Escaping lockdown: revisiting the economic scenarios

One month ago, we described three potential economic scenarios for the remainder of this year and 2021. Since then, we have witnessed some of the worst economic data in history, the biggest policy response outside wartime spending, and a near 50% retracement in both the massive widening of US credit spreads and the 34% peak-to-trough plunge in the S&P 500 index.

Despite the difficulties in interpreting the COVID-19 case data and different individual countries’ experiences, the strict lockdowns across large parts of the world appear to be working to decrease the infection rate, reduce hospital admissions, and prevent some of the more dire predictions about fatalities. This is encouraging governments to prepare a timetable for a gradual relaxation of restrictions.

We are still waiting for most gross domestic product (GDP) data from the first quarter, although China has produced a first print of a 10% quarterly drop. This seems reasonable to us and, combined with high-frequency indicators, offers a template for the output loss the rest of the world is likely to experience in the second quarter relative to the fourth quarter of 2019. However, the initial numbers will probably underestimate the scale of the drop and will be prone to heavy future revision.

All these developments have led us to update our main scenario modelling in two principal ways. First, we now expect a slower initial recovery in our most optimistic scenario. It has become clearer that even on the most positive likely path forwards, some form of social distancing is likely to persist at least through 2020.

The second is that we have made our other two scenarios less negative. The unprecedented scale of the fiscal and monetary policy response has meant a persistent debt-deflationary collapse is less probable.

I have summarised each of the three scenarios below, but please bear in mind that each reflects a range of outcomes rather than a precise path. For example, scenario 2 could look like scenario 1 at first. In all the scenarios, the third quarter of this year is likely to look better than the second as governments at least partially end restrictions. The scenarios then diverge substantially over subsequent quarters, but we continue to believe the most likely path is somewhere between the first two scenarios.

Scenario 1: Strong but partial rebound in the second half of 2020, and return to normal by the end of 2021

• A near 10% year-on-year fall in global output is likely in the second quarter of 2020. This is already more than twice as bad as during the global financial crisis.
• COVID-19 infections and deaths continue to decline, allowing countries to follow a similar path to China. Each country has its own timetable, but on average a gradual but steady relaxation of restrictions starts in May. By early July, most shops, businesses, manufacturing and construction could be open but social distancing remains and affects industries like leisure, hospitality, and travel until the end of the year.
• This should allow a reversal of about half the fall in the level of output in the third quarter and leave output about 4% from normal in the fourth quarter, which would be typical for a recession at this stage.
• A widespread vaccine becomes available in 2021, allowing a return to normal socialising and the pre-virus trend by the end of 2021.
• The huge policy response acts as a bridge to limit the damage to incomes during the shutdowns and then further fiscal stimulus is deployed to turbo charge the recovery. Monetary policy remains exceptionally supportive throughout, with no premature tightening in 2021.
• A historic spike in global unemployment occurs in the second quarter, followed by a potential 50% reversal by the yearend as work resumes. Unemployment continues to fall rapidly in 2021, but is still not back to pre-crisis levels by the yearend. For example, US unemployment could peak at 15-20%, ease to 8-10% by December, but only reach 5% by the end of 2021 (versus 3.5% in February 2020).
• Global growth would be around -3% in 2020 (roughly the same as the financial crisis for the year as whole) and +7% in 2021.

Scenario 2: Some recovery, but permanent scarring

• Output falls by 10% year-on-year in the second quarter of 2020. Growth continues to be impaired as precautionary saving rises to repair balance sheets, and some of the support programmes run-off well before demand has normalised.
• Inflation expectations become de-anchored below target levels, which makes monetary policy less effective, but deflation is avoided.
• Restrictions take a little longer to be lifted than in the first scenario. After an initial modest recovery in the third quarter of 2020, renewed outbreaks lead to some re-imposition of restrictions which slow the recovery around the turn of the year.
• Unemployment falls, but remains high in 2021 (i.e. similar to one year after the financial crisis).
• Global growth is -6% in 2020 (about double the financial crisis for the year as a whole), but partially snaps back in 2021 to 5%.

Scenario 3: Persistent slump

• The fall in output exceeds 10% year-on-year in the second quarter of 2020. The huge rise in long-term unemployment and bankruptcies undermines confidence.
• Restrictions are lifted more slowly than in the first two scenarios, but this still leads to a small recovery in growth in the third quarter of 2020. However, the virus flares up again, forcing renewed heavy restrictions in the fourth quarter and a double-dip recession. This scenario has many other negative social, financial and political consequences, especially across emerging markets.
• Monetary policy is exhausted and fiscal authorities become reluctant to add further to already massive deficits as support runs out. Deflation adds to the real burden of debt, prolonging the slump and leaving a large permanent scar of more than 10% of GDP.
• Growth is -8% in 2020 (about three times worse than the financial crisis) and barely grows at 1% in 2021.