As I wrote in my last few posts, the impact of “the virus recession” is likely to be brutal and huge, BUT short-lived. This is because the “fundamentals” were generally fine before the recession started and are likely to be generally fine once it is over. There are however a few risks that this recession could bring about and must be kept in mind, especially in terms of what to expect once we enter 2021.
Governments and central banks are all over this and will throw everything they have and the kitchen sink at it in their “whatever it takes” approach. This means ALL major markets will be held afloat with infinite money creation used by central banks to buy assets galore in order to support prices and keep yields from exploding and causing enormous damage.
The infected population of the USA will stabilize at one point, either at a very high number or lower number, depending on the “intensity” of social distancing policies and the speed at which normal economic activity is started again. In all scenarios, the economy will take a major hit in 2020, at least for 2020Q2 and 2020Q3, but maybe also 2020Q4. But it will eventually pass.
The “worst case” is that almost everyone will have been infected and either will have survived or died by end of year. I know it sounds “brutal”, but that is the worst case scenario… My point is that it will eventually pass, and once 2021 rolls in, it will slowly become a bad memory, while most activities will pick up. Stock indices will pick up convincingly once the number of cases and deaths start declining convincingly, which I am guessing will be some time in the Fall.
In other words, 2020 will be a rough year for both financial markets and the “real economy”. But as is the case of natural disasters, it will pass and things will move along as of the New Year. Sure, there will be less hand shaking, more online work and education and more “virus paranoia”, but all in all, life will continue probably quite normally. That said, there are risks…
I see some potential risks that should be kept in mind once we enter 2021. Here is my list:
- All this mega stimulus will remain “in circulation” once things return to normal, and the underlying “normal” is what we had just before the storm hit as of February 2020: low unemployment rates everywhere and economies at or near “full potential”. There was no inflation due to remaining slack and all kinds of other structural forces such as technology, globalization, demographics, and more. But still, we will return rather quickly to normal if things are kept together and all this stimulus money will STILL be “floating around”, plus several truck loads of extra bond supply… all this means we could finally see some inflationary pressure and once capital eventually flocks back to stocks and foreign markets and the Fed stops buying bonds galore, we could also see falling federal bond prices, and that would mean higher interest rates… on the back of sky-high debt loads for governments and corporations… This could become problematic: high debt with low interest rates is fine, but high debt + increasing interest rates = problems!
- Keeping with the debt subject, high government debt accumulated due to past debt and historic “stimulus” will eventually bring forth the subject of reigning in deficits and government debt, and that means one of 2 things: increase taxes OR decrease government spending (on what?). Both of these could cause significant social tensions and market jitters.
- If this virus shock causes some countries to retreat from “everything global”, we could have trade disputes and disrupted global supply chains, thus causing a negative supply shock which could be at least partially permanent… and that means higher costs and price pressures, hence adding to inflationary pressures and higher interest rates.
- If the eternal blame game continues between the USA and China, we could see geopolitical tensions, thus adding to the above-listed risks, in the same directions.
- Finally, the “short-but-brutal” recession shock could be too much to digest by the economy and things could fall apart and get ugly, especially if large corporations and financial institutions fail some time in 2020. This could start feedback loops that cause a large one-off shock to turn into a multi-year hell. In that case, the scenario of “going back to normal” will not hold…
As long as inflation remains under the radar, there is nothing major to fear in terms of “falling into depression” and all that, but if inflation rises, then you get problems. Keep this in mind as the situation progresses. Be sure to follow me on Medium for ongoing texts mostly on finance, economics and global markets, but also sometimes other things… and clap and share!