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Jeff Meli Ajay Rajadhyaksha

Episode 19

Jeff Meli in conversation with Ajay Rajadhyaksha

Will the coronavirus pandemic tip the world into a recession?

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Stresses to the global economy caused by the novel coronavirus pandemic have overshadowed other macroeconomic risks to global growth discussed in the previous episode of The Flip Side. Recently, global markets have seen the worst price volatility in equities since the 2008 global financial crisis, record-low yields throughout developed markets and central banks taking emergency action. Additionally, crashing oil prices have contributed to market strain.

In episode 19 of The Flip Side podcast, Jeff Meli, Head of Research, and Ajay Rajadhyaksha, Head of Macro Research, debate to what extent the economic risks posed by the coronavirus will affect global markets and whether the disruption will be enough to cause a global recession.

  • Jeff Meli: Welcome to this episode of The Flip Side. My name is Jeff Meli, I’m the Global Head of Research at Barclays. Now, in the last episode of The Flip Side, we talked about three challenges facing the U.S. economy.

    One was the potential rise of Bernie Sanders as the Democratic nominee for president. That’s faded a bit with Joe Biden’s resurgence in the more recent primaries. A second was the risks posed by Boeing and the challenges that they face with the 737 MAX.

    Now, that hasn’t gotten better but it probably hasn’t gotten worse. And actually, if anything, all of those risks are being overshadowed by the coronavirus, which was the third issue that we discussed. That’s gotten a lot worse.

    Obviously, there have been market disruptions globally. We’ve had the worst price action in stocks since the global financial crisis.

    Now, we have record low yields throughout the developed markets so, for example, U.S. Treasuries are at the lowest yield levels ever. And we’ve seen some emergency central bank action, for example, the New York -- the U.S. Federal Reserve cut by 50 basis points intra-meeting to try to call markets.

    I’m joined today by Ajay Rajadhyaksha, our Head of Macro Research, to discuss the economic risks posed by this virus in more detail.

    Ajay Rajadhyaksha: Thank you for having me, Jeff. At this point, I wouldn't fight you on the idea that there will be economic disruption, I think that is a given. The question is, how deep. You will see recessions in some economies for sure, but I think we really need to answer whether this actually ends up causing a global recession.

    Jeff Meli: And I think we should define a global recession. According to the IMF, that means global growth less than 2.5 percent. So in the U.S., we’re used to thinking of a recession as growth being negative.

    Why is the global recession defined differently? Well, that’s because emerging markets like China tend to grow much more rapidly than the big developed market economies. And so the average across the world tends to be positive all the time. It’s if it gets below that threshold, we think that there’s been a global recession.

    I think to get below 2.5 percent growth globally, we would require both a sharp slowdown in some of the biggest emerging markets plus a recession in some of the biggest developed markets.

    Ajay Rajadhyaksha: Now, look, I know it is hard to not get swayed by price action, it’s hard to abstract from all the bad news especially given the human consequences of COVID-19. But on the purely economic front, I still am hopeful that we will not see a global recession. There will be recessions especially in parts of the Euro area, but it’s not clear that it will extend globally.

    And I’m hanging my hat on a couple of things. The first is that China does seem to have seen the back of the worst of this virus. It is getting back to work. Today, for example, a major corporation CEO made the claim that all his factories in China are back online.

    So that economy took a big hit but they’re about to restart their engine, and that means that the other major economy, the United States, would have to get into -- go into recession to get a global recession, and I think that remains unlikely.

    Think of the starting point, the United States entered 2020 with the head of steam, the consumer was in great shape, labor markets were creating jobs for years and years and years at levels that we haven’t seen.

    And financial wealth effects both from equities and from housing have also been stored up for several years. And even with the price action over the last few weeks, that I don’t think has fully reversed.

    Second, the U.S. does have more policy tools both on the monetary policy side, but I would argue even on the fiscal side there generally tends to be more political will to act in the United States than, say, in countries of the Euro area.

    Jeff Meli: OK. So I actually think we are about to have a global recession. And I have a couple of reasons why I think that those are going to overwhelm the positives that you just talked about, Ajay.

    So first of all, this isn’t just a hit to manufacturing, this is a hit to services. And services, you don’t get that activity back. With manufacturing, there’s usually a bounce back, you make up for lost ground, that’s not how a drop in services activity works.

    Second, accompanying the COVID-19 concerns, we’ve seen a massive oil bust. Now, that used to be a positive for the U.S. economy, because we were net importers of energy, but now, the U.S. is actually the world’s largest energy producer. There are over a million jobs involved in the -- in the oil sector alone in the U.S. So an oil bust actually now, I think is a net negative for the U.S.

    Third, there are definitive pressures to the rest of the world. Europe is a focal point, Italy in particular. And fourth, we’re just getting started on cases here. So we’re already seeing things like segregations in certain parts of Westchester County, which has been a bit of a hotspot for COVID-19.

    But if you look at the Italy case numbers, you can see, you can get exponential growth and the exposure to this virus and we’re only scratching the surface potentially here in the U.S. So let’s get into it.

    Ajay Rajadhyaksha: All right. I’m going to concede one point right off the bat. I think we both agree that Europe is likely to go into a recession and it is probably going to be reasonably severe.

    I don’t think it quite (inaudible) doubled up between 2011 to 2013. That one, if you remember, they had six straight quarters of contraction, and I don’t think we get anywhere close to that.

    But I acknowledge that what Italy has done is quite draconian. They have -- especially given the size of their population, the size of the economy, they started by quarantining their main economic engine, there will be knock on effects not just from tourism but on the broader services sector.

    And it’s not clear to me that some version of that is not repeated in some of the other countries in Europe. So yes, the Euro area is going to have a significant recession. I can see that.

    Jeff Meli: Yes, I agree. And I think there are linkages between Northern Italy and other -- of the economic powerhouses in Europe, such as France and Germany. So you’re likely to see effects there as well.

    And I think the other point to consider is that Europe just doesn’t have that much of a buffer from a starting point. Growth in Europe is pretty anemic, talking about something like on the order of 1 percent a year, so there’s just not that much of a contraction that they can handle before it actually becomes a recession.

    It’s also true that in certain dimensions, policy is kind of maxed out there already. So for example, the European Central Bank, the ECB, has instituted negative rates now for years. We talked about that in a prior episode of The Flip Side.

    They’re already buying not just government debt, but also corporate bonds, so already doing quantitative easing well in excess of what the U.S. Federal Reserve ever did during the financial crisis here. There’s just not that many more levers for policymakers over there to pull.

    Ajay Rajadhyaksha: Well, that is one big lever I would argue still left. I agree with you on the monetary policy side. But this is the time for the fiscal side to step up. Look at all in bond yields across the Euro area, even in Italy, but especially in bigger economies like Germany.

    And you could argue that the bond markets are screaming for a new fiscal stimulus from the government that ends up pushing these economies out of the recession that they are about to go into.

    And there are some steps in that direction. The Germans have made noises about walking away from that debt break. The United Kingdom’s Prime Minister has, for a while now, promised lots of new fiscal stimulus. He promised that in the context of the E.U. U.K. trade negotiations, but that doesn’t mean that it doesn’t help if the U.K. economy is facing a challenge associated with COVID-19.

    Even Italy, today morning, for example, they announced that they would push for a $28 billion stimulus package. These are not small numbers and, if absolutely needed, those numbers could well go up.

    Germany, in particular, I would say, is an economy where the vast majority of sovereign debt is not just in negative territory. It is also the one major economy in the world where there is a ton of fiscal space. Their fiscal profile has improved every year for the last several, and now is the time to put it to work.

    Jeff Meli: Well, I hear you, Ajay, on the -- on the need for some fiscal stimulus, but nonetheless, I think we’re in agreement that regardless of actions that the authorities might take, we are talking about a pretty substantial component of the global economy going into recession.

    Ajay Rajadhyaksha: Yes, but the Euro area has flattered to deceive for much of the last several years, 2018, 2019 Europe is largest and third largest economy. Two years in a row flirted with recession. And Germany, for example, barely avoided a technical recession in the fourth quarter of 2018 as far back as then. And the world economy in general was OK.

    I think China is the key. The factors that the Euro area is probably sliding into recession but the hope is that China has turned the corner at least in terms of getting back to work. The quarantine steps that are clearly working, there is an incentive on the part of the government to make sure that growth doesn’t slow down far too much.

    And it is a command and control economy. And there are advantages to a command and control economy in situations like this, that Western purely market oriented economies do not have. So yes, there’s been a ton of damage so far. I -- it’s very hard to argue that that is not the case. But the question is, where do we go going forward?

    Jeff Meli: OK, let’s think about the potential resurgence of China here. I think that’s an interesting question because on the one hand, it does look like the number of cases has declined dramatically and we are hearing about folks getting back to work.

    But we don’t know if the virus would start spreading again once people start getting back to work and start interacting with each other again. Like you mentioned, China took some pretty aggressive steps, steps that I think a less authoritarian government might have struggled to actually implement.

    We’ll see how these things work in Italy and in other jurisdictions. But I think there is a risk of this actually start spreading again, which would be like a double dip in China, which I think would be very damaging.

    Second, I think there is a kind of an open question here. It’s great if China gets back to work. They’re a big export economy. But who are they going to sell to if everybody else in the world is having their own economic troubles? It’s not obvious that there’s going to be any customers for the stuff that they’re making.

    Ajay Rajadhyaksha: A fair point, both. Here’s the thing, Jeff. At this point to see a global recession, assuming that China has turned the corner in terms of the drag on economic activities, the numbers have yet to play out.

    But in terms of actual economic activity on the ground, assuming that Q2 in China is significantly better than Q1, to get a global recession going forward, you really need the United States to slip into one, and I don’t think we will.

    The main reason for that is the starting point, the U.S. entered 2020 with the head of steam. The U.S. labor markets have been very, very strong for years and years. The household savings rate for the U.S. consumer was a very healthy 7.5 percent to 8 percent entering this period.

    Wealth effects even after the pullback that we’ve had in global equities and U.S. equities are still generally positive, especially when you factor in the rise in home prices over the last several years. And it takes a lot to undo that to the point of two negative quarters.

    Jeff Meli: OK. So first, there’s no doubt that the labor market in the U.S. has been an amazing source of strength for the economy. However, I think full employment like we’ve been experiencing for multiple years now can be a tenuous equilibrium.

    So layoffs can happen very quickly if you have a loss of business confidence and a lack of concern around losing access to employees. So what I mean by that is if you’re a company that enters a period of difficulty, were left to your own devices, you might cut back on your workforce somewhat.

    But you’re worried that all your competitors will hire those people. And once you overcome whatever problems you face, you’re going to have a hard time hiring them back because they’ll have moved on to new jobs, then you might think twice about letting people go in the first place.

    So in other words, full employment can be sort of self-fulfilling, right? But it can also go very quickly the other direction. So, for example, take what’s happening in the energy sector in the U.S. At this point, there is no doubt that the weakest players must lay people off in order to have any chance of surviving the big declines in oil prices.

    That means even the stronger players would not be worried about not be able to rehire employees if and when oil prices rebounded. They could take measures now to cut back on costs and probably would be in safe territory once oil recovered. So I think we should be careful about full employment being very tenuous. It’s true that the job gains have been quite remarkable up until now, but I think they could turn on a dime.

    And the second is about wealth effects. Like the math is the math and the stock market is still way up since it was in 2016 and actually still up since it was at the depths of 2018 too. But I think volatility acts as its own drag actually on confidence. So regardless of the nominal prices, the fact that markets are whipping around like this has to be scaring businesses and consumers.

    Ajay Rajadhyaksha: So you make two points, Jeff, and I’m going to push back with two of my own. Your last point about job losses, now, this is going to sound a little perverse, but one of the things we have realized about this cycle is that the amount of economic growth required to keep people in their jobs is just lower than it past cycles.

    Take Germany as an example. I told you, they flirted with recession twice in two years, and yet, the German unemployment rate is close to all time lows. Similar with the United Kingdom, it slowed down in the negotiations around Brexit, and yet, the amount of people employed in the U.K. is at all time highs. Normally, that implies that productivity is poor, but in this particular episode that growth is slowing down, that might just mean fewer jobs lost than otherwise.

    The second is there is some help that policy can do. Payroll tax cuts, for example, which have been -- which have been floated in the United States, that makes it easier for companies to keep people employed for an extended period, even if some of those people can’t show up at work for reasons to do with this virus for two weeks, four weeks, et cetera.

    Jeff Meli: Well, look, I think there are legislative actions that could be taken in the U.S. to mute the effect of the virus. I think the issue around their efficacy will be one of timing. So they need to be done now before companies actually start to take action and reduce their workforce or cut costs.

    So to me, it’s really an issue of whether the government would be able to act fast enough to keep us from sliding into a lower employment equilibrium. And I think you mentioned payroll tax cut as one possibility, and I agree that that would be a step that would basically reduce the costs associated with maintaining your workforce, and that would be a positive plus it also obviously would increase the amount of money flowing to consumers.

    There’s other legislative proposals that have been floated that whilst may make perfect sense on the human side, may actually work in the opposite direction on the economic side. So for example, there’s been talk about mandating sick leave, that’s paid.

    Now, of course, in the midst of a health scare and virus on the human side, that could make a lot of sense and we would not want to dismiss that. On the economic side, that could actually raise the costs associated with maintaining your workforce if that’s imposed on employers as opposed to paid for by the government.

    And if that was the case, that might actually hasten the move towards a lower employment equilibrium. So I think the nuances on the policy side are actually going to matter for whether this helps or hurts on the pure economics.

    Ajay Rajadhyaksha: That is true, but I think we have to go to the starting point that the policies made are generally likely to be helpful than not. And, at least, on the monetary policy side, I would say that it’s an unequivocal positive.

    The U.S. Central Bank will not only go to the zero lower-bound more importantly, because of how clean, how well-behaved the inflation profile in the United States has been for the last decade, they are likely to stay there for the next several quarters even if inflation does make a comeback. That kind of certainty actually helps a lot, especially for financial assets.

    And you know what? That, whether we like it or not, does matter to the real economy. Go back to 2008 or even any other recession. Usually, there tends to be a negative feedback loop between financial markets falling, financial conditions tightening, and then that feeding into the real economy and so on and so forth. And that cycle, I think, I hope, will not build up this time.

    Jeff Meli: Well, I guess the question I have, Ajay, on that is, what is the role of monetary policy in this specific instance? So, keep in mind, the Fed had already cut rates several times before COVID-19 really spiked.

    Rates were extremely low. I think it would be -- one thing to say you don’t expect a funding crisis like we had in the financial crisis, OK, so we’re not expecting banks not to be able to fund themselves or money funds to have problems. I would agree with all of that.

    And so the severity of the recession may not be anything like what we experienced during the last -- during the last cycle. But it’s not obvious that lower rates are really going to help economic activity like this. If you’re worried about leaving your house, I’m not sure that the next 50 basis points of cuts from the Fed actually makes you go on vacation, right?

    So at some level, this is -- this is such a nonstandard event that I’m not sure that standard tools are really fit for purpose. I would also say that one of the consequences of the financial crisis is that banks have been disintermediated by other lenders in a lot if -- in large parts of the economy.

    And one important part where that’s taken place is what’s called SMEs or small and medium-sized enterprises. Basically, small businesses don’t get their money from banks anymore. They get their money from third-party lenders.

    It’s not easy for the Fed or any other central bank to figure out how to keep that kind of credit channel operating. They normally put money into the banking system, which then lends it to those sorts of enterprises, 50 percent of employment in the U.S. is at this sort of small companies. If they run out of credit, you could see the job losses escalate very quickly.

    Ajay Rajadhyaksha: All right. So look, I agree that monetary policy is not a silver bullet for everything, especially the problems posed by this crisis. And you are right that the SME sector, the sector that doesn’t actually tie itself closely to the financial markets is a sector that is harder for the U.S. central bank to get to.

    But the Fed also wears the regulatory hat. They can move ease conditions on that side, they can direct banks to -- and tell them that there will be regulatory relief, that they should not be that quick to call in loans, pull lines of credit, turn off revolvers, et cetera for small and medium enterprises.

    Again, it wouldn’t be perfect and there will be challenges along the way, but ultimately, I think it’s a question of degrees. And recessions usually happen, not a slowdown, but an actual recession because financial markets do play a role in making things worse and making people feel much worse, and I think that will happen to a much lesser extent as well.

    Jeff Meli: Well, Ajay, there’s a couple of issues that you haven’t mentioned that I think are leaning against the U.S. here. One is the route in oil. So oil prices have fallen largely in response to demand destruction associated with COVID-19. Also because of disputes within OPEC. At this point, the U.S. has over a million jobs in the energy sector. Those are definitely at risk at this point.

    Ajay Rajadhyaksha: Well, that might be the case, Jeff, but we have seen this movie before. We saw a similar decline in oil prices in 2015 and the overall U.S. labor market held up pretty darn well.

    Jeff Meli: A final point for me, Ajay, is that this is really just the beginning of our experience with the virus here in the U.S. The caseload is still manageable. Just look at the numbers in Italy, it went exponential.

    It was seven cases several weeks ago, it’s now over 10,000, very quickly got to a point where (inaudible) risking overwhelming their health system. If that were to occur here, I think all bets are off in terms of the implications on the economy.

    Ajay Rajadhyaksha: So I’ll say a couple of things. First, the United States is a more economically heterogeneous and just a bigger country. Europe, as we know, is more densely populated. And as a result, you would imagine that the virus is quicker to spread.

    The other is that there are lessons to be learned from what South Korea has done, what Taiwan has done. These countries took the first hit. And if we learn from what they’ve done, I think we can go a long way towards mitigating the economic impact of COVID-19.

    Jeff Meli: OK, thanks for joining this episode of The Flip Side. Clients can read our latest research on the virus and its economic and market implications under #virus available on Barclays Live.

Authorised clients of Barclays Investment Bank can log in to access related reports on Barclays Live:

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The Flip Side

Episode 18: Planes, politics & viruses: Emerging risks to US growth? 

Barclays Research analysts Jeff Meli and Michael Gapen debate the degree to which a new set of macroeconomic risks may pose a threat to US and global growth on The Flip Side podcast.

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About the analysts

Jeff Meli is Head of Research within the Investment Bank at Barclays. Jeff joined Barclays in 2005 as Head of US Credit Strategy Research. He later became Head of Credit Research. He was most recently Co-Head of FICC Research and Co-Head of Research before being named Head of Research globally. Previously, he worked at Deutsche Bank and JP Morgan, with a focus on structured credit. Jeff has a PhD in Finance from the University of Chicago and an AB in Mathematics from Princeton.


Ajay Rajadhyaksha is Head of Macro Research at Barclays, based in New York. He oversees the global research and strategy efforts of the economics, rates, FX, commodities, emerging markets, securitised, and asset allocation teams. Since joining Barclays in 2005, Ajay has held various positions, including Co-Head of FICC Research and before that, Head of US Fixed Income Research and US and European Securitised Research.

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