Listen: The Essential Podcast, Episode 1 Closing the Confidence Interval – Economic Impacts of COVID-19

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Nathan Hunt: This is the Essential Podcast from S&P Global. My name is Nathan Hunt.

Since reports emerged of a novel coronavirus outbreak in Wuhan, China in early January, economists, government officials, central bankers, and investors have tried to make sense of what impact this pandemic may have on the global economy. My guest today is one of the people who has been leading that effort for S&P Global.

Paul Gruenwald is the Global Chief Economist at S&P Global Ratings. His team of economists have been working tirelessly to understand the macroeconomic impact of this fast moving pandemic. Paul, thank you for joining me today.

Paul Gruenwald: Thanks, Nathan. It's good to be with you.

Nathan Hunt: Just to set the stage for our listeners, where are you calling in from right now?

Paul Gruenwald: I'm in my apartment in Battery Park City in lower Manhattan, and it's a nice sunny afternoon

Nathan Hunt: Okay, yes. Paul, you and your team meet regularly to look at economic indicators and forecast the direction of economies around the world. Take me back a few months ago. What was your forecast at the time for the global economy?

Paul Gruenwald: Well before all of this COVID-19 pandemic started, we actually had a pretty good outlook for the global economy this year. To take the U.S. as an example, we were forecasting growth of around 2%. The labor market was quite robust with unemployment at about 3.5%, so the economy was close to a textbook steady state. We had good growth in most of Europe and then China was continuing to slowly de-leverage and continuing growth at around 6%, so we were actually in a pretty good spot the last time we did our quarterly forecast, which was at the end of last year.

Nathan Hunt: Okay. But that's obviously changed significantly, even in the last day or so. Where are we now?

Paul Gruenwald: Right. Well, we have changed our forecast already several times as the developments for Corona become clearer. We're now down to global growth of just 0.4% in 2020. That's about three percentage points lower than our previous forecast at the end of 2019. We have a 1.3% contraction in the U.S. this year, and a 2% contraction in Europe, and even China should be below 3%, so we are significantly below where we were just three months ago. In terms of the timing or the phasing, we see the worst being Q1  in China, some spanning of Q1 and Q2 in Europe, and the second quarter here in the U.S. So we're significantly below where we were just a few months ago.

Nathan Hunt: Expanding out beyond that, you know, when you look at South America or Africa, do you have any projections for those areas?

Paul Gruenwald: Well, what's becoming clear is that the virus is spreading to those areas. So in terms of our sequencing, it would seem to be China, Asia first, Europe second, the U.S. third, and emerging markets fourth. We're still trying to get some initial data for EMs and the virus is spreading quickly, so we would expect the data to turn south soon for that part of the world. What we're watching is that those countries, or many of those countries don't have the health systems that we have here in the more advanced countries, so it could potentially be worse for the same shock, but that's clearly another downside risks to our forecast.

Nathan Hunt: Returning to the U.S. example, when was the last time we saw a quarterly contraction of this magnitude?

Paul Gruenwald: I'm not sure we actually have one on record. For the employment, we had 3.3 million jobless claims and in the current week, that was four times higher than the previous record from 1982 and five times higher than the worst during in the global financial crisis. So we're clearly in a rather unique situation. The depth of this downturn may not be as severe as the global financial crisis, but certainly the speed or the velocity is much, much faster.

Nathan Hunt: Tell me a bit about what you're seeing out of China. What data points do you look at to get a sense for the state of the economic growth there?

Paul Gruenwald: Well, first, China's important because it's the only template we have, and as I said, they went through the COVID-19 crisis first.  The backward-looking data are actually quite bad. We have a 12% drop in industrial production in the January/February period. But some of the more concurrent data such as FedEx data or traffic data, or some of the consumer confidence data seem to be showing a stabilization. So this template we're working with, with one quarter shock, and one quarter of stabilization, and then a recovery that seems to be playing out in China, although the upturn looks to be a little bit slower than we had originally anticipated.

Nathan Hunt: There have been discussions in some quarters that, you know, once China lifts some of the restrictions around movement and travel, that there could be a return of the pandemic at high levels. What would you be looking at then to see early indications? From an economic standpoint, what numbers would you be looking at to understand what the impact of that could be?

Paul Gruenwald: Right. Well, well, first we're leaving all the medical assumptions to the health professionals because we don't have any expertise there, but I mean, what we've been watching, these contemporaneous indicators, we all started watching Tomtom.com for traffic patterns. We'll be looking for sentiment data on productive capacity, etc. Essentially what we went through a few months ago, let's hope we don't go to that space. We've had a little bit of an uptick in China recently, as citizens returned from abroad, but a curve that we all talk about still looks pretty flat, and that's where you want to be.

Nathan Hunt: When you say you're looking at Tomtom.com data, can you explain to our listeners what that data is and what it shows?

Paul Gruenwald: Yeah, it's GPS generated traffic data. So if you go in and you pick your favorite city and you put it in there, you can see the normal daily traffic pattern, rush hours have peaks and weekends are slower, et cetera. If you type in the city of Wuhan, it was totally flat for several months, which clearly reflects the shutdown of the city. Last time I looked, which was a few days ago, you can see traffic patterns dropping in New York because of the person to person social distancing. I'm sure other cities would look like the same thing. These sorts of, you know, modern data or big data sources are good because they're essentially real time and they can make at least an indirect ways give us a sense of what's happening in the economy. Great.

Nathan Hunt: Okay. At the global level, what industries and what sectors are most likely to be impacted by this downturn?

Paul Gruenwald: Okay. That's something we've actually spent a lot of time discussing with our credit colleagues. The sectors that are hardest hit are the ones that are directly affected by social distancing. So we would have airlines, entertainments, bars and restaurants, automobiles, oil and gas on top of that because of the drop in energy prices. Brent's now in the $20 per barrel range, so it's not a uniform impact across all of the sectors. It's very uneven and focused on the ones where the restrictions on people to people contact are having the biggest effect.

Nathan Hunt: Is there a model for this? Is there a historical parallel you look to in terms of understanding what's happening right now?

Paul Gruenwald: The short answer is no. We know what recessions and downturns look like, but a health-driven economic crisis of this sort is something where we don't really have a template. We do have our macro accounting frameworks and we can look how the sectors are linked and how supply and demand interact, but we really don't have a model here, so we're using the tool box as best we can, and to be honest, we're all learning very quickly.

Nathan Hunt: You had said earlier in terms of the global financial crisis that we all lived through very recently, you had said you expect this to look different because of the immediate impact. What other factors would you think could potentially be different looking forward?

Paul Gruenwald: Well, there's a couple of different things. First, we're seeing the market turbulence and the risk aversion and the flights qualities. So in that sense, this COVD-19 crisis, I guess, rhymes a bit with the global financial crisis, but unlike the global financial crisis, where there was a corpus of impaired debt and credit that needed to be resolved through some combination of, you know, write down and forgiveness, this is an exogenous health shock so it's hitting the economy quite quickly. It may not necessarily do any lasting damage, so we would expect a sharper downturn and a larger recovery, but sort of the whole, the contour, and the narrative is different. So again, we know how economic cycles work, but having one imposed from a health event on the outside is unique, but I don't think maybe to directly answer your question, the GFC is a very good template to use to study the COVID-19 crisis.

Nathan Hunt: Let's switch to talking a little bit about monetary policy. When you look at what's been done so far, have the central banks already done everything they can do? Do they have any dry powder left?

Paul Gruenwald: Well, the central bank always has dry powder, right? Because they can create assets and liabilities in its own currency. Foreign currency is a different thing. But we've seen central banks move into action very, very quickly this time. They have the playbook from the GFC. So we've seen policy rates taken down to zero. We've seen asset purchasing programs being reactivated sometimes without limits. Central banks also want to make sure that markets are functioning properly, that there's liquidity, that there is price discovery and that there's buyers and sellers, that we see intervention in the commercial paper markets and the money markets. The Fed would be buying this time, some investment grade corporate paper, a European central bank has loosened some restrictions on proportions of government bonds that they can buy. So the central banks have gone into action quite quickly. We've got a couple of new central banks in the zero club in Australia and New Zealand. So the central banks have been very proactive and they can always create more liabilities and buy more stuff. So I wouldn't say that they don't have any dry powder left, but again, we might be going into some uncharted territory as central banks respond to this particular crisis.

Nathan Hunt: A lot of people are saying basically that this cannot be solved through monetary policy alone. When you look at how central banks are responding, are they using every tool in their arsenal?

Paul Gruenwald: I would say yes, and they can create new tools in the sense that if they want to intervene in market X, and they haven't done that before, they can intervene in market X. But your right about the ability of monetary policy to counter a demand shock. So the responses we've seen to ensure market  liquidity and price discovery, et cetera, are the role of monetary policy. But what we really need is something to replace the sharp drop in private sector demand and that obviously points to a public sector demand. So we've seen big fiscal packages rolled out. It looks like the $2 trillion stimulus is going to pass here in the U.S. and the Europeans have already passed a package. So through combinations of guarantees or direct payments to workers or unemployment payments, or incentivizing firms to keep employees on the payroll, those are the sorts of things that are going to create demand in the economy and that's mostly a fiscal obligation or a fiscal role rather than a monetary one.

Nathan Hunt: Looking at fiscal policies and what we've seen globally, which policy responses do you think are the most effective at this point in time?

Paul Gruenwald: The effective ones are the policies that are going to replace at least a good chunk of the lost demand coming from the labor market. People are either losing their jobs or being put on furlough. Firms are having difficulty meeting their expenses, including their payroll. So. Whether we're keeping the firms afloat and the employees on the payroll, or paying employees directly through longer unemployment insurance or higher dollar payments that are being contemplated in the U.S., all of those things that get spending power quickly into the pockets of households and small businesses in particular, those sorts of demand creation efforts by governments are going to be the most effective.

Nathan Hunt: Okay. Not to put you on the spot here, but in terms of, you know, fiscal policy responses, what have you seen that you would think would be potentially less effective? You know, because there's a lot of talk, you know, in the press about people trying to sort of grab some goodies right now. And do you see any evidence of that? Do you think any of the responses are perhaps less productive?

Paul Gruenwald: Well, there were some discussions during the recent congressional debates on the $2 trillion package that some items weren't directly related to the crisis. I guess that's part of the usual log rolling you get when you have these stimulus packages. But I think in terms of the specific measures, one thing we're watching is the difference between, let's call one approach the U.S. approach and the other approach the European-Asian approach. In the European-Asian approach, the objective seems to be to keep the employee-employer relationship intact by trying to incentivize firms to keep workers on their payroll and also to keep small businesses afloat during the worst part of the crisis. In the U.S. we hear some of the same language, but it seems more tilted toward damage control, lengthening unemployment benefits, you know, putting money directly into people's pockets. And the reason I make this point is when we get to the upturn and we will get to the upturn, hopefully sooner rather than later. Perhaps the European approach of keeping the labor employee relations intact and keeping the SMEs and business, that will facilitate a quicker upturn because labor markets are essentially big matching operations. And if the employees have lost their jobs, they've got to reconnect with the firms. And if the firms have gone out of business, they need to restart. So we have kind of an interesting contrast here between the European-Asian approach and the US approach. We'll wait to see whether that's a meaningful difference, but they are two different ways of dealing with essentially the same shock.

Nathan Hunt: When you're looking forward now, right, and you and your team have been looking at changing conditions, very rapidly changing conditions, and reevaluating projections, what would cause you to reevaluate from here? What numbers are you looking at next to evaluate whether the projections can hold or you need to make a new set of projections?

Paul Gruenwald: Okay. Well, there's two parts to the forecasting process now. We always have some confidence interval around our economic forecast. That's normal in forecasting. You want that interval to be as narrow as possible, but now we're trying to map a health shock into an economic forecast, so those confidence intervals are much wider. What we've seen already in the last few months as we've revised our forecast lower, is that the effects of the measures to stem the coronavirus have had bigger economic impacts than we had projected. We don't have any history of modeling social distancing and its impact on consumer and firm behaviors. So as that relationship between the health shock and the economic variables continues to evolve, we will continue to reassess our views. We're always trying to get to the best forecasts we can with the information available at the time. And that's where we are right now. But unfortunately, as you know, many economic indicators come with a lag. So we're just starting to get some really bad data in the U.S. but that's coming well after we knew we were in an economic crisis. So those are the types of challenges the team is facing and we will try to continue to do our best in difficult circumstances.

Nathan Hunt: Paul, you've been doing this for a long time .You've seen economic crises come and go. Has there ever been a time when your personal confidence interval was, let's say, as broad as it is now?

Paul Gruenwald: I would say no, I haven't gone through something like this before. I've been around a while, so I'm going through the Asian financial crisis and even some of the LatAm Brady bond debt crisis before that, and then the global financial crisis. But I think because this one is generated by a health shock and mapping that into a macro financial shock, we just don't have any template for that, as we discussed earlier. So it's a challenge and in a way, it's kind of an invigorating challenge, and it's something we're going to have to live through. But I would say in my history of doing this for what, 25, 30 years, this has been sort of the biggest forecasting and economic challenge I've faced.

Nathan Hunt: As you look forward, obviously this is an unprecedented situation and you've made projections, had to reevaluate those projections based on changes no one could have anticipated, but what will you be looking at next? What numbers are you looking at in order to see if current projections will hold or will cause you to reevaluate further?

Paul Gruenwald: Right. Well, I think before we can talk about the economic recovery, we're all looking again at the curve.  We want to make sure that the virus is under control. We've seen the curve flatten in China. I checked the data this morning. It's starting to flatten a little bit in Italy and here in the US it's still going pretty much straight up. Once we start to get the health situation under control, then the restrictions can be lifted and then economic activity can resume. So most health forecasters, and again, we're just throwing to the health experts on this, forecast the US curve to be flattening around the middle of the year. I'll leave that sufficiently vague, which is why we have Q2 as the worst quarter, then a period of stabilization, and then a pickup. When we get to that happy point where the curve is flat and we can start getting back to normal. Then we'd need to start thinking about the safe of the recovery. And that's a whole other discussion, but it's really driven all by the health situation and then the measures to contain the rise of the virus and how that spills over into economic activity by consumers.

Nathan Hunt: Right. Well, when would you expect to see the beginnings of a recovery globally and also for the United States?

Paul Gruenwald: Well, there's two parts to that. Again, one is, when does that V begin? We're obviously on the down part of the V and everyone, and not just government officials, but all of us would love to see this all over sooner rather than later. It's really a question of how much economic output is lost forever. What we can tell you is that if you think about what drives growth or at least trend growth, that's the labor force, the capital stock and productivity, and if we think those get through this COVID-19 crisis largely unchanged, then there was no reason to think that trend growth would not go back to the pre-crisis rate. Let's see. For example, in the US, you know, the US is a 2% economy, and when this is all said and done, hopefully 2021 early in the year, we're back to 2% growth. The question is how much output has been lost forever? We're canceling sporting events, we're canceling entertainment, we're deferring all kinds of consumption. How much of that is gonna come back? So again, putting on the forecaster hat, we're probably going to end up on the same slope trajectory as we had before, but on a lower path. So the distance between the old path and the new path would be the output that's lost forever. Our U S team has done a little bit of work around this. Looks like their forecasts are assuming about a 2% permanent loss of output in the US. But again, it's still early days and I would put again, that confidence interval around that particular number.

Nathan Hunt: It seems like there are a lot of government officials around the world who were really hoping for a V-shaped recovery. What do you think the chances of that are?

Paul Gruenwald: Well, first of all, in most economies, household consumption is the biggest part of GDP. So we want to keep that intact. The parts of household consumption are driven by income, which is your wages as well as wealth, which is your stock of financial and nonfinancial assets. Part of the labor market has been shut down because of the social distancing. Estimates of the part of the economy that are affected are around 20%, so that's a serious chunk of demand. So when we go back to normal, the question is how quickly can we reboot the economy? And again, if the labor market is a big matching exercise between potential employees and employers, and that takes time to resolve. If firms can start up production quickly, rather than opening up a new business that had, let's say, been shut down because of the crisis, that reboot is the key to the recovery. That's not really an issue in the downturn, but as we, as we get the all clear and we move into the recovery, the reboot speed, I think is going to be a function of these measures taken by different governments across the world. And again, if the US labor market can reboot quickly, and if firms can start up again quickly, there may not be much difference between the U S approach and the European Asian approach, but that's not obvious to us right now. So again, when we get to that happy point, when we're talking about our recovery, we'll be watching how those differences play out very closely.

Nathan Hunt: When you talk about comparing the US model and  the European-China model, you've talked a lot about how their approach may support the labor market more for recovery. Why is the labor market so important? Why is it so important that we maintain the health of the labor market through this downturn?

Paul Gruenwald: Well, I mean, again, it depends on the length of the crisis, but we're thinking that once we get the all clear on the health situation, that the bounce back will be pretty quick. I don't know how those social distancing regulations will be reversed. That's the decision of the health authorities, obviously, but as they get reversed, I think we're going to have a lot of pent up demand. By that point, people will have been confined to their homes or apartments for a long period of time. So I think it's both intuitive and kind of economically correct to say we're going to get a big bounce. Again, whether we lose some output in the end or not as something we'll have to think about during the recovery, but there's no reason we shouldn't get a nice bouncing growth once the restrictions are lifted. How long is the distance or the time between the all clear and the recovery? And that's a really tough question. We have everything back to normal, kind of mid 2021 right now, but we should watch China to the extent that China has been successful in curbing or flat-lining the virus and how quickly they bounce back, that's probably the only template we're going to have for the US and Europe, but I think we're all hoping that's a shorter recovery rather than a longer one.

Nathan Hunt: We've talked a bit about the recovery. I know these are dangerous questions, but I want to talk a little bit about the end game here. Do you see a recovery being imminent in, say, the first half of 2021 or what is your sense for the end game?

Paul Gruenwald: Again, I think the key to all of this is going to be the labor market and the depth of the pain on unemployment and the depth of the pain to SMEs and the vulnerable sectors. I think the larger firms are generally in much better health and they will be getting help from the fed and purchasing investment grade debt, etc. But as the data continue to roll out, we'll get a better picture of the damage to the unemployment and SMEs sector. And the response we will see is almost surely going to come from the fiscal side. If we need no more support, there's not much the central bank can do to help those groups, but I think we could potentially see another way for fiscal support. Speaker of the House Nancy Pelosi kind of hinted at that already in one of her recent speeches, but we're clearly on the downside now. It's a question of how bad it's going to be, and I would say watch the labor market data to try to track that, and we will take it from there.

Nathan Hunt: Thank you very much, Paul Gruenwald. I hope you stay safe, stay healthy, and I look forward to talking to you again soon.

Paul Gruenwald: Right. Same to you, Nathan.

Nathan Hunt: Thanks for  listening to the Essential Podcast from S&P Global. You'll find links in the show notes for the articles we've discussed today. To read all of our coverage of the coronavirus outbreak  and markets, visit SPGlobal.com/coronavirus. Thank you.