"Worst. Recession. Ever."

Submitted by Michael Every of Rabobank

When Harry Met Comic-Book-Guy

Worst global downturn since the Great Depression” says the IMF. Actually, it’s potentially worse than that. We are seeing credible (initial) claims in the UK and US that millions/tens of millions are going to be unemployed – again taking us back to black & white memories of long queues of the jobless holding signs saying “Will Work For Food.”

We are also seeing calls for GDP to collapse by up to a third in the presumed Q2 trough in the UK and the US, as just two examples, which in the space of months would already take us to the kind of depths plunged back in the 1930s (and actually this will be the worst recession since the 18th century according to one UK report.) Moreover, in a world far more economically-integrated today than it was in the 1930s, what happens in the (smaller) West will rapidly hit the (larger) rest.

As will the virus itself, of course. What is to stop it rampaging through Africa and South Asia, as just two examples? “Heat!” we have been told. Yet besides the fact that Covid-19 is transmitting in Indonesia and Singapore we see a report today that French scientists have found some strains of the virus can survive long exposures to temperatures of up to 60c, and it takes almost boiling point to kill it. Another (non-peer reviewed) study from Australian and Taiwanese researchers based on samples from India has shown Covid-19 is already mutating, shifting its mechanism used to bind to human cells - the paper concludes “This means current vaccine development…is at great risk of becoming futile.” Moreover, a Chinese scientist is warning of a serious risk of a second global wave of Covid in November – exactly the pattern seen in the 1918-19 Spanish Flu.

I have to lean on black humor at such times and think of The Simpsons’ Comic-Book-Guy and his dead pan review: “Worst. Recession. Ever.

Not that this matters to markets at the moment. Major sovereign bond yields are ultra-low and not going anywhere for years – so the pressure is off; US high risk credit is now far less high risk given it has a Fed backstop (and what doesn’t?); and equities are back in bull market territory in many locations. That is partly on the back of a steady drum-beat of stories about when economies currently under lockdown are re-opened – which may not be too far away. How this workable when universal testing is still absent, high-tech contact tracing is just being rolled out, if the summer heat might not kill Covid off, and when the virus might be mutating ahead of what is already the most rapid vaccine development in history remains to be seen.

Equally, however, markets are ecstatic because there is no need to actually do any thinking at the moment. The Fed has made clear that there are to be no losers – or at least that one does not have to bother trying to pick the winners.

As in the infamous scene in the movie ‘When Harry Met Sally’, all that markets need to do to make money is to say I will have what the Fed is having.

How much further can we take the dichotomy of bull markets as we head to 10%, 15%, or perhaps 25% unemployment? Let’s test the structure in a teleological manner. Can everyone lose their jobs or be paid to do nothing, and all activity stop except that of the government, but everything still remain happy in markets because the Fed will just keep setting the price of assets? I believe we tried that from the 1930s up to 1991 (“We pretend to work and they pretend to pay us”) and it didn’t work out so well for those on the receiving end of it.

Yes, via MMT and helicopter money we could potentially see a ‘Sit For Victory’ war-economy that pays most people to stay at home until a vaccine is eventually rolled out alongside universal testing – but only in the richer members of the OECD. Emerging markets are not going to be able to do the same financially or practically. For them it’s all Comic-Book-Guy and no Sally.

Consequently, as the BIS argue, they are going to be forced to beg for USD liquidity – and soon. On which front, we hear that there is a split in the G-7 over how the IMF is to respond. There is agreement that a limited debt moratorium will be offered to struggling economies, which is better than nothing. However, the IMF’s desire to use its potential USD1 trillion lending power by massively increasing the issuance of Special Drawing Rights, as was done to the tune of USD250bn during the GFC, is apparently being blocked US Treasury Secretary Mnuchin. No more US cash is being offered to the IMF, who prefers to keep the Fed front and centre of the USD liquidity roll-out process. (And I refer readers once again to our recent Eurodollar special on the real politik of the USD as global reserve currency.)

Of course, there is no longer going to be any US cash for the WHO either, or at least for 60-90 days while a review “to assess the World Health Organisation’s role in severely mismanaging and covering up the spread of the coronavirus” is completed. As the editor-in-chief of The Lancet has responded, to cut the funding of the WHO in the face of the current crisis is “a crime against humanity”; as is arguing there was no human-to-human transmission, repeatedly saying that it wasn’t a pandemic, declaring that international travel should not be halted, and that wearing masks is not helpful - at least according to the critics of the WHO within the US, who conclude “Worst. WHO. Ever.

Meanwhile, back in markets China has responded to its “V-shaped post-Covid recovery” with another rate cut: the one-year Medium Term Lending Facility to banks was slashed from 3.15% to 2.95%. Yet again we have a muddle over which rate really matters most in that economy, but the underlying picture is crystal clear. China needs to get far more liquidity into the real economy, but can’t match the level of easing being seen abroad for fear of destabilising CNY and ending up dealing with the kind of USD real politik being shown above. If it does get dragged into it, think not of Comic-Book-Guy – think of Fallout Boy.