Investors should expect U-shaped recovery

8 May 2020

According to Western Asset’s base case scenario outlook, investors should expect a longer, U-shaped global economic recovery as near-term growth will be severely impacted.

However, this shortfall would be largely transitionary as policymakers pushed to resuscitate economic activity through significant central bank policy easing, providing extensive liquidity and enhanced fiscal stimulus.

The actual timing of any eventual recovery would be tied to the length and severity of the pandemic—which was a key uncertainty at this point—therefore portfolios should be positioned to withstand further market volatility, yet remain flexible enough to capture exceptional value opportunities as they appeared, the manager said.

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In the US, given the very healthy financial shape of both businesses and households on the eve of the crisis and the breadth and timeliness of government and central bank measures to sustain private-sector finances, the economic bounce-back could be strong and relatively quick, the firm said.

Western Asset said it disagreed with claims that businesses and households were highly leveraged.

“Also, we believe that central bank efforts to intervene directly in credit markets—with capital backing from the government—will be successful in forestalling widespread bankruptcies, so that firms will be able to survive and participate in the recovery,” the manager said in the note.

“Finally, we are also inclined to think that the impact of the virus on national health and national health systems will be much less severe than some are predicting.”

As far as Europe was concerned, the growth forecasts for 2020 were slashed in response to the COVID-19 pandemic, with an expected Eurozone’s contract by around 6%-8% this year, but the contraction would become more pronounced with every week that restrictive measures continued in the effort to contain the viral outbreak.

At the same time, for many countries in Europe, this would be the worst recession since WW2.

“2021 is likely to see a moderate recovery, but the size and distribution across countries will depend crucially on the longer-term policy support measures implemented at this time at the national and supranational levels, including the Recovery Fund still under discussion by the Eurogroup,” Western Asset said.

In Asia, China was on a quick recovery track and near-term numbers would demonstrate the effect of extreme containment and centralized control, as would the first wave of recoveries in North Asian economies such as South Korea, Taiwan, and Hong Kong.

However, for emerging market (EM) economies in Asia (the second wave of countries infected), the near-term outlook is weak, especially for Malaysia, Thailand, the Philippines and Indonesia, as the risks of an extended lockdown were material to both households due to the effect of income as well as corporates that were dependent on discretionary consumption among other factors.

“The heterogeneity of Asian economies will continue to reflect the divergence in growth between economies more closely linked to China’s consumption and the Asian tech supply chain as well as those that are more endogenously driven,” the firm said.

“What is consistent is that Asian economies have the policy space, the political stability and the populace support to deal with the vicissitudes of an uncertain economic environment. With this in mind, our base case for the region remains cautiously optimistic. We expect continued monetary and fiscal accommodation where needed in the year ahead.”

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