Although first-quarter GDP data confirm that the U.S. and euro area are in recession, some signs out of China suggest a shorter-than-expected downturn.
Editor's note: This article has been updated since its original publication to include recently released data and commentary.
The first-quarter GDP data released at the end of April for the U.S. and euro area officially confirm something we have known for some time: The global recession has started. However, my colleagues and I at Morgan Stanley Research believe that this downturn will be sharper—but shorter—than the Global Financial Crisis (GFC) that began in 2008.
As economies reopen and more workers return to their jobs, mobility trends and production levels should further improve.
Why is this our view? To begin with, recession was triggered by an exogenous shock, in the form of a public health crisis, instead of rising imbalances around the world, which is the typical basis of a recession. This downturn also didn’t start as a financial crisis, and the banking system is in better shape today than it was prior to the 2008 crisis.
Further, this recession has prompted the most coordinated and aggressive monetary and fiscal easing that we have witnessed in modern times. For China and the G4 regions—the U.S., euro area, Japan, the UK—fiscal deficits as a percentage of GDP will be 1.5 times their levels during the previous recession. Similarly, G4 central banks are aggressively expanding their balance sheets. The Federal Reserve’s balance sheet will expand by 38 percentage points of GDP, more than the 20-percentage-point expansion during the Fed’s three stages of quantitative easing after 2008.
By our estimates, global economic contraction will trough at 7.5% in the second quarter of this year (far worse than the 2.4% contraction in the first quarter of 2009), while output—for the world as a whole and developed markets—will return to prerecession levels in 4 and 8 quarters, respectively, compared with 6 and 14 quarters after the GFC.
Let’s look at why we believe this recession may be shorter. Currently, a number of the high-frequency indicators we track suggest that the global economy is in the process of bottoming. Consumers’ future expectations have improved, mobility trends have moved up from their troughs, and consumer spending is contracting more slowly than in the early weeks of the outbreak.
In the U.S., our IT Services & Payments equity analyst, James Faucette, has pointed out that credit card transaction data indicates that both transactions and sales have picked up in the past two weeks. China’s economy bottomed in February, and we believe the euro area has likely troughed in April, with the U.S. following suit from late April. Other regions, such as Central & Eastern Europe, the Middle East, Africa and Latin America, should bottom out later.
We’re now seeing signs of a phased reopening in the U.S. and Europe. As economies reopen and more workers return to their jobs, mobility trends and production levels should further improve. In the U.S., some states have begun to reopen, and our U.S. economics and biotechnology teams estimate that 54% of the economy will be in a meaningful reopening phase by mid-May. This estimate assumes that states will be able to reopen 28 days after the peak in new confirmed coronavirus cases (Phase 2). European economies will also progressively reopen from early May onwards.
As we move toward a gradual reopening in parts of the world, we have been closely observing developments in China to see how various sectors of the economy are normalizing and how this experience may inform our outlook for the rest of the world. To be sure, our views are shaped by the path, but not the duration and magnitude, of recovery, considering the differences in the severity of the outbreak and the underlying composition of economic activity between the U.S., Europe and China.
In China’s case, the manufacturing, infrastructure and construction sectors recovered relatively quickly. Data suggest that manufacturing is back in expansionary territory, while property sales and demand for steel and cement are growing again in year-over-year terms, just 10 weeks after the peak in new cases. Supply-side disruptions have eased quickly, and production levels have experienced a V-shaped recovery. All of that suggests that the manufacturing sectors in the U.S. and Europe could be on a similar path after reopening.
However, since the U.S. and Europe are more consumption-based economies, investors are closely watching Chinese consumer activity. Although the pace of recovery has varied across different segments, consumption in China is showing signs of progress. That said, the phased relaxation of social-distancing measures has dampened the overall pace.
Sales in China’s online retail channels, which account for 30% of total sales, are back in positive territory year-over-year, and traffic to shopping malls sits at 70% of normal levels, although malls are now fully open. Smartphone sales have seen a V-shaped recovery and demand for tech products has broadly improved, according to our Asia technology analyst, Shawn Kim. Yet, spending on other consumer discretionary products still lags.
China’s consumer goods companies—staples, home appliances and apparel—expect normalization, defined as back to normal levels of year-over-year growth, by the end of June. Restaurants have 50%-80% of their customer base back, but nightlife venues are still closed in Beijing, Shanghai, Guangzhou, and Shenzhen; and cinemas will remain dark until early June. Our China consumer analyst, Lillian Lou, expects these channels to fully reopen by the end of June or beginning of July, and traffic to normalize in the third quarter of 2020.
One last note: The reopening of economies has prompted concerns about a second wave of infections and potential double dip in the economy. We readily admit that many unknowns concerning the virus remain, and we do expect additional waves of infections to occur. However, the phased reopening, scaling up of public-health authorities’ ability to test and contact-trace on a meaningful level, the development of medical solutions to treat and prevent the disease, and the awareness of the population at large offer some reassurance that we have a much better chance to reduce the size and scope of future outbreaks.
Adapted from a recent edition of Morgan Stanley Research’s “Sunday Start” series (May 3, 2020). Ask your Morgan Stanley representative or Financial Advisor for the latest market strategy coverage and reports. Plus, more Ideas from Morgan Stanley’s thought leaders.