Volume 24, Issue 14 March 30, 2020.

  Source: Globe & Mail


Policy Goes All In
Douglas Porter, CFA
BMO Chief Economist

This week brought yet a bigger wave of policy actions globally, in the face of a raft of tough economic data reflecting the earliest stages of the pandemic. Starting with a bazooka blast from the Fed on Monday morning (unlimited QE, expanded purchases), then Senate approval of a massive $2 trillion fiscal support package, then passage of upscaled Canadian fiscal measures; then, a Friday morning Bank of Canada rate cut and dive into QE, it was quite the week. The over-riding message is that, yes, this economic hit is unlike anything we have seen before, but the policy response is also unlike anything we have seen before, and with impressive pace.
 
The seemingly non-stop flow of policy measures provided some serious support for financial markets. Even with a Friday pullback, global equity markets snapped a five week streak of heavy-duty declines, courtesy of a powerful, three-day, mid-week rally. For example, the MSCI World Index popped by just over 15% in the three days to Thursday, and is headed for about a 7% rise for the week. The venerable Dow spiked 21.3% in the three-day bounce; and yet, was still 24% below its record high reached just last month. Most other markets showed generally fewer signs of extreme strain, although policymakers continue to scramble to address stresses as they arise.
 
The rebound in equities was a tad jarring, coming against the backdrop of the earliest clear measures of the North American economic impact of the coronavirus, not to mention the ongoing acceleration of confirmed cases. The most notable stat was the surge in U.S. initial jobless claims to 3.28 million, almost five times as large as the worst week in 2009. This followed last week’s flash estimate that half a million Canadians applied for EI over the same time. Note that next week’s U.S. employment report will largely dodge the hit, since the survey was conducted just prior to the major shutdowns—but not so for Canada’s report on April 9. Meantime, timely business sentiment surveys for March around the industrialized world shuddered lower, with Canada’s small business barometer dropping to a record low.
 
Prior to about the middle of this week, the policy response from Canada seemed on the light side, especially compared with the aggressive fiscal and monetary measures seen stateside. (This week’s Focus Feature outlines the major policy steps taken around the G7, and attempts to compare the fiscal measures on a similar basis.) But the gap then narrowed notably. First, the direct support from the fiscal package of just last week was nearly doubled in a stroke (from $27 billion to $52 billion, or 2.3% of GDP), and some provinces unveiled new spending as well (B.C. and Ontario), bringing the tally to over 3% of GDP. Then, Ottawa announced Friday that wage subsidies for small and medium businesses will be cranked up to 75% (from the initial 10% proposal), a huge step up. While details are pending, this will likely add more than 1% of GDP to the running tally on direct new fiscal spending.
 
And, on the monetary policy front, the BoC fully matched the Fed’s total rate changes with Friday’s 50 bp cut, and finally embarked on QE. Recall, that the Bank was one of the few holdouts on the QE front in the 2009 crisis, so this is a very big shift. The Bank will buy at least $5 billion of GoC bonds weekly “until the recovery is well under way”, which likely will bring the total to well above $100 billion (essentially funding the new fiscal measures). Governor Poloz stressed that this change, along with a new program to purchase commercial paper, was aimed more at the proper functioning of financial markets, or liquidity measures, and not ‘stimulus’ per se.
 
Will this impressive array of policy measures be enough? The sour end to the week in financial markets suggests perhaps not. In fairness, almost all policymakers have indicated that they will do whatever it takes to support the economy through this extremely difficult period and more announcements await. Just as one example, House Leader Pelosi is already mulling yet another fiscal package, on top of this week’s huge $2 trillion suite. As for this week’s big three-day rally in stocks, note that in the 2008 crisis, the S&P 500 had a six-day rally amounting to a 19% bounce, and eventually rose 23% to January 2009, before falling another 28% to its March nadir. So, even a powerful rally like this week’s doesn’t necessarily mark the bottom. One would imagine that we will need to see that either the economy has stopped deteriorating (and it’s far too early for that) and/or virus cases have stopped accelerating before a true bottom can be formed. However, just as this economic backdrop is truly unique, market moves may also be truly unique in this cycle.  Forecast Update: Amid the broadening shutdowns and despite the latest wave of policy steps, we are further adjusting our forecasts for 2020 this week. In summary:
 
• Global growth is now expected to be flat this year (from 0.8%), with downside risks persisting, and compared to last year’s sluggish 2.8%, and approaching the 0.1% drop in 2009. We took a heavier axe to Europe and North America in particular this week. For now, we are maintaining our oil price forecast, at an average of $35 for WTI this year and $45 next, as Russia sent early signs of looking for a production deal. However, with WCS plumbing new lows as one example, the risks are clearly to the downside.
 
• U.S. GDP is now expected to contract 2.5% this year. For perspective, that would match the worst year for the U.S. economy in the post-1950 era (2009 saw a similar decline). Output will drop in Q1, and then fall at a double-digit annual rate in Q2 (now pegged at 25%). We continue to expect a strong rebound in H2, but the entire year’s drop compares to our previous 0.5% estimated decline (which was already a big step down from 2.3% in 2019).
 
• Canada’s GDP growth is being cut to -3.0% this year, down two points from last week’s call of -1.0% (and versus a 1.6% rise for all of last year). Canada will likely take an even heavier hit due to the slump in commodity prices (especially oil), and also a still-milder boost from fiscal stimulus, at least up to this point. Here, too, we expect a big Q2 contraction (also down 25%) after a 6.5% drop in Q1, but also a big rebound in H2. The downward revisions more fully reflect the reality of the full closures, and the prospect that they will last longer than first suspected.
 
The outlook for interest rates is straightforward now, with rates essentially at the lower boundary for both the Fed and the Bank of Canada. We expect no further rate moves right out to the end of 2021, and also no move to negative rates by either bank—Governor Poloz was clear on that front. But while it will now be quiet on the rate front, there will no doubt be many more moves on the liquidity and QE fronts in the weeks ahead.
 
• The Canadian dollar flared back up after buckling heavily last week, in part due to a retreat in the U.S. dollar, but with no thanks to still-weak oil prices. Even with the bounce, we see the currency remaining under pressure in the months ahead, with a possible test of the $1.50 level (or below 67 cents). We look for the loonie to settle down along with other markets by the second half, but it will be challenged to get back above the 75-cent level even in 2021.
 
To explain the dramatic and persistent forecast changes, we are only building in the news on closures as they become official and not pre-guessing those steps. Given the sweeping nature of the closures now in place, the forecasts may stabilize for a spell, as we all get a better sense of how long they will persist. While it’s obvious that we can’t make guarantees on the life-span of these forecasts, and we continue to take it on a week-by-week basis, near-term changes will likely be much less dramatic. Notably, a consensus on the Q2 hit seems to be gelling (not far from where we have settled), although all forecasters are no doubt still heavily challenged by the unique nature of this downturn.

 

Have a great week.

Frank & Mark.




Source: Globe & Mail, BMO Capital Markets, Bank of Canada

Canada:

Canada aggressively ramped up its own package on Friday, which could now approach $100 billion (more than 4% of GDP), while the rest of the G7 is moving as well—even Germany has relaxed its borrowing restrictions. Meantime, monetary policy has been even faster out of the gate, and more aggressive than we’ve ever seen. Both the Bank of Canada and Federal Reserve have now cut interest rates to the lower bound; the Fed rolled out QE infinity; and the Bank of Canada unveiled the start of its own QE program for the first time to support market functioning.  YTD, the TSX is down 25.6% and the benchmark 10-year yield ended the week to yield 0.86%.

U.S.:
Equity markets rebounded sharply this week, with the S&P 500 adding 10.3%. Before a Friday pullback, the S&P 500 had rallied 20% from the early-week lows, but is still down 25% from the pre-COVID high. The good news that the market has keyed on in recent days includes a massive wave of fiscal support, led by the U.S. Washington’s program will run at about $1.6 trillion in direct support, or 7.5% of GDP, including a mix of direct handouts and incentives for firms to keep employers on the payroll through the crisis.  YTD, the S&P 500 is down 21.3%, the Dow Jones Industrials are down 24.1%, and the Nasdaq is down 16.3%. The yield on the 10 year Treasury closed at 0.72%.




Source: BMO Capital Markets 

The Good:  Wholesale Trade Volumes +1.7% (Jan.); SEPH Employment +64,865 (Jan.); —and Services +51,839.


The Bad: Ottawa posted a budget deficit of $10.6 bln (Apr.- to Jan.)—vs. $1.2 bln deficit last year.