Submitted by Michael Every of Rabobank
Break-out > Lockdown > Break-up
As mentioned yesterday, with recognition that virus may have peaked we see that momentum continues to build to try to get us back to normal. We still have extensions of the lockdown being rolled out in many locations – but we can see what is going to happen next: Break-out > Lockdown > Break-up. Austria was already planning to reopen some elements of the economy anyway, and some Danish schools were to go back; now some German schools will restart on 4 May, as will hairdressers and smaller shops (which are surely the kinds hardest to implement social distancing in). Moreover, in the US we saw a group of protestors surround the state Capitol to demand that Michigan be reopened for business, while Pennsylvania’s senate over-ruled their governor to demand the partially reopening of that state. President Trump is also about to announce an easing of stay-at-home rules today, apparently.
Clearly, lockdowns destroy the economy. That much will be obvious from Q2 GDP data, with the collapse in US industrial production and the Empire PMI yesterday, and the simultaneous nose-dive in retail sales despite panic buying, all making that abundantly clear. The Fed Beige Book also helpfully underlined that “Economic activity contracted sharply and abruptly across all regions….all districts reported highly uncertain outlooks among business contacts, with most expecting conditions to worsen in the next several months.” Perhaps even tomorrow’s Q1 GDP data in China will show the same – although would one want to bank on that?
However, we can see three things that will happen next after what happens next on re-opening:
#1 A push-and-pull between different regions and different authorities over how fast and where and when to re-open. This could be federal-state or regional, or between health and finance ministries. There is no clear consensus of what is best to do now from various perspectives. On one level local autonomy is always best – but it adds to the already-confusing patchwork of varying virus responses and means neither full national nor international economic connectivity can return as before COVID-19.
#2 Even after re-opening, normal life is not going to be normal as we knew it. New Zealand’s Prime Minister has made that clear (as has the RBNZ Governor not ruling out negative rates even as the worst of the virus may perhaps be behind the country). Imagine you are a restaurant with the tight margins they always have: how do you survive with a scared public staying at home and social distancing measures meaning just one person per table? The economic just aren’t viable. The same is true for cinemas nobody goes to; hotels with low or zero occupancy; and for planes that will need to have three or four people per row, maximum, and two empty rows between occupied ones to comply with social distancing even when they can fly again: how much is that going to push flying out of the price-range of a far weaker household sector? Of course, for larger firms perhaps this does not matter as in this crisis we have already seen that making money, or prudently putting money aside for a rainy day, no longer matters: having friends at the central bank does. Or serving a national security interest – in which regard the US is suggesting it will pay shale oil producers to keep the stuff in the ground. It’s not as if we haven’t seen the same with agriculture - think of the farmer in Catch-22 who got rich “not growing alfalfa”. Ironically, in this respect the pre- and post-COVID economies may be similar, in that there can be real money in not producing things.
#3 Crucially, if we don’t get this re-opening just right then many voice warn we can start the clock until the second wave of virus infections hits. True, we have now built up larger healthcare capacity. Yet for a struggling business the effort to re-open, only to then have to close again, may prove both economically and psychologically disastrous – just as it was the second wave of Spanish Flu in 1919 that proved the most deadly to those who caught it.
Maybe, and it’s only a maybe, markets are starting to actually do some actual thinking in this regard--briefly--given the risk-off tone today. The kind of “1, 2, 3” scenario above is bad for most everyone and everything, but arguably for equities and emerging markets the most. As such it’s no surprise we see MXN and THB under pressure again, Mexico most so after its sovereign rating was downgraded to one notch above junk. Even AUD could not rally today on the latest in a long line of fantastical unemployment reports, where March jobs rose 5.9K vs. -30K expected and unemployment fell two ticks from 5.4% to 5.2% (the claim is that this is pre-COVID, in which case one has to ask how many days of March the survey actually covers?)