Source: Bloomberg. Federal Reserve websites and press releases, ECB website and press
releases, UK Government website, speech transcripts and March 2020 Budget. ML ‘China
Economic Watch’ as at 31 March 2020.
Relative to the measures G20 enacted during the GFC, which the IMF5 calculate as
2.1% of GDP, the fiscal response has been impressive. The monetary response is also
approaching GFC levels, which the IMF calculate as 29.8% across the average of
G20 countries.
But this isn’t the GFC. Banks are much better capitalised, household debt is
manageable and only corporate debt levels appear elevated. The impending fall in
GDP will be historically large but it is important to remember that it is temporary.
Once countrywide lockdowns are lifted, it seems highly likely that household
spending will pick up again, especially if this coincides with a Northern hemisphere
summer. If governments can avoid widespread unemployment and the destruction of
viable businesses through no fault of their own, then normality will return, perhaps
quickly. For now then, it appears that policymakers are reacting quickly enough and
with enough targeted measures to avoid the most devasting outcomes.
Looking forward, it seems hard to envisage an exit from the current super-loose
monetary and fiscal policy, many of which are on war-like settings. Historically, the
response to this was financial repression through capped interest rates, credit
controls and the limited movement of capital. Of course, this is exactly what China
does now and given the huge dislocations seen in markets in recent weeks, and the
taxpayers’ money it has taken to calm them down again, one wonders whose financial
system has it right?
6Fast and furious: policymakers react forcefully to COVID-19
Conclusion
The COVID-19 crisis is the most dislocating episode to strike society and economies in decades.
It has inverted our usual forecasting horizon, with limited near-term visibility but reasonable
confidence in the medium term.
Economies are likely to experience an historic lurch lower, followed by a fast recovery, dependent
on how quickly the virus is brought under control.
Monetary and fiscal policy has attempted to offset the worst of this, and the huge amounts of
stimulus they have already pumped into the financial system and wider economy will aid this recovery.
In the medium term, if the labour market is relatively insulated and productive capital not destroyed
during the following months, the global economy will recover much of its lost growth.
Notes
1
The Black Swan, Nassim Nicholas Taleb, Allen Lane, 2007 978-0-713-99995-2
2
The Guardian, accessed 30 March 2020.
https://www.theguardian.com/world/2020/mar/24/nearly-20-of-global-population-under-coronavirus-lockdown
3
UK Financial Sector Market Wide Pandemic Exercise 2006 Progress Report. 2008 update. Accessed 30 March 2020.
https://www.fbiic.gov/public/2008/june/Market%20Wide%20Pandemic%20Exercise%202008%20Progress%20Update%20May%202008.pdf
4
UK Department of Health UK Influenza Pandemic Preparedness Strategy 2011. Accessed 30 March 2020
https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/213717/dh_131040.pdf
5
IMF Fiscal Monitor, May 2010
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