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2Q2020 One of the Worst Quarters in History

The second quarter of 2020 is shaping up to be the worst quarter in history in terms of contraction in demand and activity. This is despite a modest bottoming of the Chinese economy.

Key summary points
  • We are tracking 2Q yoy real GDP growth to be -12% in the US, +3% in China and -7% in Singapore
  • Assuming a modest return to activity starting from June onward, 3Q growth would turn positive
  • Even a sizeable jump in qoq activity in 3Q willl leave output significantly below capacity
  • Moreover, the downside risk to this scenario is considerable
  • A resurgence of the pandemic in the US and China would upend expectations considerably

Chart of the Week: The worst quarter ever

2Q2020 is shaping up to be the worst quarter ever in recorded history in terms of demand and activity contraction. Atlanta Fed’s US GDP Nowcast model is tracking an unprecedented 42% contraction this quarter (qoq, SAAR). The model has turned particularly pessimistic in the past week, reflecting the latest dismal releases on jobs, industrial production, manufacturing activity, and retail trade.

Commentary: Looking past 2Q

Even as some key economies around the world take small towards easing lockdown measures, the damage for the current quarter is already done. The second quarter of 2020 is shaping up to be the worst quarter in history in terms of contraction in demand and activity. This is despite a modest bottoming of the Chinese economy. Atlanta Fed’s US GDP Nowcast model is tracking an unprecedented 42% contraction this quarter (qoq, SAAR). The model has turned particularly pessimistic in the past week, reflecting the latest dismal releases on jobs, industrial production, manufacturing activity, and retail trade.

As per our GDP Nowcasting model, we are tracking 2Q year-on-year real GDP growth to be -12% in the US (fairly similar to what would be the corresponding figure from the Atlanta Fed Nowcast), +3% in China and -7% in Singapore. These outturns will be consistent with the path forecast by the IMF, which sees global growth contracting by 3% this year.

The issue at hand is not the unprecedented depth of this quarter’s global economic contraction. Rather, for policy makers and market participants, the question is how the second half of the year will shape up. Even the prevailing consensus forecast for the year, dire at first glance, is based on a gradual return to normalcy in 2H20. Many policy packages and fiscal programs are timed to expire by June, with the expectation that ongoing easing of lockdown will progress steadily, gaining momentum in 3Q, rendering some of the support measures in place less essential.

Assuming a modest return to activity starting from June onward, 3Q growth would turn positive among the post-lockdown economies. Indeed, given the likely depth of 2Q contraction, even a tentative return to activity will produce pleasing headline growth figures for 3Q, although the actual level of activity would remain substantially below the level of 1Q, or even 4Q19 for that matter.

Hence even a sizeable jump in quarter-on-quarter activity in July-September will leave output significantly below capacity, keeping the global economy on overall contractionary territory for the entire year.

Moreover, the downside risk to this scenario is considerable. A resurgence of the pandemic in the US and China (and in other major economies of EU or North Asia) would upend investor expectations considerably, leading to a flight to safety and a major spike in asset price volatility, in our view.

As economies attempt to normalise, the tricky trade-off between life and livelihood will likely haunt consumer and business sentiment for a considerable period. Areas such as travel, tourism, dining, and mass gathering (sports, concerts, conferences, gaming) will either operate at substantially below capacity to ensure safety or be subject to a debilitating start-stop dynamic if the pandemic comes in waves. As difficult as the 2Q has been, the heroic supportive measures put in place in most countries in the world has acted as a critical band aid. As support measures run out but economic distress does not dissipate entirely, the risk is many corporate debt defaults and business failures will surface, rendering the chance of a smooth recovery moot.

Macro Insights Weekly: Looking past 2Q

Indonesia: Market expectations are divided as we approach the BI rate review. We see a little more than even chance that the BI rate will be
cut by 25bps to 4.25%, convinced by a manageable inflation outlook and stable rupiah (appreciated 9.5%/USD in 2Q yet far). Since the downside surprise in 1Q20 growth, which is set to intensify in 2Q, risks of a full-year contraction has risen. Ahead of this we expect the BI to cut rates alongside absorbing part of bond supply to facilitate a strong fiscal response.

Japan: April exports are expected to continue the double-digit decline for the second consecutive month. Global lockdown, together with the state of emergency in Japan, is likely to hit both exports and domestic demand badly in 2Q. As a leading indicator, manufacturing PMI already declined to 41.9 in April, the lowest over 11 years. The inflation numbers for April
are also due this week. Headline CPI is expected to drop to 0.2% YoY from 0.4% in the previous month, reflecting the plunge in oil prices and the decline in inflation expectations.

Malaysia: Disinflationary pressure could intensify further in April with the headline CPI inflation likely to register -0.4% YoY, from -0.2% previously. In fact, inflation could linger around -0.6% in the coming months on the back of the slew of cost reduction measures introduced by the government, a lack of demand impetus and low energy prices. Indeed, the negative output
gap is widening, which could tip full year inflation into negative level. We now expect headline inflation to average -0.4% for the full year, down from our previous forecast of zero.

Taiwan: April export orders should have fallen by -3.7% YoY, reversing the 4.3% rise in the previous month. Manufacturing PMI plunged to 42.2 in April, 8ppt down from the 50.4 in March, and the lowest seen since January 2009. Demand for some ICT products like laptops and tablets has remained strong due to the “stay home” phenomenon. But the deterioration in
labour market is likely to curb the upgrade demand for smartphones in major economies.

Thailand: 1Q20 GDP growth is likely to slump by -3.5% y/y vs 1.6% in 4Q19. For Thailand, the infection was a double whammy – hurting its externals-oriented focus (tourism and trade), as well as impinging on domestic demand as strict social-distancing measures were imposed. With the infection count easing in recent days, the economy is easing up curbs, but return to normalcy might take another quarter at the least. We expect the economy to contract more sharply in 2Q before edging back up, but full year output is be in recession. BOT is expected to cut the benchmark rate by 25bps to 0.5%.

China: The 1-Year Loan Prime Rate is expected to stay at 3.85% in May amid a stabilizing domestic demand. However, we expect another 30bps cuts in the rest of the year amid the global COVID-19 outbreak. Further rate cuts
are needed to cushion the fall in external demand. In fact, it has dropped by 30bps in the past 4 months.

Hong Kong: The jobless rate is expected to rise further from 4.2% in 1Q to 4.8% in Feb-Apr. The employment situation of retail, accommodation and food services sector will continue to warrant the biggest concern. Unemployment rate of construction and import/export trade sectors are also set to rise further amid the halted construction and external trade. On inflation front, the CPI is expected to ease further to 2.0% in Apr from 2.3% in Mar due to the weakening economy.

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