Just over a month ago, global markets first confronted the reality that the coronavirus was a global issue. Since then, new cases globally have escalated rapidly and global capital markets have experienced exceptional volatility. The month of March 2020 saw extremely sharp declines in the prices of risk assets across the globe but we also saw an impressive response from governments and central banks. In many cases policymakers have demonstrated a coordinated will to do whatever is necessary to limit lasting impacts on their economies from the coronavirus containment measures.
Monetary and fiscal policy responses
The unique nature of the economic shock has ramifications for the design of the monetary and fiscal policy response. Given the “throttling” of activity is deliberate, the role of policy is not to stimulate but to bridge and smoothen. Central banks’ role is to smoothen the market functioning phase to avoid a liquidity crunch and support bank lending and keep governments borrowing costs low.
Fiscal authorities can ‘assist’ with some of the losses from temporary supply constraints and demand shortfall so as to avoid deficiencies in production and employment. It can provide grants, guarantees and wage subsidies where bank lending alone will not be enough to keep businesses solvent through the shutdown. As different economies have different setups, the policy response has to be tailored to the particular circumstances. There is no ‘one size fits all’ policy recommendation.
Assessing the policy response
The scale of the initial response from global policymakers has been relatively swift and only really matched in scale by the response to the global financial crisis. It is unlikely to comprehensively meet all of the challenges ahead but, as the year unfolds, we should get a better idea of the sectors of the economy that need the greatest support with measures likely to evolve accordingly.
The economic impact of the lock down is likely to be severe in 2020; with a global recession looking likely. The pause of activity could be followed by a significant rebound and a partial recapture of lost activity. However, for this to happen businesses and households require support to ease the cash flow burden caused by revenues either stopping or being substantially reduced, whilst fixed costs mount.
In essence, the global economy requires a bridge loan and forbearance in order to mothball productive capacity during this period. Central banks are introducing targeted measures to address liquidity issues and to ease financial conditions, making it easier for financial institutions to lend.
Given the scale of economic disruption that is facing the global economy in the months ahead and despite the tremendous volatility, market infrastructure appears to be broadly weathering the storm.
There will be lasting impact from these policy measures, a further extension of the low interest rate environment is likely into the foreseeable future, emphasising the need to look to alternative sources for yield within a portfolio.
From a multi asset portfolio point of view, the current environment whilst extremely challenging offers opportunities! Within the range of PruFund portfolios we had already reduced risk in May of last year as part of our 2019 Strategic Asset Allocation (SAA). We were concerned about the stage of the economic cycle and what we saw as advanced valuations across a range of asset classes.
The significant and sudden repricing of risk assets, in many cases indiscriminate, has presented us with a range of opportunities where cautiously and selectively adding risk to our portfolios becomes a more attractive prospect again.
The important takeaway from the past few weeks is that there is an underlying global, coordinated willingness from policymakers to put in a huge amount of monetary and fiscal policy measures to limit any lasting impacts on the world economy from national policies to halt the spread of coronavirus. This gives us confidence that currently very elevated risk premia will once again compress, and whilst the economic impact is likely severe we remain of the view that the lion’s share of the disruption from the coronavirus pandemic will be felt in 2020.