The COVID-19 Pandemic

by Sean Tweedie | March 31, 2020

Over the course of this month the COVID-19 pandemic had continued to worsen. At the time of writing this over 777,000 people have become infected globally with the deal toll having risen to 37,500. With most countries having implemented different forms of social distancing measures and many businesses not being able to operate the global economy has been thrown into a recession. Policymakers have rightfully decided that a temporary shutdown of nonessential economic activities is a price worth paying for in an attempt to contain the virus. The good news is that quarantines do contain the spread of the virus as has been demonstrated in Wuhan where no new infections were recorded by the 18th of March and the rate of infections started to decline rapidly after the first 10 days. See Figure 1. Gauging the impact on the world economy is difficult. No one knows at this stage how long it will take to contain the virus. Presently it is estimated that the level of real GDP outside of China is likely to be down 1% to 3% in Q1 of 2020 relative to Q4 of 2019, and a further 5% to 10% in Q2 relative to Q1. On a sequential annualized basis, this means growth could register a negative print of 40% in

most countries, a metric that has few parallels in history. China should see a modest rebound if Growth in Q2 due to their success in containing the virus although economic activity will remain well below pre-crisis levels.

The global economy has experienced both a massive demand and supply side shock. When households are confined to their homes spending is reduced which, coupled with both people and businesses higher propensity to save in times of heightened risk, aggregate demand is reduced. On the supply side, production is impaired by peoples’ inability to get to their jobs and for businesses to function normally. Both these shocks have been concentrated in the service sector, which for most economies makes up two-thirds of GDP, making the situation far worse. In a recessionary environment the services sector is normally what helps stabilize the economy from sharp declines in more cyclical sectors such as manufacturing or housing. Unfortunately, it’s not the case this time round. The question on many peoples’ minds is what can be done to reduce the impact on the economy? Most Central Banks, who have capacity to do so, have responded by cutting interest rates (monetary easing).

The South African Reserve Bank (SARB) is one of many Central Banks who have implemented interest rate cuts that is aimed at making borrowing cheaper and encouraging investment and expansion. Although monetary easing helps, it alone will not be enough considering the fact that rates are close to zero in most developed economies. Fiscal stimulus

is also needed. See Figure 2.

The global economy is facing a shortage of cash. Businesses are tapping credit lines at a time when banks would ordinarily be looking to increase their own cash reserves. Banks, however, still need to meet liquidity requirements imposed by Basel III rules an

d are therefore holding as much cash as possible in the form of excess reserves and have curtailed lending in the repo market. Repos are the lifeblood of capital markets and without repos, market liquidity (the ability to sell and buy securities) quickly deteriorates. The U.S. Dollar is at the forefront of this liquidity constraint due to its status of being the reserve currency of the world. See Figure 3. Borrowers are buying Dollars at any cost. Because of the massive increase in demand, the Greenback has soared to its highest levels in 17 years with the subsequent collapse of risky currencies such as the Rand, Norwegian Krone and the Brazilian Real.


The Federal Reserve, in response to the liquidity crisis, has embarked once again on expanding its balance sheet (Quantitative Easing) by initiating the purchase of $500 billion in treasuries and another $200 billion mortgage-backed securities as part of its unlimited Quantitative Easing measures. The Federal Reserve has furthermore opened swap lines with a number of Central Banks to ease overseas funding pressures. These measure form part of a $2 trillion fiscal package, far larger than the stimulus provided in 2008. Other Central Banks, such as the European Central Bank (ECB) and Bank of England (BOE) have implemented similar stimulus packages Both the ECB and the BOE have relaxed their liquidity ratio requirements for their banks to improve liquidity conditions and it is likely that the FED will follow suite. If Central Banks can address the issue of the liquidity crunch, the stimulus from China should be a key driver in the FX market. China has historically played a big part in lifting the global manufacturing cycle and as such will be an important determinant for global growth. It appears that Chinese stimulus will be comparable with what was implemented in 2008 and should therefore help restore global growth. As global growth hopefully improves over the coming months, we should see the U.S Dollar weaken from its highs and see a rebound in risk currencies such as those of emerging markets. See Figure 4.


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