Looking forward on coronavirus, the economy and markets

This weekend was a good one, with nothing too exciting roiling markets. So, rather than focussing on the near term, let me get out my crystal ball today and tell you what I see coming down the line. I’ll break it up into discrete bits below.

Backside coronavirus response

I am sticking with my view that we will see a (premature) lifting of lockdown because of the absolutely wrenching impact it is having on the economy. I have seen estimates that some 29% of economic activity is already offline in the US, for example. And this same loss of output is replicated throughout the world. It’s almost comical to think that exactly a month ago I was writing questioning whether we were in recession already when it is now clear this is a Great Depression.

Right now, we are in the thick of it, with health officials and epidemiologists predicting much worse for the US on the pandemic front in the next two weeks as the incubation period for the virus ends in various parts of the US, causing case counts and deaths to mushroom. The sense I get from looking at Seattle and New York City in the US, which were hit early, is that this is a rolling crisis on the national level, just as it has been on the international level. Seattle is on the backside of this first wave. New York is nearing the apogee.

So, I think we can watch for the response in China and Italy first on the international level, and Seattle first, and then, New York on a US level to get a sense of how this will play out. In China, they have already relaxed restrictions with a mild increase in Covid-19 case counts. That’s not a good model for the West though given the brutality of China’s lockdown. Italy, where they are discussing ‘antibody passports’, is more the model.

There is a growing sense in Italy that the worst may have passed. The weeks of locking down the country, center of the world’s deadliest coronavirus outbreak, may be starting to pay off, as officials announced this week that the numbers of new infections had plateaued.

That glimmer of hope has turned the conversation to the daunting challenge of when and how to reopen without setting off another cataclysmic wave of contagion. To do so, Italian health officials and some politicians have focused on an idea that might once have been relegated to the realm of dystopian novels and science fiction films.

Having the right antibodies to the virus in one’s blood — a potential marker of immunity — may soon determine who gets to work and who does not, who is locked down and who is free.

That debate is in some ways ahead of the science. Researchers are uncertain, if hopeful, that antibodies in fact indicate immunity. But that has not stopped politicians from grasping at the idea as they come under increasing pressure to open economies and avoid inducing a widespread economic depression.

Backside outcomes

This is the kind of thinking that will almost definitely happen everywhere, especially as small businesses are bankrupted en masse and many people in advanced economies find themselves penniless.

I am not a scientist. And even though both of parents were biochemists, working with health and disease, I have no expertise there. I am not going to venture into that realm except to say you have to model outcomes.

A worst-case scenario is where the relaxation of the lockdown is premature and you get re-infection and a second wave that is equivalent or bigger than the first. A base case, hopefully, is a second re-infection wave that is worse than China’s but better than the initial wave. And the third best case scenario is a China outcome, where the second wave is almost minuscule compared to the first. Even as far back as mid-March, people were talking about Singapore, Taiwan and Hong Kong facing a second wave. But, they are less the model for the West than Italy because their first wave was small and their preparedness was better.

None of this takes into account the potential for a deadly Covid-19 mutation of the 1918 influenza sort, or of a third wave hitting in the Fall of 2020. I am talking purely of what happens when we relax restrictions. And judging from Italy, this could start rolling out as early as May in waves, according to how late the first wave crests.

Economic outcomes

When I was thinking about the economic impact yesterday, three markers from the US data came to mind. First was the jobless claims numbers of 10 million over two weeks. Second was the 701,000 unemployed number we got on Friday. And third was the inability of small businesses to get liquidity.

The jobless claims dataset is the best real time economic data we can get since it is released weekly and with only a lag of five days. It is telling us that we already have 10 million people unemployed in the United States after two weeks of bloodletting. And so, we should expect that number to go much higher if the lockdown lasts. With May an early estimate for relaxation in Italy, expect these numbers to stay elevated in the US until June and July at a minimum, with the South and Midwest, that avoided lockdown, getting hit last, and, therefore, exiting lockdown last. Could we see 30 or 50 million unemployed in the US alone? I think the answer is yes. And that is one reason you will see the (premature) backside responses.

The unemployment data confirm the grim nature of the crisis because it was from data collected through mid-March and came in at seven times higher than anticipated, even though a lockdown was yet to be in place in most of the US, and even though major furloughs had not occurred at that time. With the next number running though mid-April, we have about another week of data to see. And so, when that number comes out in early May, it will show perhaps 15 or 20 million people jobless in one month.

Lastly is the small business problem. Here’s Wells Fargo on Twitter today:

This is not good. It tells you that the small business portion of the US stimulus bill isn’t going to prevent a massive wave of bankruptcies. These insolvencies lie in front of us. And so, the lost output, the lost income and the impact on spending, wages, employment and commercial property is yet to come as well.

Again, this is a lightning fast version of a Great Depression scenario, which in the 1930s unfolded over years as opposed to weeks.


Equity markets are not taking this in yet.. As I write this, the market is due for another bounce as optimism has returned. None of the economic carnage has hit earnings reports yet and visibility on guidance is low because of the unprecedented nature of this disaster. So, analysts are flying blind. Furthermore, Q1 earnings and guidance are unlikely to be helpful here as well since Q1 avoided a big impact until March and company earnings guidance is likely to limited.

My view here is that the scale of the drop in earnings and the long-lasting impact won’t be fully processed for weeks or months because there will always be that hope that earnings snap back in a V-shaped recovery. Adding to the downside risk is the lack of share buybacks and the loss of 401(k) injections feeding into passive investment vehicles that buy shares.

The first wave of selling was a panic and a liquidity crisis. Once the Federal Reserve put a floor under credit markets and the US Congress released a large fiscal stimulus package, this crisis was arrested. But none of that addresses the Great Depression in the real economy which lies ahead.


The floor under credit markets is more about liquidity than credit easing. That means the Fed is looking to make sure healthy companies can issue credit in a normal way. And they have achieved this outcome. Before the Fed’s injection of liquidity, we had back-to-back weeks in which investors yanked more than $100 billion out of bond funds. Since then, we have had back-to-back weeks of record issuance, with investment-grade corporates raising $200 billion in funds in the debt markets.

What accounts for the turnaround? Not just the Fed but yields. As Reuters put it a week ago:

The investment-grade bond index soared to a roughly 350 basis point spread over U.S. Treasuries, compared to a low of 100 basis points, as borrowing cost even for the most credit-worthy companies soared, according to Karp.

Remember, this does not include high yield. My view is still that IG credit has a Fed backstop and equities and junk never will. Sure, Yum and Carnival Corp were able to get deals off. And perhaps more issuance is coming. But, the only thing enticing about these deals is the yield. We are on the verge of some serious defaults. And so, these investors chasing yield are going to get burned.


Speaking o getting burned, energy credits are a big part of high yield and optimism there has risen on the back of some dubious thinking around production cut agreements that have not come to pass. The only market really tanking overnight was energy, with both WTI and Brent selling off.

Oil is still well off the lows we saw before, with WTI briefly trading below $20 a barrel. SO, there is definitely more downside risk here given the Depression that will take shape in the real economy. I think we will see WTI retesting the $20 level in due course.

The dollar

At the same time, the US dollar will rise, not just in commodity terms but against all other currencies as firms and countries look to roll over their dollar-denominated debt obligations.

One way to think about this is as a fat tail event, where the rush for dollars causes a two-sigma event to become a six-sigma event and then a 30-sigma event. If US dollar currency pairs hit specific levels, the need for dollars will become acute and a liquidity crisis will ensue, causing the dollar to explode higher.

So, while DXY is now at 100, it could just as easily soar to 105 or 110 and beyond overnight – the equivalent of the 25 sigma event Goldman Sachs CFO David Viniar talked of in the Great Financial Crisis. And central bank swap lines won’t be enough to stop this from happening because there are tens of trillions of dollars in offshore dollar credit.

Three years ago, Ambrose Evans-Pritchard wrote of how the Bank for International Settlements warned of $14 trillion of debt from derivatives and swaps contracts hidden in footnotes too. So, any real economy liquidity triggers will boomerang back onto the financial system as well.

My take

Policy makers can only do so much. The coronavirus mandates lockdowns worldwide. And, what’s more, research from the 1918 Flu pandemic has determined that it’s the pandemics which depress the economy, not the public health interventions.

Cities in which multiple interventions were implemented at an early phase of the epidemic had peak death rates approximately 50% lower than those that did not and had less-steep epidemic curves.”

So, late and incomplete lockdowns make things worse. That means a certain amount of economic decline is baked in the cake for months. Our hope has to be that policy makers start now to develop backside policy responses that limit a second or third wave because that’s my best case outcome for physical, economic, and market health too. Greater and repeated testing for coronavirus in a coherent relaxation scheme is the best way to get the economy back up and running.


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