Bold policy action

We believe the required policy response includes drastic public health measures to stem the outbreak. A decisive, pre-emptive and coordinated policy response needed to stabilize financial markets is taking shape, particularly in the U.S. The key: policies to forestall any cash flow crunches among small businesses and households that could lead to financial stresses and tip the economy into a crisis.

Implication: Coupon income is crucial in an even more yield-starved world, including corporate credit and dividend income in selected equity sectors.

U.S. unemployment poised to surge
U.S. unemployment rate, jobless claims and recessions, 1980-2020

• The U.S. labor market is experiencing some of its biggest turmoil in modern times with the shutdown of many parts of the service sector. We see the unemployment rate surging, tracking jobless claims. See the chart above. Delinquency rates on consumer loans are close to their pre-crisis average. And rising unemployment may make a substantial number of households vulnerable to a fall in income.
• Central bank policy has moved from mostly alleviating the dysfunction of market pricing and tightening of financial conditions to ensuring credit flows to businesses and local governments. Central banks – especially the Fed – have quickly used their full range of tools and invented new ones in a far shorter timeframe than the GFC. The Fed’s balance sheet has swelled 50% in just two months.
• The Federal Reserve built on its “whatever it takes” approach to helping the economy through the coronavirus shock, announcing $2.3 trillion in new lending support to small business payrolls and local governments. U.S. policymakers are looking to add to the already passed $2 trillion fiscal support package to help small businesses. Euro area finance ministers look set to launch an array of measures providing broad support along similar lines – potentially including use of the European Stability Mechanism. Successful policy implementation is key now. Japan passed fresh stimulus taking its fiscal spending plans to about 10% of GDP.
• The G20 agreed to a temporary debt standstill for the 76 poorest countries. The International Monetary Fund is responding to an unprecedented inflow of emergency lending requests, to date from 102 countries.
• Limited monetary policy space has put in focus the lack of tools left – and could backfire as a result. Some actions are raising questions about whether they may undermine the independence of central banks. The UK Treasury activated a funding facility for spending that will be directly financed by the Bank of England, rather than the gilt market, but called the move temporary.
• We expect governments to significantly ramp up fiscal spending – far beyond what was already estimated in 2020 – on health systems and to provide support to small businesses and households.
• It’s crucial to have proper guard rails around policy coordination, as we wrote in our Dealing with the next downturn paper.

Bottom line: We believe the longer stringent lockdown measures are in place, the more fiscal stimulus there is to come. Policy execution is key.