Updated: March 23, 2020
Hi, I'm Joe Lupton from Global Economic Research at J.P. Morgan, and you're listening to At Any Rate, our Global Research podcast where we take a look at the stories behind some of the biggest trends, themes, and industries and markets today. It's been a chaotic time for markets and it's going to be even more chaotic time for the global economy.
We're here to talk about a number of those issues, unfortunately, we are not in the studio, but my guest and I are calling in from our homes, as are many people working from their homes in these kind of trying times.
So just stepping back, it's hard to keep up with the data flow. There's a lot of policy supports happening as well. All of this feels a little bit stale as new things are coming down the pipeline, and it reminds me a little bit of that I Love Lucy episode where they're in the chocolate factory and Lucy and Ethel are trying to keep up with the chocolates as they're whizzing by.
We've seen big sell offs in equities, collapse in energy prices, all of this is compounding concern surrounding the spread of the coronavirus, which is really the root cause of all of this. Today, I'm joined by Joyce Chang, chair of global research, to talk about the global impact of the COVID-19 outbreak. Hi, Joyce, thanks for being here.
Joe, great to be with you. And boy, what a week it has been. The speed of recent market moves is historically unprecedented, and policymakers are truly being tested. And even though they've responded and they have synchronized the responses, this outbreak has weighed on global financial markets. We've seen a selloff in stocks, bonds and commodities as investors have raced to boost cash in an effort to really buffer themselves from the broadening economic damage that's caused by the virus.
The route in the U.S. stock market has erased almost a third of the value in the three major equity benchmarks over the past year. And in the treasury market, which is the most liquid bond market in the world, we've seen liquidity really just disappear. But we've also seen, just looking at the markets, a speed of the selloff which is without precedent. From the peak of the market, so the SMP 500, to going to a bear market, it was only 15 trading days.
I think this whole selloff is going to be remembered as the great liquidity crisis and it's something that we've been looking at J.P. Morgan since the global financial crisis. What are the consequences of the rise in algorithm, the trading, systematic trading strategies passed as investment, and the role that the banks used to play as more of a buffer holding inventory, that all was transformed by the global financial crisis.
Right. And Joyce, in terms of just what you're hearing when you're talking to people at our bank, around the street, how much is the stress in funding markets a source of real concern here? You know, the equity markets get all the attention. Credit spreads are kind of blowing out as well. But funding markets are also kind of seizing up a little bit, aren't they? And that is reminiscent a little bit of the global financial crisis. What are you hearing out there?
Well, the markets having been seizing up and the Fed has been very quick to intervene and to, really state very clear that they're going to continue with that intervention. And you've really seen policymakers go back to the toolkit that was in place during the 2008, 2009 financial crisis to ease stress in the credit side of the money market. So we've seen a reintroduction of the commercial paper funding facility and also the primary dealer credit facility.
Together, with the stimulus package, we've also seen other central banks acting as well. You've had the Bank of England came out and said that they would buy 200 billion sterling of U.K. government bonds. The European Central Bank and the Bank of Japan also made a major announcement. The European Central Bank announced a 750 billion Euro pandemic emergency purchase program above the existing asset purchase program. And this means that they're going to actually purchase around 120 billion per month, and they've even included the Greek sovereign bond in this. So we've seen just a rapid series of responses by policymakers around the globe within the last 72 hours.
Right. So let's just step back a second. You've had significant market moves seizing up in the near-term funding markets, which is a source of problem. Not just for market participants, but for corporate trying to meet their working capital needs. You've had a policy response to that. You touched on a few of those things. But let's step back and say a little bit about the real root cause here is the virus.
What's the kind of current state of events here? Is it kind of over in China? Is it now the rest of the world? And how much longer does the rest of the world, have to deal with this before things start to flatten out as people are talking about?
Well, the focus really is outside of China right now. So there's more than 200,000 in the global infection toll right now. More than 80,000 of that is China, but we've seen now that the death rate in Italy is exceeding that of China. So China is beginning to get this under control. They were the first in. They're probably going to be the first out of this, but there's fears about a second wave. And there's been a real change in the way of thinking. So a couple of weeks ago, everybody thought, "Will this be V-shaped?" Now what they're really talking about is, how do we space out this shock? Because we don't have the medical facilities to deal with it. So now it's much more, about trying to just slow down the severity of the outbreak, but this means that the duration could actually last longer than what we thought.
So whereas a few weeks ago, everybody thought the V-shape would be possible, now there's much more of a sense that this is going to extend well beyond the second quarter even and be something that goes into the third quarter of the year.
But Joe, I wanted to ask you, just now that we're looking at this being something that the duration, we no longer think tha,t the first quarter has already passed us and that even the second quarter, it might be hard to get this under control. What is the toll that it's taking on the global economy? How are you revising the forecast for global GDP growth? How are you looking at the impact this could have on consumer sentiment and also on the labor markets?
There's no doubt that this has gone from something that we thought initially was going to be a severe shock in China that had some rippling out effects on the global economy to now something where this is a global pandemic in terms of the virus and very much a global macroeconomic event in a very serious way. This is a huge shock. This cannot be understated, and we now think that we are currently in a global recession. We are looking for global GDP to contract over a percent this year. For our listeners, a contraction in global GDP is a very rare event.
We did see a contraction in global GDP in the global financial crisis. This will actually be on par with that. We think China could be down as much as 40% annualized in the first quarter. That is then followed by the U.S. and Euro area as you look into the second quarter where we're looking for U.S. to be down 14% annualized. We're looking for the Euro area to be down 22% annualized in the second quarter, so overall, global GDP is going through a serious event here.
Now, the big question and you kind of touched on it in terms of the virus, spreading out and the duration lasting a little bit longer is how long will the macroeconomic shock last? This is going to depend a lot on policy support. Things are moving certainly on the monetary policy front. On the fiscal front, things are moving quickly, but of course they take a little bit more time, and we're seeing big packages start to be talked about and even rolled out, including the U.S. where the current administration is talking about a package as big as over a trillion dollars, which would be bigger than the package that was done during the global financial crisis. That was on the range of about 800 billion.
So that policy will start to kind of kick in. It will bridge the gap, and then hopefully provide some support, so that as the virus fades when we move into somewhere in the third quarter, people start to come back to work, businesses rehire, and the global recession kind of gets off to a pretty good start.
Overall, we think global GDP could be up as much as 20% annualized in the third quarter. But a lot of uncertainty around it. Labor markets will be damaged through the rough patch here where we see the U.S. unemployment rising up to as much as 6%, which is, a good 2.5% above where we are now. Joyce, your background is in the emerging markets are there areas with any emerging market stresses that we should be worrying about?
Well, you have had policymakers take a lot of actions. I mean, looking at this since the beginning of the year, 16 central banks have cut rates. And we think there are 24 more rate cuts by central banks by the middle of year. In the emerging markets, 15 out of 22 emerging markets, we think are going to ease further between now and the end of the year. But all eyes are on China right now. What does that China rebound look like, and is there a risk of a second wave?
We've brought China's growth rate down all the way to 1.1%. And when you think about this back of the envelope, every 1% off of China's growth takes about half a percent off of global growth. But the areas that are the most impacted when China slows down is the emerging markets particularly the commodity exporters. So you've got the double whammy. You've got the China slowdown and you also have just this dramatic drop in oil prices as well, with everybody saying, "Boy, that OPEC meeting in June, that's a very long time away."
So we are keeping a very close eye on many of the commodity exporters. We see very sharp slowdowns, coming in Latin America take a look at a country like Mexico, couldn't track as much as 15% in the second quarter of the year. There is some fiscal response that's occurring, but we think the fiscal policy overall will add maybe 1.3% of the GDP this year. That's still not going to match the pace at which we're seeing, these contractions. And I think the real problem is if the argument is you can't overwhelm the health system so we need to slow this down, this is going to take months, not weeks.
So that whole point is have we written off the first quarter, the second quarter? What if you really aren't seeing a comeback until the fourth quarter of the year? Is it going to be a lost year? That's what a lot of people are asking right now.
Right. Let me ask you this, Joyce, one of the arguments made by the high frequency traders is that, they're there providing tons of liquidity that no one else is able to do but if what we're really seeing here is actually these guys move with the rest of the market and they actually do it much more quickly, are they actually exacerbating problems and does the whole foundation of that argument kind of fall apart if what we see is they disappear when you really need them?
Well, what we've seen in the U.S. Treasury market was that about 75 to 80 percent of that market was high frequency trading, and that dropped to about 50 percent right now. And so, this is one reason why you've really had to have the authorities step in. So, when it's a bull market, people don't really question this, but we're now seeing how rapidly the market conditions can change.
And I think the difficult thing about, COVID-19 is that it's hard for anyone to put a guess on the duration of this. Some of the consequences of this, there are always unintended consequences out of every crisis, do we have to look at the regulation that was in place and think about whether some of this should be reversed so that the policymakers can act quickly and have that flexibility?
During the global financial crisis we often heard about the need for a lender of the last resort. Now what I'm hearing is that we need is an employer of the last resort. We basically need to give companies money to keep people on the payroll. You essentially have to pay people not to go to work.
You're 100% right. Labor markets are going to be very key here. I don't think we should kid ourselves, though. Labor markets are going to deteriorate rapidly. You're going to see, over 100,000, maybe 200,000 fall on monthly payrolls, for a good, maybe even couple months in a row. And then the question is, can you turn that around and how quickly can you turn it around?
There's no doubt goods sector's going to get hit very hard here, and you can see factories shutting all over the place. But what's going to be unique is the service sector, and the nature of the downturn is such that service sector activity is also getting hit very hard. And that's what makes this a much bigger event than would typically be the case. They're going to experience something that they're not used to, probably even worse than what they had during the global financial crisis.
Lots of things to be watching here, it's going to be a pretty tumultuous period that we're going go through. I wish it could've been a kind of more upbeat podcast, but it's going to be a grim few months here. This wraps up our discussion for today, Joyce, thanks for joining me, I hope our listeners have enjoyed the conversation as much as I have.
Well, thank you so much, Joe, I mean, but what a week it's been and a lot to talk about and to think about in the weeks and the months ahead.
Thank you, everyone, for listening and please stay tuned for more episodes of At Any Rate, J.P. Morgan's global research podcast series.
This communication is provided for information purposes only. Please read J.P. Morgan research reports related to its content for more information, including important disclosures. 2020 J.P. Morgan Chase & Company, all rights reserved. This episode was recorded in March, 2020.
The World Health Organization (WHO) officially declared the coronavirus outbreak a global pandemic on March 11th, as the outbreak has now spread to 100+ countries. Total infections outside of China are accelerating, with the global infection toll surpassing 200,000 as of March 18, with China’s contribution at more than 81,000. As coronavirus spreads at the community level, public health policies are shifting from ‘containment’ to ‘delaying’ and/or ‘mitigation.' This approach accepts the idea that the virus will spread in society and emphasizes slowing the speed and scale of the diffusion process.
J.P Morgan economists’ views on the economic consequences of the virus shock have evolved dramatically in recent weeks with respect to the severity and duration of the outbreak. J.P. Morgan Global Economics Research now expects the global economy to experience an unprecedented contraction during the first half of the year as containment measures are driving deep collapses in monthly economic activity.
The U.S. economy is projected to contract by 14% in the second quarter, after experiencing a 4% contraction in the first quarter, before recovering to 8% and 4% growth in the third and fourth quarters. Euro area GDP will suffer an even deeper contraction, with double-digit declines of 15% and 22% in the first and second quarters, before rebounding by 45% and 3.5% in the third and fourth quarters.
“There is no longer doubt that the longest global expansion on record will end this quarter. We now think that the COVID-19 shock will produce a global recession, as nearly all of the world contracts over the three months between February and April,” said Bruce Kasman, Chief Economist at J.P. Morgan. Initially, the expectation was the novel-recession may generate limited labor market damage, but J.P. Morgan Research is now forecasting the unemployment rate for developed markets as a whole will rise 1.6 percentage points in the next two quarters.
“The rise in unemployment will be sharper in the U.S. than in the Euro area. Most immediately, U.S. initial jobless claims should spike above 400,000 in the coming weeks,” said Michael Feroli, Chief U.S. economist at J.P. Morgan.
The outbreak has also weighed on global financial markets, which have seen a synchronized sell-off in stocks, bonds and commodities as investors, companies and financial institutions have raced to boost cash in an effort to help buffer themselves from the widening economic damage caused by the virus. The rout in U.S. stocks has erased almost a third of the value in the three major equity benchmarks over the past month.
Policymakers are acting in unison and taking actions beyond monetary policy to cushion the demand drop, keep illiquid firms solvent and prevent a seizing up in aggregate credit flows. On the evening of March 15th, the Federal Reserve (Fed) slashed its target range for the Fed funds rate by 100 basis points to the zero lower bound and also unveiled a massive package of measures which includes the purchase of assets ($500 billion of Treasuries and $200 billion of mortgage-backed securities), lowering the rate on discount window loans, lowering required reserve ratios to 0% and reducing the cost of cross-currency dollar swap lines.
In addition, on March 17th, the Fed re-introduced the Commercial Paper Funding Facility (CPFF) and Primary Dealer Credit Facility (PDCF) that were in place during the 2008/2009 financial crisis to ease stress on the credit side of money markets. Altogether, the U.S. stimulus package amounts to around $1.3 trillion. At an emergency meeting on March 19th, the Bank of England (BoE) cut its benchmark interest rate to a record low of 0.1% from 0.25% and said it would buy £200 billion ($232 billion) of U.K. government bonds. Policy makers concluded that further stimulus was needed to ease growing financial strain and support growth and inflation.
The European Central Bank (ECB) and Bank of Japan (BoJ) also announced greater asset purchases. On March 18th, the ECB announced a 750 billion euros ($807 billion) Pandemic Emergency Purchase Program (PEPP) above the ongoing Asset Purchase Program (APP), which includes Greek sovereign bonds and will bring total asset purchases to around $120 billion per month. The BoJ said it would double stock purchases and help companies get loans in response to the coronavirus pandemic. The central bank pledged to buy exchange-traded funds (ETFs) at an annual pace of around 12 trillion yen ($112.55 billion), double the amount it had pledged to buy up to now. The next focus will be whether the BoJ cuts the negative short-term policy rate further, along with compensation for profits of banks.
In total, global policy rates have been cut by 55 basis points year-to-date through March 18 and roughly 50%-60% of the world in GDP-weighted terms are at, or near, the effective lower bound.
“From the beginning of the year through March 18th, 16 central banks have cut rates. As of that date, we forecast 24 more rate cuts by central banks by mid-year and at least 15 out of 22 emerging markets (EM) central banks will ease further. In total, EM central banks could potentially ease by another 80 basis points. In addition, fiscal policy is projected to add 1.3 percentage points to global GDP this year,” said Joyce Chang, Chair of Global Research at J.P. Morgan.
Countries and territories around the world have imposed travel restrictions to curb the spread of the coronavirus. The latest restrictions come from the president of the European Commission, who is proposing a 30-day ban on non-essential travel into the bloc.
On March 11th, the U.S. barred the entry of all foreign nationals who had visited China, Iran and a group of European countries during the previous 14 days. The ban was later extended to foreign nationals leaving the U.K. or Ireland. In China, most new arrivals in Beijing must now undergo a 14-day quarantine period at a designated hotel or other assigned location. In Europe, many countries have imposed a full suspension on all flights arriving and departing, as borders are closing around the world.
“The collapse in air travel demand brought on by these severe travel restrictions and the reluctance of travelers to fly has the potential to materially reshape global aviation more meaningfully than the events of September 11th,” said Jamie Baker, U.S. Airline and Aircraft Leasing Equity Analyst at J.P. Morgan.
North America drives one-fifth of global activity, but generates two-thirds of global profits. This implies that airline failures may solely occur elsewhere, thereby paving the way for higher international margins for the North American 'Big Four' (Air Canada, Delta, American and United) as the crisis fades. 2019 was already witness to a record number of airline failures despite a favorable fundamental backdrop.
Airline stock picking and credit selection has grown more complex, as investors must increasingly discount scenarios previously considered unthinkable such as prohibiting healthy Europeans from entering the U.S., or the partial or complete shutdown of the U.S. airspace, a scenario that cannot be ruled out.
“Liquidity analysis consistent with United’s stress-case scenario as recently described by its CEO does not lead to any insolvencies within our coverage space, which runs counter to the growing market view and results in attractive risk/reward, in our view, following the recent unprecedented volatility,” according to the stress test analysis and liquidity models developed by Baker and Mark Streeter, Equity and Credit U.S. Airline Analysts, respectively, at J.P. Morgan.
J.P. Morgan’s airline analysts do not see the industry on the precipice of a cash crunch in the coming weeks or even the next few months, but a longer-than-expected virus cycle remains a real risk. U.S. airline stocks and credit have responded positively to talks regarding potential government aid and J.P. Morgan Research expects improved market liquidity cognizance and further clarity on government intervention could potentially lift stocks and credit from here. However, the level of liquidity modeling that has been conducted is scant, and equities and credit may be discounting outcomes more dire than necessary, if the virus runs its course over a few months.
The coronavirus outbreak is a large and unexpected supply and demand shock both for the Chinese and global economy, given the important role China now plays in global growth. China now accounts for around 17% of global GDP, compared to only 4% in 2003 at the time of the SARS episode. In 2003, China accounted for less than 4% of global tourist spending compared to just under 20% at present. In the U.S., the list of affected activities is already long and includes the cancelation or suspension of major U.S. sports leagues and the closure of Broadway theaters.
“Overall, we think the consumer spending categories that are most at risk of virus-related disruptions account for around 7% of GDP. We assume activity in this group falls to 63% of normal activity in March, followed by 25% in April, 63% in May, and fully recovers to 100% of normal activity in June,” said Michael Feroli, Chief U.S. economist.
J.P. Morgan Research has further revised down China’s growth forecast in 2020 in response to the deterioration in the COVID-19 outlook in recent weeks. Economic activity and industrial production have not recovered as quickly as previously forecasted.
“We expect normalization of the work resumption rate to occur only in the second half of March, and the rebound in the second quarter will not be enough to offset first quarter losses,” said Haibin Zhu, Chief China Economist and Head of China Equity Strategy at J.P. Morgan.
“Our new forecast assumes a dramatic negative shock in the first quarter. The coronavirus is an unexpected demand shock and it has also become a notable supply shock due to prolonged factory shutdowns. We expect China’s GDP will contract by 41% quarter-over-quarter when seasonally adjusted (annualized rate), down from a pre-virus forecast of 6.3% growth,” said Zhu.
“This should be followed by a strong rebound in the second quarter at 57% quarter-over-quarter when seasonally adjusted. However, because the global pandemic will lead to a disruption in global demand and likely also global production and delay China’s normalization of economic activity due to concerns about a second wave of contagion, we now forecast full-year growth in China at merely 1.1% (versus a pre-virus forecast of 5.9%),” added Zhu.
Index, 4Q19=100, sa
Source: NBS, J.P. Morgan
The key outlook issue is whether this two-quarter downturn becomes a more traditional and longer-lasting downturn, which depends on the path of the virus and the success of measures taken to insure rapid containment.
“We now expect the infection curve in China to peak at 105,000 by mid-June in our base-case scenario, but negative risks persist as we see a potential second infection wave in our pessimistic case which includes 130,000 infected by mid-August” said MW Kim, Head of J.P. Morgan’s Asia-ex Insurance team.
The model created by J.P. Morgan’s Insurance and Pharma and Biotech analysts, Ashik Musaddi and Richard Vosser, now projects Germany, France, Italy, Spain and the UK (also known as the EU5) will peak towards the end of March, with a peak in active infections close to 80,000.
Index, 4Q19=100, sa
Source: NBS, J.P. Morgan
Index, 4Q19=100, sa
Source: NBS, J.P. Morgan
In mid-March, the entire global cruise industry effectively halted operations for 30 days, with some international brands suspending service for 3 weeks and Princess Cruises voluntarily halting for 2 months. This move was under direct pressure from the U.S. government and greatly reduces the risk of perhaps several more 'Diamond Princess'-like scenarios. It also comes at a time when cancelations for forward bookings are significantly elevated and new bookings have been materially lower.
“It’s more likely than not that the industry won't resume operations in 30 days and cash burn for the industry in the interim is significant. Stock performance has passed the point of expecting any industry profitability in 2020, in our view and is now trading on liquidity risk, an analysis that largely depends on the ultimate duration of the outbreak,” said Brandt Montour, Gaming and Lodging Analyst at J.P. Morgan.
J.P. Morgan estimates Carnival, Royal Caribbean and Norwegian will lose roughly 7.5% of full-year capacity per month. In terms of run-rate expenses, about 13-15% is fuel, 7-11% is food, 20-30% is ship-based labor, 20-30% is other operating and 25-30% is selling, general and administrative expenses (SG&A).
In terms of reducing costs, significant expense savings can most likely be found in fuel and food, while comparatively little will be found in labor near term, given the difficulty of re-staffing just 30 days in the future. Flexibility in SG&A will depend on each operator’s own level of disruption and strategy from here, but roughly 50% of marketing expense has likely already been cut, as well as a small portion of G&A. J.P. Morgan Research estimates deeper cost cuts to the extent the shutdown gets extended. 2020 capital investment plans, outside of pre-financed new ships, are also being dramatically cut.
The impact from the shutdown is in addition to the other canceled sailings year-to-date. This has taken place mostly in Asia and worth 6-8% of pre-virus earnings before interest, tax, depreciation and amortization (EBITDA) and due to ongoing damage to future sailings from increased cancelations and a sharp drop-off in bookings activity.
This hit to earnings is severe, even when compared to the impact September 11th had on the industry. Cruise bookings declined around 40-50% in the immediate aftermath of 9/11 and normalized after 2-3 months, leaving a hole in the region of 5% net revenue yields over the next 12 months; a move that impacted industry EBITDA by around 12.5% according to J.P. Morgan estimates. By comparison, the Global Financial Crisis impacted net yields in 2009 by around 10%, but the sensitivity here is not linear and operators will start cutting when net yields breach below 5%.
“We don't see the cruise lines tripping debt covenants anytime soon, but a cash shortfall becomes a greater risk as the shutdown persists later into the year. Taking into account recently announced financing actions and the latest capital expenditure (capex) plans, the team estimates Royal Caribbean and Norwegian would have to lose 70% and 65% of pre-virus EBITDA, respectively, before there would be a cash shortfall in 2020,” added Montour. This assumes flat working capital, an increasingly optimistic case, given the large deferred revenue liability in the form of customer deposits, which could become a significant drag and depends on how many customers choose to rebook at a later date (and take the incentives, in the form of extra cruise credits) or opt for a full refund.
Thank you for signing up
Please verify your sign up in your confirmation email.
Don’t see a confirmation email from us? Check your SPAM folder and add ‘email@example.com’ to your list of safe senders.
This communication is provided for information purposes only. Please read J.P. Morgan research reports related to its contents for more information, including important disclosures. JPMorgan Chase & Co. or its affiliates and/or subsidiaries (collectively, J.P. Morgan) normally make a market and trade as principal in securities, other financial products and other asset classes that may be discussed in this communication.
This communication has been prepared based upon information, including market prices, data and other information, from sources believed to be reliable, but J.P. Morgan does not warrant its completeness or accuracy except with respect to any disclosures relative to J.P. Morgan and/or its affiliates and an analyst's involvement with any company (or security, other financial product or other asset class) that may be the subject of this communication. Any opinions and estimates constitute our judgment as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This communication is not intended as an offer or solicitation for the purchase or sale of any financial instrument. J.P. Morgan Research does not provide individually tailored investment advice. Any opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients. You must make your own independent decisions regarding any securities, financial instruments or strategies mentioned or related to the information herein. Periodic updates may be provided on companies, issuers or industries based on specific developments or announcements, market conditions or any other publicly available information. However, J.P. Morgan may be restricted from updating information contained in this communication for regulatory or other reasons. Clients should contact analysts and execute transactions through a J.P. Morgan subsidiary or affiliate in their home jurisdiction unless governing law permits otherwise.
This communication may not be redistributed or retransmitted, in whole or in part, or in any form or manner, without the express written consent of J.P. Morgan. Any unauthorized use or disclosure is prohibited. Receipt and review of this information constitutes your agreement not to redistribute or retransmit the contents and information contained in this communication without first obtaining express permission from an authorized officer of J.P. Morgan.
Copyright 2020 JPMorgan Chase & Co. All rights reserved.