Why recovery will hinge on continued government fiscal stimulus

Risks abound and markets are expected to be 'choppy and volatile' in the short term

Why recovery will hinge on continued government fiscal stimulus

A “swoosh-shaped” recovery for the global economy is dependent on continued support from central bankers and other policymakers.

HSBC GAM’s Q3 outlook said uncertainty remains the pervasive feature of the macro environment and pointed to a number of potential factors that might derail the recovery, which the bank believes began in Q2.

It highlights fiscal policy error and withdrawing stimulus too early as potential triggers, while it also warns of the scarring effects of the crisis, including sticky high unemployment, the failure to get a vaccine and, of course, the possibility of a second wave. There is also the risk that geopolitical tensions – like the trade war – are overlooked and could, therefore, shock the market.

The outlook took the perspective of concerned investors who are fearful for the global economy and wondering how much worse the virus could get. They will want to know what measures are being taken by authorities to limit viral spread, as well as details about monetary stimulus to lower the cost of corporate debt and fiscal stimulus to support vulnerable consumers. Attention is now focused on how much fiscal stimulus governments will continue to inject.

It read: “Investors eagerly process each new bit of information. When the implications of a new development are unclear, as in the case of COVID-19, investors may well feel that the only safe option is to sell now and figure it all out later. We should therefore expect markets to be choppy and volatile in the short term as further news breaks about the virus and its economic and financial implications.”

While the Canadian economy is well-positioned to deal with this uncertainty and episodic volatility, concerns remain over long-term damage to trade flows or labour markets. HSBC GAM believes, therefore, that market expectations for a rapid normalization may be “overly optimistic”, while if global growth is slower to pick up, there is also a higher risk that broader cyclical issues could emerge. The bank, for example, is watching for any signs of corporate debt defaults, although markets are currently applying a low probability to these types of risks.

The report added: “While the global economic data remains mainly negative, parts of China and industrialized Asia have begun the road to recovery faster than many had expected. Asia has been the lead indicator through this crisis, and the latest statistics show a clear back-to-work dynamic.

“Our base-case scenario assumes a ramp-up of testing and tracing, only isolated further outbreaks of the virus and a vaccine available in the middle of 2021, with some restrictions persisting until mid-2021. Working backwards, it means the recovery had already begun in the second quarter.”