Some in the markets are making the argument that absent additional stimulus, the U.S. is at risk of repeating the slow-motion recovery seen after the 2008–09 recession. But will history really repeat itself?
Concerns about a replay of the weak 2010–19 recovery has been one the reasons behind the Biden administration’s “go big” mantra. This helps explain not only the $900 billion stimulus plan passed in December but also the $1.9 trillion package currently being debated and the even larger $2 trillion to $4 trillion infrastructure package expected later this year. But how does this downturn compare with the 2008–09 one?
The fiscal response to the 2008–09 crisis was late, small and temporary. The Recovery Act went into effect nearly five months after the Lehman bankruptcy and after 5 million job losses. Moreover, it quickly became clear that the package was too small, with the unemployment rate rising from 7.6% when it was passed to a peak of 10.2% in November 2009. Furthermore, growth is normally very strong coming out of a major recession, as illustrated by a 6.2% and 7.9% increase in GDP after the recessions of 1975 and 1982, respectively. By comparison, GDP grew by only 2.8% following the 2009 downturn. Despite this, there was virtually no fiscal follow-through. Instead, focus shifted to deficit reduction when unemployment was still above 9%.
This time around, the fiscal response has been and continues to be dramatically different. Instead of a five-month lag, the government acted almost immediately with $2.9 trillion in fiscal stimulus that totaled more than double the Recovery Act of 2009. Granted, the COVID-19 shutdown necessitated a larger response than the Lehman crisis, but the fiscal follow-through has only widened the gap between the two periods. The $900 billion December 2020 package came with unemployment at 6.7%, and the current $1.9 trillion package is being debated with unemployment around 6.3%. If the Democrats use the reconciliation process to pass their infrastructure program, they will have to wait for the new fiscal year in October. By then, the unemployment rate is expected to be around 5%, or just 0.7% higher than the Congressional Budget Office’s estimate of full employment.
Beyond inadequate fiscal stimulus, it can also be argued that the banking and real estate crisis created deep wounds in the financial system and economy that led to a slow recovery. Moreover, the euro area crisis in 2012 and the trade war in 2018–19 represented headwinds. While these were relatively small shocks, each instance did result in hesitancy in business investment.
Conversely, the COVID-19 crisis should leave much smaller economic scars. Moreover, household balance sheets are in a completely different place, as home prices have grown steadily through the crisis and equity prices sit near all-time highs. Household savings is another key difference between the two periods. Due to constraints on services spending and massive income support from the government, household savings have surged. In the aftermath of the 2009 recession, liquid savings weakened. In contrast, estimates put excess savings north of $1.5 trillion before the current round of stimulus that could push excess savings over $2 trillion. While the deferral of spending due to lockdown measures limited the immediate impact of stimulus, this benefit didn’t disappear but, rather, has shifted to when the economy reopens.
Taking everything all together, there are a number of ways in which the current crisis differs from 2009. According to the Congressional Budget Office, the U.S. economy did not reach full employment until 2017, or 31 quarters into the recovery. Conversely, estimates have the economy returning to full employment during the back half of 2022, or in one-third the time it took during the last downturn.
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COVID-19 has delivered a historically large exogenous shock to many parts of the global economy, including global trade. This week, Steve Bash, head of City National Bank’s International Banking group, joins us to discuss the state of international trade and what to expect in the post-pandemic world.
One- to two-week view: The euro should remain range bound in the coming weeks. The good news is that COVID-19 cases continue to fall. The bad news is that a likely extension of lockdown measures to mid-March will be an offset. The appointment of former European Central Bank (ECB) President Mario Draghi as prime minister in Italy and his new cabinet should provide a boost if they propose credible reforms, but this should only be temporary. Overall, European growth continues to lag U.S. growth (see contrasting PMI performance) on the back of differences in COVID-19 restrictions, the magnitude of fiscal support provided and proposed, and vaccine distribution in the U.S. outpacing that in Europe. However, the global COVID-19 narrative continues to improve, and the picture for growth in the eurozone looks better now than it did at the turn of the year.
Three- to six-month view: With the factors that pushed the euro higher in 2020 having faded or starting to fade, gains in 2021 should be harder to come by. Moreover, the prospect of more fiscal stimulus and a faster vaccine rollout in the U.S. relative to Europe increases the chances for a return of U.S. exceptionalism and U.S. growth that outpaces European growth. Near-term optimism on a recovery in global growth helps the euro higher, but the single currency should dip into year-end as U.S. yields rise, the ECB continues to fight deflation and market focus shifts to questionable domestic growth fundamentals. In essence, it is difficult to see a sustained euro rally without European economic exceptionalism and the prospects of ECB rate hikes.
One- to two-week view: The pound traded above 1.40 on the interbank market for the first time since 2018. Recent strength has been driven by vaccine performance and markets pricing out negative rate risks. Overall, the view on the pound remains constructive, as vaccines appear to have the U.K. set to reopen its economy ahead of other EU countries, but caution would be advised in buying the pound at these elevated levels. On Brexit, the EU has rejected calls from the U.K. to reset their post-Brexit relationship. With the EU–U.K. relationship poor, the next round of talks on services is unlikely to go well for the U.K., but near-term price action will be more driven by vaccine and infection headlines as we approach the end of February, when Boris Johnson is expected to outline the easing of lockdown measures.
Three- to six-month view: The U.K.’s vaccine rollout outperformance and resulting economic optimism have provided a boost to the pound. Compounding this support has been the message from the Bank of England that it is unlikely to impose negative rates. While the vaccination program is encouraging, there are reasons to remain cautious. The first reason is that the economy isn’t moving ahead of its peers but simply catching up to them. The second factor is the impact of vaccinations. While relative pace of vaccinations will affect the relative trajectory of the U.K. economy over the next few quarters, it won’t impact the long-run sustainable economic trend rate, which is more relevant for the medium-term pound. In this respect, Brexit, which has been overshadowed by the pandemic, has been and should continue to be an economic drag. This means that the U.K. economy will have to recover not only from its pandemic underperformance but also from the damage done by the narrow trade deal that is fundamentally bad.
One- to two-week view: USD/JPY should continue to range trade as it tracks the broad dollar trend/U.S. yields. Bank of Japan (BOJ) Governor Haruhiko Kuroda’s recent comments on the upcoming policy review indicated that the basic framework to policy under yield curve control (YCC) and negative interest rates would not be altered, but the parameters under which these two policies are operating was open to fine-tuning. At present, the most likely outcome appears to be a relaxation of YCC with a strong commitment to further easing. This would not be a game changer. A deepening of negative rates is possible, but USD/JPY will likely have to appreciate below 100 for this to happen. Fourth-quarter GDP in 2020 surprised to the upside, but lockdown measures raises the possibility for contraction in the first quarter of 2021. To the extent that an extended state of emergency leads to a sharper deceleration in economic activity and BOJ dovishness, the yen will face depreciation pressure. To this end, the speed of vaccine rollouts, which started last week, remains important.
Three- to six-month view: The medium-term outlook is still biased toward a stronger yen. However, rising U.S. yields have pushed USD/JPY higher and represent the strongest headwind to further yen appreciation. Given this, it should be noted that U.S.–Japan real yield spreads still support a move toward 100 yen per U.S. dollar (USD) even if U.S. yields move somewhat higher. Regarding monetary policy, markets will be looking out for the results of the BOJ’s policy review due in March. If media reports are correct, the BOJ could signal the de facto end of YCC by announcing a wider trading band. An emerging point of discussion is the impact of Japan’s vaccine imports. Estimates put Japan’s vaccine bill at around $2 billion to $3 billion, or roughly half of Japan’s total trade surplus with the U.S. in February of last year. This could provide some support to USD/JPY, although this support is likely temporary.
One- to two-week view: Canada continues to outperform its peers in terms of vaccine doses secured per capita and is seeing a decline in COVID-19 cases. The main risk factor to Canada’s economic recovery is the slower vaccine rollout relative to its peers. However, faster vaccine rollouts and large fiscal stimulus in the U.S. should provide support to Canadian exports and investment activity. The upshot to a slow vaccine rollout in Canada is the potential for a quick bounce-back in the economy once inoculations gather pace and allow for restrictions to be lifted. Oil prices have move up sharply since the start of February but should normalize after the market works through its weather-related issues. Canadian retail sales came out softer than expected, but lockdown measures played a role in this. Overall, the Canadian dollar (CAD) remains susceptible to global risk sentiment, broad dollar moves and oil prices in the near term, with a bias for consolidation.
Three- to six-month view: The medium-term CAD outlook remains constructive. While the USD has picked up some support, further CAD appreciation is supported by the Canadian economy’s proximity to the U.S. due to increased U.S. demand for Canadian exports. Moreover, the CAD should benefit from a move up in commodity prices as the global economy continues to recover. Notably, oil has been a strong performer on a year-to-date basis, and the outlook remains bullish. On monetary policy, the Bank of Canada has adopted a more positive tone and laid down the parameters for eventual QE tapering, adding to the positive medium-term outlook. In essence, the bank has tied paring back policy support to the economy performing “in line or stronger” than the bank’s forecast, making the country’s vaccine progress something to keep an eye on. Finally, there is the potential for federal elections this year, but the impact on CAD is likely modest and mainly tied to possible changes in fiscal policy.
One- to two-week view: Recent indicators show China’s economy continuing to grow; however, there has been moderation in the pace of this growth and inflation. Nevertheless, relative economic outperformance, a current account surplus and relatively high yields form the base for a bullish view and support a continued drift lower for USD/CNY. Eventually, COVID-19 vaccine distribution will allow the rest of the world to close the growth gap, but for now, China’s yield advantage and foreign investor inflows support further gains. While it has been reported that China is considering measures to allow greater outbound investments, as huge inbound flows have led to steady yuan appreciation, expect policymakers to keep a close eye on domestic outflows. On the geopolitical front, China is looking at restricting rare earth supplies to critical U.S. industries. Overall, while the U.S. will take a more conventional approach to China, expectations remain for U.S.–China tensions to stay elevated as President Biden retains a tough-on-China approach.
Three- to six-month view: The yuan’s year-to-date appreciation against the dollar index reflects supportive fundamentals and solid fund inflows. China’s export sector has outperformed, and while there is medium-term risk that a resumption in production in the rest of the world could undermine this, risks for an immediate setback are limited. On the flow front, bond inflows remain solid and should continue given China’s relative yield advantage. Regarding the central bank, the People’s Bank of China has yet to signal any strong resistance to yuan gains except for a continued relaxation of measures designed to control outflows. This implies that Chinese officials are not yet uncomfortable with recent currency appreciation.
One- to two-week view: Commodity prices, including iron ore prices, continue to provide support for the AUD. On the economic front, PMI readings and retail sales both came in softer than expected. Minutes out of the RBA’s latest meeting reiterated the bank’s dovish stance as the bank expects “very significant” monetary support will be needed for some time as it will take years to meet its inflation and unemployment goals. Meanwhile tensions between China and Australia continue to linger but have only led to a limited economic impact thus far. However, any moderation in Chinese economic activity or fiscal tightening will impact Australian commodity export volume. Expect markets to continue to buy into any dips.
Three- to six-month view: Recent price action has been driven by strength in key commodity prices, with iron ore being a particularly important catalyst, as prices continue to benefit from a rebounding Chinese economy and disruptions to supply chains outside of Australia. However, Chinese economic growth has started to moderate, and other producers are ramping up production. This is particular important as commodity prices are a key driver for the AUD. Regarding monetary policy, the RBA announced an extension to its QE program. While history shows that QE has had a limited impact on exchange rates, it should still lead to a weaker AUD on the margin. As for trade, Australia–China trade tensions continue to linger, but critically, China is not expected to put restrictions on iron ore due to the lack of alternative supplies.
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