A lot can happen in just a few weeks, that much is clear, writes Martin Fowler.
Expecting infection rates to fall as rapidly as they appear to have done in China now appears forlorn. Most countries have been hopelessly unprepared to deal with this pandemic. Frantic efforts to contain the virus, including border closures and public lockdowns, have arrived too late as infection rates proliferate. Public health systems are already under severe stress and it will only escalate from here.
In turn, it is likely that the world is already in recession as containment measures are making it virtually impossible for many businesses to stay open, particularly those in the travel, tourism, restaurant and retail sectors. According to health experts, these closures may need to extend for at least six months or more, resulting in business closures and huge job losses. Individuals without incomes will rely on government support payments, which, in most instances, won’t be enough to support their rent or mortgage repayments. This is likely to lead to a sharp rise in property foreclosures driving asset prices lower, not to mention a very depressed environment for consumer spending.
Suggestions that this downturn could be worse than the GFC now appear very real. At least during that crisis, any solvent business stayed open. This rather grim prognosis is reflected in sharemarkets, which have fallen off a cliff in recent weeks, tumbling more than 30 per cent from their February peaks.
Credit markets too have begun to show signs of distress, particularly in the high-yield end. This will only get worse as banks are struck by a potent combination of business and mortgage loan defaults, leading to large losses. As a result, any business that has loans maturing will face a nervous wait as banks inevitably tighten their lending criteria in these times. If the borrower is refused an extension, they then risk facing the even more brutal bond market where credit is usually available but not always at the right price. If the interest rate is too high, the last resort remains shareholders where raising capital in a depressed market will require a heavy discount and the issuance of a large number of shares, potentially leading to a sharp fall in the share price.
In recent days, central banks in the US, Europe and Australia have begun to initiate massive monetary stimulus measures to try and restore market confidence.
- On 14 March, the US Fed announced it would reduce its official cash rate to zero and launch a US$700 billion quantitative easing program over the next few months.
- On 19 March, the ECB announced an €750 billion Pandemic Emergency Purchase Program where the ECB can buy up public and private sector shares on flexible terms, providing a lifeline to business and governments across Europe to keep them solvent during the crisis.
- On 18 March, the Reserve Bank of Australia cut its official rate to 0.25 per cent and also announced it would provide at least $90 billion at 0.25 per cent pa over three years to banks – if they lend that cash to small and medium-sized businesses.
- Scott Morrison followed that with a further $66 billion stimulus package on 22 March, allowing individuals to draw on up to $10,000 of their super and businesses to access up to $100,000 in subsidies to retain staff.
Having failed to normalise interest rate policy during the economic expansion that began in mid-2012, these interest rate cuts and liquidity injections will likely fail to stimulate the economy. Companies and individuals won’t want to borrow money to invest in new plant and equipment when demand has fallen off a cliff. However, what it will do is stabilise distressed credit markets somewhat as it should restore confidence that companies will be able to refinance maturing loans at cheap rates. To that extent, it is still a vital and positive development.
To date, markets have been unconvinced by these monetary policy developments as they know that in the absence of a commercially available vaccine, this won’t get people back to work nor will it replace the wages of displaced workers or compensate businesses for lost revenue.
If a commercially available vaccine is still 12-18 months away and a lockdown is going to continue for at least six months, if not longer, then what is needed is seismic fiscal stimulus on a scale not seen before. Governments in every major economy need to consider compensation for lost revenues and wages to all businesses and workers affected by lockdowns. Compensation of 50 per cent to 70 per cent might cost up to 20-plus per cent of GDP. While it would significantly increase government debt levels, most major countries could probably afford to do this as a one-off (there will be some exceptions). Indeed, some economists argue that it would do less damage than a tax cut that amounts to say 2 per cent of GDP, as ongoing costs can have a structural impact.
Measures of this extreme nature we believe are required to restore the confidence of anxious and nervous businesses and households that they will be looked after during this difficult time. Failing a vaccine, it is only then that further sharemarket falls might be stemmed.
To this end, the signs are starting to look more encouraging. In the US, the Republicans have released a massive multibillion-dollar stimulus plan that’s akin to a helicopter drop, providing cash of up to $1,200 per adult and $500 per child.
It may not be enough, but it’s a start. We expect much more to come, and we will need it.
Martin Fowler is a partner in Pitcher Partners’ wealth management division.
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