Since October 2019, clear signs of a global growth recovery had begun to emerge, as trade tensions and monetary policy began easing simultaneously. Now, with the unfortunate outbreak of the coronavirus in China, how threatened is that recovery?
While the coronavirus outbreak suggests some downside risks to growth for one to two quarters, in our view, it’s more likely to delay—rather than derail—the recovery.
Data points since the fourth quarter of 2019 have surprised on the upside, confirming an inflection in the global cycle. These included hard data, such as retail sales and industrial production, and soft data, such as consumer confidence and purchasing manager surveys. Now we have some counterpoints, with a likely near-term drop in China’s GDP growth dragging on the overall global economy and spilling over into local economies, principally via the trade and tourism sectors.
The critical question: How long it will take to contain the outbreak? The final impact on growth will depend on the breadth of disruption to long-term business activity in China, global trade and tourism flows. However, an optimistic window of two to three months could minimize the impact.
Mitigating Impact
Manufacturing and trade sectors had borne the brunt of the global slowdown in 2019, but a comeback has been emerging. Manufacturing Purchasing Manager Indices (PMIs) began turning in November, followed by improvement in industrial production in November and trade data in December. Even with the coronavirus outbreak, we believe this trend is still sustainable, given the stabilization of end demand, the completion of the inventory adjustment cycle and a fundamental upturn in Asia’s tech sector.
Compared to past outbreaks, the authorities in China (and elsewhere) are taking stronger measures to restrict travel to and from affected areas, and various health authorities have issued advisories on self-quarantine for anyone who recently traveled to China. Although these responses will disrupt economic activity in the near term and create more volatility, we could also see a stronger rebound from pent-up demand and increased production.
Policymakers in China are likely to mitigate the economic impact by accelerating infrastructure spending and implementing other forms of policy support. The day-to-day situation remains fluid, but our preliminary assessment is that, if the situation starts to normalize in two months (i.e., the number of new cases peaks), year-over-year global growth could take a hit of around 0.15 to 0.30 percentage point in the first quarter, then resume a recovery path for the rest of 2020.
Easing Conditions Globally
Over the past four quarters, the global weighted monetary policy rate has declined to levels below even those seen in 2016. We don’t believe central bankers will withdraw that policy support very quickly; indeed, in the past few days, the Federal Reserve, European Central Bank and the Bank of England, respectively, have each maintained their dovish stance. Last week, the Fed also made a subtle, though important, change to how it characterizes its inflation outlook to emphasize its commitment to its 2% goal, reinforcing the high bar that Fed Chair Jerome Powell has set for raising U.S. interest rates again.
In China, the fiscal policy stance should also remain supportive, as we expect the cyclically adjusted primary fiscal deficit to remain high at 8.3% of GDP in 2020. This would be the first time that the government has maintained fiscal deficits at these levels for two years in a row.
Even before the coronavirus outbreak, policymakers had intensified efforts to support growth by front-loading fiscal spending. Local governments are issuing bonds at an accelerated pace: January, 2020, saw $105 billion of bond issuance vs. $20 billion in January, 2019, with a higher proportion of the proceeds going to fund infrastructure. Robin Xing, our Chief China Economist, expects additional measures to support growth, should the downside risks to economic activity intensify in the coming weeks.
Overall, we expect to see temporary weakness in China’s economic data from February to March and, to some extent, in the rest of the world, particularly in economies more exposed to China’s growth dynamics. But, assuming that the virus is contained within two months, and given our view that the fundamental growth drivers are still intact, we should get back onto the recovery path from the second quarter onwards, with global growth rising to 3.5% by the first quarter of 2021.
Adapted from a recent edition of Morgan Stanley Research’s “Sunday Start” series (Feb 2, 2020). Ask your Morgan Stanley representative or Financial Advisor for the latest market strategy coverage and reports. Plus, more Ideas from Morgan Stanley thought leaders.
