Lockdowns are very destructive for growth. We know that from the record-setting declines in GDP from the first global lockdowns back in the Spring. And we are getting a renewed sense of that fact now as Europe’s economy has contracted under the burden of a second lockdown. The question now is whether the US will follow.
Flash Eurozone PMI is dismal
Yesterday’s figures from Markit show Europe’s Composite Output Index at 45.1, a 6-month low and well below the 50.0 level between expansion and contraction. Here’s Markit’s write-up:
With the exceptions of the declines seen in the first two quarters of this year, the average PMI reading of 47.6 in the fourth quarter so far is the lowest since the closing quarter of 2012 (during the region’s debt crisis) and indicative of a steep decline in GDP.
The deteriorating performance was broad-based, albeit with the service sector hardest hit from virus containment measures. While manufacturing output growth merely slowed in November to the lowest since the start of the sector’s recovery back in July, attributable to a marked slowing in order book growth, service sector output fell for a third month running, with the rate of decline accelerating sharply to the fastest since May.
France was one of the worst at 39.9, down from 47.5, as its lockdown has been more pronounced. Notice that the services sector has now been falling for three months on the trot, not just in France but in Europe as a whole. This suggests that consumer behavior again preceded government policy. Consumers were effectively frontrunning government policy, with the lockdowns a late reaction to the rise of Covid-19 infections rather than preemptive government policy.
Germany, which has managed the virus better than its large population peers in Europe, has had a less violent and more preemptive shutdown. And the economic figures appear to show this working to prevent the worst-case outcomes in neighboring France. The Flash composite PMI did fall to 52.0 from 55.0. And that’s the lowest since July. Nevertheless, according to Markit, manufacturing numbers at 62.7 were still among the highest in the survey’s history.
Let’s draw two preliminary conclusions then:
First, waiting to lock down means you have to lock down harder. And that’s more debilitating economically than doing so earlier. Forward-looking policy makers will save their population much economic pain by biting the bullet and increasing nonpharmaceutical interventions (NPIs) as signs of increased infections rise.
Think of it like slamming on the brakes to avoid an obstacle. You might think you can avoid it and refrain from braking to keep your momentum. But if you break late, you have to break hard. And that slows you down more.
Second, people still seem to take fright before government intervenes. I am struck at how the numbers were already receding right across the Eurozone before any lockdowns were imposed. That tells you that you cannot avoid an economic impact due to a rise in infectiousness.
Combined with the first takeaway about late lockdowns leading to worse economic outcomes, this suggests that late policy adjustments are also negative. If consumers frontrun policy, the later governments enact increased NPIs to deal with rising infectiousness, the more of an economic hit they will take.
What about the US?
I have been saying that the US is headed for a similar outcome to Europe. My base case is now a double dip recession. That’s predicated on the concept outlined above that economic pain is unavoidable if you let coronavirus infections run out of control. But, as much as I believe that late public health policy interventions lead to worse outcomes, I cannot be sure.
What we do know is that, last week, the US topped 1900 deaths on three daily occasions. And we are now running at above a 7-day average of 1400 deaths. Noted epidemiologist Trevor Bedford sees this average topping 2000 in December.
Now, the data have not caught up with this outcome – which is why I hold out some hope that the US can avoid a double dip. Yes, initial jobless claims vaulted higher last week as localized economic rollbacks surfaced. But that’s one week’s data. And yesterday’s PMIs from Markit showed the US still in expansion.
In fact, the Flash U.S. Composite Output Index came in at 57.9 versus 56.3 in October. That’s a 68-month high. And the manufacturing high was even better at 74 months with a reading of at 56.7 versus 53.4 in October.
But I look at the PMIs as slightly lagging to coincident. The fact that the levels are still increasing suggests forward momentum. But, in the face of partial shutdowns and potentially rising joblessness, this momentum can reverse quite abruptly.
Moreover, December looks to be the critical month here. Not only is that when we hit Bedford’s 2000 deaths a month figure due to already infected American residents, Bedford estimates we also have an average lag of 22 days between infection and death. To the degree the American Thanksgiving holiday turns into a massive super-spreader event, this will show up around Christmas time. And that’s also when the fiscal cliff on pandemic assistance and eviction hits.
So I take only small comfort in the US PMIs. I expect the numbers to roll over and eventually fall below 50. Let’s hope I’m wrong.
The Global Double Dip
In any event, the largest economies have an outsized impact on the global economy. And the fall in Europe is brining us to the brink of a global double dip recession already.
Flash PMI surveys for the US, Eurozone, Japan and UK, which collectively account for approximately half of global GDP, indicated an expansion of business activity for the fifth consecutive month in November, though the rate of expansion was the weakest since the recovery from severe lockdowns in the second quarter began. At 51.2, the G4 economies’ flash PMI output index^ was down from 52.6 in October, and also well below the long-run survey average of 53.5 seen in the five years prior to the pandemic. The reading therefore hints at a slowing in the rate of expansion to a pace further below the recent long-run average.
At least three different vaccine trials look to be our ticket to a return to relative normalcy in due course. But we have to get through this fall and winter with a Covid-19 spike and seasonal flu combining to significantly alter social behavior.
I believe there are significant pockets of the economy that are vulnerable to the altered social behavior we should anticipate. And governments in the EU and the US are already experiencing political challenges in filling in the gaps. So, despite the buoyancy of equity markets – we are on track for the best month since January 1987 – downside risks remain elevated. And potentially because of animal spirits buoying markets, that downside risk, should it materialize, will be more potent in creating a risk-off environment.
I have some more expansive thoughts on this downside for later publication. It will be centered on high yield bonds and spread widening as opposed to default, based on a talk I did with Saba Capital’s Boaz Weinstein yesterday. Look for that in the coming days.