US Macro Outlook: Let's Bend The Economic Growth Curve

Three recovery scenarios? Franklin Templeton Fixed Income discusses the implications for growth, employment, and investment.

Sonal Desai, Ph.D. Chief Investment Officer, Franklin Templeton Fixed Income

Nikhil Mohan, MSc Economist, Research Analyst,Franklin Templeton Fixed Income

Summary

A CRISIS LIKE NO OTHER

The current economic crisis, triggered by the COVID-19 pandemic, stands in a class of its own, very different in key respects from major past crises—including the 2009 Great Recession and the 1929 Great Depression, often used as comparators.

The current recession has been engineered by government fiat in response to health concerns, rather than being due to any fundamental imbalances in the real economy or the financial sector. Policymakers have shut down virtually overnight large parts of the economy—in the United States and other major countries—ordering people to stop working and consumers to stay home, so as to halt the spread of the virus. This had two important implications.

First: Policymakers knew very well that the adverse economic impact of extreme social distancing would be immediate and massive, and therefore launched an immediate and massive policy response.

Second: Most corporates and businesses have assumed that the sudden stop to the economy will be temporary. This has been especially evident in the very large share of temporary layoffs in total layoffs: temporary layoffs accounted for nearly 80% of the 1.35 million new unemployed recorded in March.1

ALL SHAPES OF RECOVERY ARE STILL POSSIBLE

The combination of these two factors—the immediate decisive response of policymakers and the readiness and desire to go back to work of employees and businesses—implies that a robust V-shaped recovery is still possible—though by no means guaranteed. In this regard, we should also note that unlike in 2008–2009, a full-fledged financial crisis seems highly unlikely at this stage—and research has shown that a financial crisis makes the impact of recessions deeper and more prolonged.

The depth of the recession and the speed and shape of the recovery hinge on three factors:

1.  How quickly and with what precautions policymakers reopen their economies;

2. Whether a second wave of contagion will cause a new round of shutdowns in the second half of the year;

3. To what extent businesses’ and consumers’ behavior will differ once the economies reopen.

The paper also covers:

  • A recession that targets the most vulnerable sections of society

  • Policy reaction: both cushion and stimulus 

  • Recovery scenarios

  • Health uncertainty and economic uncertainty—a hard tradeoff

CONCLUSION

We are tackling a crisis like no other. This implies that we face a whole new set of challenges, but also that we should not assume it will be a replay of the worst past recessions—though that risk exists. Any shape of recovery is still possible. The initial swift and massive policy response puts a robust economic recovery still within our grasp. To achieve it, we believe policymakers need to reopen the economy in a timely manner and with the right health precautions. A smart and speedy restart of economic activity can protect those most vulnerable to the virus and safeguard those most vulnerable to the catastrophic health and economic consequences of a deep prolonged recession. This paper has laid out the alternative macroeconomic scenarios that we believe might still play out—and that form the fundamental analysis backdrop against which we are framing our investment strategy.

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ENDNOTES

  1. Source: US Bureau of Labor Statistics, as of March 2020.

What Are the Risks?

All investments involve risks, including possible loss of principal. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Special risks are associated with foreign investing, including currency fluctuations, economic instability and political developments. Investments in emerging markets involve heightened risks related to the same factors, in addition to those associated with these markets’ smaller size, lesser liquidity and lack of established legal, political, business and social frameworks to support securities markets. Actively managed strategies could experience losses if the investment manager’s judgment about markets, interest rates or the attractiveness, relative values, liquidity or potential appreciation of particular investments made for a portfolio, proves to be incorrect. There can be no guarantee that an investment manager’s investment techniques or decisions will produce the desired results.