Smoothing the hump and its cost
Government responses around the world to the spread of covid-19 have been fast changing over the past week in an attempt to try and lower the likely peak number of people contracting the virus, as well as the small percentage of people who contract the virus and develop severe symptoms requiring intensive care treatment in hospital. The main concern globally, including in Australia, is that health services, especially hospitals, will be completely overwhelmed if the number of those contracting covid-19 grows to the worst case modelling predictions of half the population or more this year, with around 10% of those needing hospital care.
While there is still much uncertainty about how extensive the covid-19 pandemic will be, there is much more certainty over the past week about the dedication of Governments to take actions to try and contain the spread of the virus. Governments, including the Australian Government freely admit that although technical recession (two quarters of negative GDP growth) is likely, they will spend selectively to try and mitigate some of the negative impact of covid-19 and that they will work with central banks.
The US Federal reserve, the Bank of Canada and the Bank of England have already announced emergency 50bps rate cuts. Early this morning, the Reserve Bank of New Zealand announced an emergency 75bps cash rate cut taking its cash rate down to 0.25%. The RBA at its regular policy meeting two weeks ago became one of the first central banks to cut rates, largely because of covid-19, reducing its cash rate 25bps to 0.50%. The RBA is likely to announce another 25bps cut to 0.25% either before or at its early April policy meeting.
Effectively, every major central bank that is in a position to cut official interest rates to near zero is doing so. The US fed today cut its funds rate a further 100 bps, bringing it down to 0.25%. Central banks will also be extending or adopting unconventional monetary policy easing measures. In the case of the RBA, it is likely that it will soon announce its plans to purchase government bonds. QE ,Australian-style, will probably work to target government bond yields to ensure that they do not rise as the Government does what it needs to do in terms of additional spending, temporarily increasing its budget deficit and borrowing demands.
Monetary policy change can essentially do nothing to affect covid-19, but it can work to ensure that short and long-term interest rates stay low; that liquidity is reasonably assured; and that the Government can borrow more to spend more. The impact of this activity should temper the negative impact on the economy as it is necessarily “locked-down” in various ways to contain the spread of covid-19.
Last week, the Government announced a range of spending initiatives totaling more than $A17 billion (around 0.9% of annual GDP) to support spending by households and businesses. The initiatives were well-targeted with one-time payments of $750 to welfare payment recipients and support payments and changes to investment allowances for small and medium-sized businesses. Most of the Government spending will be in the bank accounts by June 30.
There are likely to be more spending initiatives by the Federal and State Governments as the need arises. These payments and other policy initiatives cannot fill the hole in the economy that will appear in Q1 and Q2 from the shut-down of activities aimed at smoothing the hump in the number of covid-19 cases over coming months, but they will make the hole less deep and they will materially aid the climb out of the hole once covid-19 has peaked.
Whether there is a limited-scale technical recession in Australia because of covid-19 or a longer and deeper recession (if covid-19 becomes a worse-case outbreak or unemployment rises markedly – say to 8% - and stays higher for an extended period) is still hard to call, but the odds in favour of a limited-scale technical recession have improved because of the various initiatives announced both around the world and in Australia. The odds have also improved because of the spending initiatives announced by Governments and the policy changes by central banks.
Many world leaders including US President Trump, China’s President Xi and our Prime Minister are referring to the containment of covid-19 as the equivalent of a war. In late 1942 Britain, the US and Australia and their allies after many and repeated set-backs in World War II, received the first unambiguously good news of the war as Field Marshall Rommel’s Afrika Corps was put to flight in North Africa. In a speech at the time Winston Churchill said “Now this is not the end. It is not even the beginning of the end. But it is perhaps the end of the beginning”. Last week and early this week it is starting to feel that similar words can be applied to the war against covid-19.
It seems that both China and South Korea have contained covid-19 spread within their borders. That is the first unambiguous good news since the start of the outbreak back in December. Many other countries, including Australia, are adopting measures that provide the best chance of containing the spread of the virus. Financial markets are likely to be volatile for a while but if we suspect policy announcements and evidence favour more strongly technical rather than lengthy recession ahead, risk assets may start to reflect a rising rather than declining trend line.
The future is more certain for those focused on interest rates. Near-zero cash rate, short and long term government bond of around 1% or less are almost guaranteed by likely RBA policy actions this year and probably next year as well.