COVID-19: Quarantined Economics

Policymakers have taken extraordinary measures in extraordinary times to flatten the recession curve. In our central scenario, we expect a sharp global recession in H1 2020 in the vast majority of developed and emerging economies, followed by a U-shaped recovery. From the ECB’s EUR1.1tn to the Fed’s USD1.5bn liquidity provisions, to business-friendly fiscal responses across the globe providing 0.5-1.2pp of growth relief depending on the country, the aim has been to weather the cash-flow crisis, avoid a more severe liquidity crisis and protect the web. However, the cost of containment could be as much as a 20-30% shock to each economy for a month, if we draw lessons from the Chinese situation. In addition, the cost of a full quarter of disruption to global trade should be USD1064bn as more economies adopt strong confinement measures, including severe border restrictions. The recovery, starting in H2 2020, will certainly be commensurate with the shock, with temporary inflationary overshoot.

For capital markets, it will get worse before it gets better. For companies, we expect insolvencies to increase by +14% worldwide in 2020. Markets are not yet fully pricing in the negative news flow coming with lockdowns affecting more than 50% of the world’s GDP. We expect short-term volatility to bring down equity markets by an additional 10-20%, a 30-50bps downside correction in long-term sovereign yields and a 100bps widening trajectory in corporate credit investment grade spreads. However, we expect capital markets to gradually reverse the losses towards year-end as policymakers’ credibility and the U-shaped recovery unfold. As for companies, 2020 will be the fourth consecutive year of rising bankruptcies and though policymakers pledged to do whatever it takes to avoid unemployment and defaults, a wave of insolvencies when business starts again is very likely.

What could go wrong? There are three canaries in the coal mine: corporate stress, liquidity and policy mistakes. In addition, we also run an alternative scenario of a protracted economic and financial crisis due to a 12-18 month health crisis (with possible reinfection). Regarding downside risks, sharp downward price movements in goods and equity markets would generate liquidity stress and credit events, unearthing fundamental weaknesses in the global economy just like in 2008-2009, including substantial stress on the corporate bond markets. Also, mind the risk of policy mistakes: as central banks and treasuries unwind unmatched level of support, the risk of relapse is high. This scenario would mean a continued recession into 2021, and an L-shaped recovery with debt monetization, systemic equity/credit/liquidity issues and more direct actions by policymakers that would disrupt market roles for years to come, with difficulty to restart the engines.

Too early to draw lessons? The COVID-19 crisis will certainly change how we see: investments in health and define inclusive capitalism; China’s soft power; globalization; the fight against climate change, another exponential, probabilistic and collective challenge ahead of us and maybe how we save for life events.


Ludovic Subran
Allianz SE
Alexis Garatti
Euler Hermes
Eric Barthalon
Allianz SE