BlackRock: "How large is the coronavirus macro shock?"

From the BlackRock Investment Institute, April 7:

Global economic activity is not simply contracting. It is being deliberately frozen and halted. Doing this at the global level is unprecedented. The near-term blow to growth is likely to be severe. We believe that the U.S. activity shortfall – the sum of activity lost every quarter relative to its pre-shock 2019 trend – is likely to be more than twice as large as the global financial crisis (GFC) shock over a three-quarter timeframe. Yet the implications for asset prices depend on the cumulative impact over time. We believe that with the appropriate policy response and execution, the overall impact of the ongoing coronavirus shock will be far less extreme than the one seen during the financial crisis.

Overview

The risk asset reaction to the coronavirus shock has so far been of an order of magnitude similar to the financial crisis. The important question for judging of the market reaction is not whether this will be a V-, U- or L-shaped recession, but whether the overall macro impact will itself be of an order of magnitude similar to the financial crisis. There has just never been such a systematic attempt to shut down activity on such a scale before. Making sense of the macro implications here is not an exercise in minutiae. What we need is to understand the order of magnitudes involved – distinguishing between the impact being “5x” and not just “x”, both on the downside and upside. This starts by distinguishing between the 1) shock and its 2) propagation. Both are very different from the GFC. The GFC’s macro damage was mostly wrought by its spread through debt deleveraging and the slow unwind of imbalances over several years. We see the 2020 damage stemming primarily from the shock itself.

A significant shock
Hypothetical hit to U.S. GDP in coming years compared with the global financial crisis, 2020

Sources: BlackRock Investment Institute, with data from Haver Analytics, April 2020. Notes: These stylized charts show how GDP can evolve relative to trend after a shock. The dotted lines show what trend GDP would have looked if there had been no shock. We compare with the 2007-2008 global financial crisis to the current coronavirus shock. In 2007-2008, the initial shock – 2.3% of GDP from Q3 2008 to Q1 2009 – was not as large as the current one we expect. The GFC shock propagated through debt deleveraging that served as a longer-term drag on pre-trend potential growth. The chart on the right shows that the GDP shortfall from this shock is front-loaded, and if containment measures are lifted there can be a quicker recovery with limited permanent damage to the pre-shock growth trend. For illustrative purposes only. There is no guarantee that any forecasts made will come to pass.. The hypothetical scenario is subject to signification limitations, in particular that this is an evolving situation and we are still trying to understand the potential for more extensive activity shutdowns due to the virus.

In 2008, the shock’s spark was in the financial system and the impact on real activity was indirect and more uncertain. The main growth consequence of the GFC was not the shock itself – the recession – but the propagation: a major decline in activity relative to its pre-shock trend caused by large-scale debt deleveraging and the unwind of imbalances over many years. The cumulative post-GFC growth shortfall in the U.S. totalled about 50% of pre-crisis GDP level – and most of it came well after the initial shock. See the chart above on the left. If we accounted for the permanent downshift to potential growth, the shortfall would be on a different scale altogether....

....MUCH MORE