The world is sailing through one of the toughest storms in a century, facing an irksome sanitary crisis with more than 10 million confirmed cases of Coronavirus and slightly more than half a million fatalities. Consequently, governments have been dealing with a complex conundrum since March, between restricting mobility to curb the pandemic on one hand, and gradually reopening the economy to avoid an even worst recession on the other. Unfortunately, the mismatch of contagion curves among several regions and fears of a second wave of spread are limiting the transition plans towards a “new reality” for consumers and firms. This complex backdrop has steered the global economy to the worst recession since 1929, as warned last week by the IMF in its World Economic Outlook.
As of today, the landscape is riddled with more questions than answers about the evolution and implications of the pandemic. To tackle some of the adverse economic effects, the world has unveiled an unprecedented policy response. From the fiscal side, nearly US$ 11 trillion of counter-cyclical measures have been deployed. In terms of the monetary response, nearly 90 countries have cut rates, in addition to quantitative programs in both advanced and emerging economies. These stimuli, although different between countries, have reduced risk aversion in financial markets and limited credit risk for households and firms. Going forward, the shape of the recovery in each economy will depend on the degree of the policy response, the performance of their epidemic curves, their interrelationships with the world economy, specific plans to reopen and possible setbacks, and other idiosyncratic factors.
As if this backdrop were not challenging enough, another relevant factor to bear in mind globally in 3Q20 is the geopolitical component. In our view, the most important will be the political process in the U.S. ahead of the November 3rd elections. However, market participants will also focus on other political aspects worldwide, from social unrest in several regions to trade negotiations.
Mexico will also cope with a challenging backdrop in the second half of the year. COVID-19 has strongly affected economic activity despite policymakers’ efforts, firms and the society at large to contain its widespread effects. In this regard, we adjusted our GDP forecast for this year to -9.8% from -7.8% previously. From a policy perspective, we expect Banxico to lower its reference rate to 4.00% in 3Q20, amid a more dovish tone recently.
The economy experienced unprecedented weakness in 2Q20, with a larger than expected impact from COVID-19. In this context, we recently updated our GDP forecast, to -9.8% y/y. This is mainly explained by the delay in the restart of the economy, with the epidemiological indicator for the week from June 29th to July 5th showing 18 states in ‘orange’ and 14 in ‘red’. This is also consistent with latest figures such as April’s GDP proxy IGAE and May’s trade balance. Going into 2H20, we will be looking to confirm if external demand helps the economy, specifically given large stimulus in the US. We also expect some support from the official launch of USMCA (starting today), especially as tensions between the US and China will probably exacerbate due to the electoral process. Nevertheless, domestic weakness will likely extend, with muted dynamism in consumption but more so in investment (see table below, left).
Regarding the economic policy response, measures so far amount to close to 4.5% of GDP, including those by the central bank (see table below, right), below the 5% average in emerging markets according to the IMF. This limited support stems from little fiscal room as well as risks to the path of debt-to-GDP –which could trigger even more reductions to the sovereign rating– and is one of the main reasons behind our forecast of a GDP expansion of only 1.8% in 2021, below market expectations.
For inflation, we maintain our 3.2 y/y forecast for year-end 2020. Nevertheless, we recognize that it has become more volatile, in large part due to both direct (e.g. more negative output gap, supply chain disruptions) and indirect (e.g. problems with data collection and lower gasoline prices) distortions because of the pandemic. In this context, we also adjusted our monetary policy view recently, seeing now two additional 50bps cuts for the reference rate to end the year at 4.00%. Although we had already identified a more accommodative stance as a risk, further easing in other countries, domestic conditions, and the latest adjustments in the statement made us reframe this situation. We expect these two cuts to take place in the third quarter, on August 13th and September 24th. Moreover, we look forward to the 2Q20 Quarterly Report, which will be published on August 26th.
After a 5% saar economic contraction during 1Q20, sharp declines in April figures point to a deeper slowdown in 2Q20. Although May data showed a stronger-than-expected recovery –strengthening the case of a “V-shaped” rebound– the recent rise in COVID-19 infections after the reopening of the economy has increased fears of a longer and more severe slowdown.
Real consumption fell 12.2% m/m in April, due to declines in sales of both durable and non-durable goods, and services. However, after the sharp rise in personal income of 10.8% m/m in the fourth month of the year on the back of the fiscal stimulus package, personal consumption advanced 8.1% m/m in May, showing that the gradual reopening led consumers to spend a good part of that income. At the same time, and contrary to expectations, companies began hiring employees after heavy layoffs in April. Despite of the above, we estimate that consumption to have fallen 32% saar in 2Q20. Meanwhile, companies continued to backtrack on their investment plans in a still uncertain environment, leading to an estimated 29.9% drop in the same period. At the same time, global weakness would have led to a 28.4% contraction in exports. In this context, we maintain our estimate of a drop in GDP of 28.9% in 2Q20 and -6.1% y/y for all of 2020.
Although our estimate incorporates a very gradual recovery in the second half, the risk is that it will be even more moderate in view of the risk of a second wave of contagion, implying a greater than estimated contraction. For example, California ordered the closing of bars in several cities and Arkansas delayed its reopening process, while Texas achieved the highest number of infections since the pandemic began and have tripled since May 31st.
Monetary policy remains very loose, with the Fed making it clear it does not intend to move the rate for an extended period and making use of its balance sheet very meaningfully, expanding by 70% year-to-date and reaching US$ 7.1 trillion. On this front, it is likely that the most interesting developments will be until 4Q20, with the revision of the Federal Reserve monetary policy strategy. However, on the fiscal front, despite four stimulus packages already approved, more is required given the prompt expiration of some key parts of these programs. In this context, a new package is likely to be approved in July, with the attention on a possible proposal by president Trump of US$ 1 trillion in infrastructure spending.
To continue reading:Download PDF
IRO and Chief Economist
Executive Director of Economic Research and Financial Markets Strategy [email protected]
Juan Carlos Alderete, CFA
Director of Economic Research
Director of Market Strategy
Senior Economist, Mexico