Economic and Market Commentary

The Long Climb to Recovery

There are several reasons a full recovery may take until 2022. Joachim Fels, global economic advisor, and Anmol Sinha, fixed income strategist, explain the factors that could push our baseline outlook into a good or bad scenario.

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Text on screen: PIMCO

Photo of Anmol Sinha in PIMCO Lobby

Text on screen: Anmol Sinha, Fixed Income Strategist. PIMCO provides services to qualified institutions, financial intermediaries and institutional investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Anmol Sinha: Hello, and welcome. I'm Anmol Sinha, and today I'm joined by my colleague, PIMCO's global economic advisor, Joachim Fels. We are going to discuss the output of PIMCO's most recent virtual forum which was held in early June. Joachim, could you start by summarizing PIMCO's updated economic outlook?

Photo of Joachim Fels in PIMCO studio

Text on screen: Joachim Fels, Global Economic Advisor.

Joachim Fels: Well, the very short summary is in the title of our economic outlook: The Long Climb. The somewhat longer summary starts with an image first used by Richmond Fed President Barkin in a recent speech. He said, and I paraphrase, "The economy rode down the elevator all the way to the basement, but will have to take the stairs back up."

Line chart titled, “The Base Case: The Long Climb” plots the GDP weighted average for developed markets, which includes Japan, Euro Area, U.S. and UK. The line drops in in 2Q 2020 and then is forecasted to pick up most of its losses by 4Q 2021.

So obviously what he meant by this is we had a very sharp, very deep recession in a very short time. Basically we went down all the way to the bottom in two months, in March and April of this year. But it will probably take something like two years, until 2022, to get all the way back up again.

Text on screen: Why full recovery to pre-crisis levels could take until 2022, NUMBERED BULLETS – 1. Social distancing, 2.  Impaired global supply chains, 3. Time needed to reallocate labor and capital, 4. Debt overhang

There are at least four reasons why we think it'll take time to reach back the old levels. The first reason is very obvious. Social distancing will have to remain in place for now. That means many places, many sectors of the economy will not be able to get back to pre-crisis levels of capacity utilization any time soon.

Second reason, global supply chains, but also national regional supply chains will still be impaired, because we are reopening the economy. We are reopening sectors and different countries at different speed. So you will still get disruptions in the global supply chain for quite some time.

The third reason why it takes time is that we will need to see a reallocation of labor and capital from those sectors that will be permanently smaller than before the crisis to those sectors that are likely to be bigger and more important after the crisis.

And then fourth, but not least, we will come out of this crisis and out of this recession with a large debt overhang, both in the household sector and in the corporate sector. And that means both consumer spending and investment spending, is likely to be subdued for quite some time.

Sinha: Joachim, could you speak to some of the key swing factors to our baseline outlook, and what are some alternate scenarios that could transpire?

Fels: We focus on economic or policy drivers. This time it's really all about the health situation. It's about whether or not we get a second wave of this virus. And depending on how these things go, we could end up in a good or a bad or even in a very ugly scenario.

Text on screen: The good, the bad, and the ugly, BULLETS – Good scenario, SUB-BULLETS – Vaccine readily available sooner than expected, Normal conditions return, BULLETS – Bad scenario, SUB-BULLETS – Widespread second wave of the virus

Starting with the good scenario that would be one where we find a vaccine that is available on a large scale for a large number of people earlier than expected. And that means there would be less need for social distancing. We could go back to normal sooner than we expect in our baseline scenario. So that's the upside scenario.

The bad scenario is one where we get significant and widespread second waves of the virus.

So that's the key downside scenario.

Sinha: Which of those two scenarios do you think is more likely if our baseline does not transpire?

Fels: We think the risks are probably skewed towards a worse scenario than the baseline scenario, because we're already seeing some signs of second waves developing. If you look at the emerging world, the virus is not under control in many of those large, emerging market countries.

So that's why we think the risks to the global economy, to the global economic outlook, are probably asymmetric on the downside.

Sinha: Joachim, we have talked about a dramatically low starting point for the economy as well as an economic outlook that suggests a very slow recovery. How do you reconcile that, though, with the fact that risk markets like equities have rallied sharply and recovered most of their drawdown from March?

Fels: Yeah, I think the main reason why risk markets have rallied so much despite a still uncertain economic outlook is what we call the primacy of policy. I think we're in a situation where markets and market participants have a really hard time to price in the radical uncertainty that is out there about the health situation, the virus, and the economic uncertainty.

And so many market participants therefore tend to ignore the uncertainty, and they rather focus on the things that they know and that are in their face.

Photo of Marriner S. Eccles Federal Reserve Board Building in Washington DC

And the thing that we know and that is in our face every day is that we are seeing a massive fiscal and monetary policy response. This has helped to propel risk markets higher. So this is likely to remain the main driver of markets going forward.

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