\n\tHaving largely ignored COVID-19 as it spread across China, global \nfinancial markets reacted strongly last week when the virus spread to \nEurope and the Middle East, stoking fears of a global pandemic.<\/p>\n\n\n\n
\n\tSince then, COVID-19 risks have been priced so aggressively across \nvarious asset classes that some fear a recession in the global economy \nmay be a foregone conclusion.<\/p>\n\n\n\n
\n\tBusiness leaders are asking whether the market drawdown truly signals a\n recession, how bad a COVID-19 recession would be, what the scenarios \nare for growth and recovery, and whether there will be any lasting \nstructural impact from the unfolding crisis.<\/p>\n\n\n\n
\n\tIn truth, projections and indices won\u2019t answer these questions. Hardly \nreliable in the calmest of times, a GDP forecast is dubious when the \nvirus trajectory is unknowable, as are the effectiveness of containment \nefforts, and consumers\u2019 and firms\u2019 reactions. There is no single number \nthat credibly captures or foresees COVID-19\u2019s economic impact.<\/p>\n\n\n\n
\n\tInstead, we must take a careful look at market signals across asset \nclasses, recession and recovery patterns, as well as the history of \nepidemics and shocks, to glean insights into the path ahead.<\/p>\n\n\n\n
\n\tWhat markets are telling us<\/strong><\/p>\n\n\n\n \n\tLast week\u2019s brutal drawdown in global financial markets might seem to \nindicate that the world economy is on a path to recession. Valuations of\n safe assets have spiked sharply, with the term premium on long-dated US\n government bonds falling to near record lows at negative 116 basis \npoints \u2014 that\u2019s how much investors are willing to pay for the safe \nharbor of US government debt.<\/p>\n\n\n\n \n\tAs a result, mechanical models of recession risk have ticked higher.<\/p>\n\n\n\n \n\tYet, a closer look reveals that a recession should not be seen as a foregone conclusion.<\/p>\n\n\n\n \n\tFirst, take valuations of risk assets, where the impact of COVID-19 has\n not been uniform. On the benign end, credit spreads have risen \nremarkably little, suggesting that credit markets do not yet foresee \nfunding and financing problems. Equity valuations have conspicuously \nfallen from recent highs, but it should be noted that they are still \nelevated relative to their longer-term history.<\/p>\n\n\n\n \n\tOn the opposite end of the spectrum, volatility has signaled the \ngreatest strain, intermittently putting implied next-month volatility on\n par with any of the major dislocations of the past 30 years, outside of\n the global financial crisis.<\/p>\n\n\n\n \n\tSecond, while financial markets are a relevant recession indicator (not\n least because they can also cause them), history shows that bear \nmarkets and recessions should not be automatically conflated.<\/p>\n\n\n\n \n\tThere is no doubt that financial markets now ascribe significant disruptive potential to COVID-19, and those risks are real.<\/p>\n\n\n\n \n\t But the variations in asset valuations underline the significant \nuncertainty surrounding this epidemic, and history cautions us against \ndrawing a straight line between financial market sell-offs and the real \neconomy.<\/p>\n\n\n\n \n\tWhat would a COVID-19-induced recession look like?<\/strong><\/p>\n\n\n\n \n\tThough market sentiment can be misleading, recessionary risk is real. \nThe vulnerability of major economies, including the US economy, has \nrisen as growth has slowed and the expansions of various countries are \nnow less able to absorb shocks. In fact, an exogenous shock hitting the \nUS economy at a time of vulnerability has been the most plausible \nrecessionary scenario for some time.<\/p>\n\n\n\n \n\tRecessions typically fall into one of three categories:<\/p>\n\n\n\n \n\tLooking at this taxonomy, and again at history, there is some good news\n in the \u201creal economy\u201d classification. Though idiosyncratic, real \nrecessions tend to be more benign than either policy recessions or those\n induced by financial crisis, as they represent potentially severe but \nessentially transient demand (or supply) shocks. Policy recessions, by \ncontrast, can be, depending on the size of the error, severe. In fact, \nthe Great Depression was induced by perhaps the largest policy error \never. And financial crises are the most pernicious kind, since they \nintroduce structural problems into the economy that can take a long time\n to be corrected.<\/p>\n\n\n\n \n\tWhat is the likely recovery path?<\/strong><\/p>\n\n\n\n Whether economies can avoid the recession or not, the path back to growth under COVID-19 will depend on a range of drivers, such as the degree to which demand will be delayed or foregone, whether the shock is truly a spike or lasts, or whether there is structural damage, among other factors.<\/p>\n\n\n\n <\/p>\n\n\n\n Having largely ignored COVID-19 as it spread across China, global financial markets reacted strongly last week when the virus spread to Europe and the Middle East, stoking fears of a global pandemic. Since then, COVID-19 risks have been priced so aggressively across various asset classes that some fear a recession in the global economy may […]<\/p>\n","protected":false},"author":1,"featured_media":3074,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":[],"categories":[747,8,6],"tags":[1069,1073],"yoast_head":"\nBy Philipp Carlsson-Szlezak, Martin Reeves & Paul Swartz<\/h6>\n","protected":false},"excerpt":{"rendered":"