Weekly global economic update
By Dr. Ira Kalish- Save for later
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What’s happening this week in economics? Deloitte’s team of economists examines news and trends from around the world.
During this crisis, many major central banks have dramatically boosted the size of their balance sheets, pumping liquidity into the market at a pace never before seen. In part, central banks are helping to fund the dramatic expansion in government spending taking place, especially in the United States, the Eurozone, and Japan. This has led some observers to wonder if we are setting the stage for a period of much higher inflation in the not-too-distant future. That is a legitimate concern—after all, there have been plenty of episodes in the last century in which monetary financing of government budget deficits led to hyperinflation. Think Venezuela, Zimbabwe, Argentina, and even Weimar Republic (or the German state) in the early 1920s. However, many investors don’t seem to be concerned. The so-called “breakeven” rate, which is a good proxy for investors’ inflation expectations, has declined in the United States and Germany, suggesting that investors actually expect a relatively low rate of inflation in coming years. Even the 10-year breakeven rate has declined, indicating inflation pessimism over the longer term. Thus, investors are clearly not betting that, when this crisis ends, there will be a surge in inflation.
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Why aren’t they concerned about the potential impact of monetary policy? The answer is the well-worn phrase: this time is different. The reality is that central banks are boosting their balance sheets in order to offset the shrinkage of economic and credit market activity. It is similar to what happened during the global financial crisis in 2008-09. At that time, central banks flooded markets with liquidity, driving up their balance sheets dramatically. Yet measures of money supply grew slowly as central banks offset a decline in bank lending. Inflation remained tame. The same is likely to happen again. Moreover, although businesses have shut down, demand has fallen sharply as well. Thus, there are no significant shortages. When the economy recovers from this disaster, it is likely to initially be slow as consumers and businesses remain cautious in the face of an ever-present virus. Thus, it is not likely that there will be pressure on prices due to excess demand. Moreover, once the crisis ultimately ends (perhaps after a vaccine is found), central banks will be able to reverse what they have done. They did so after the last crisis. The temporary expansion of government spending will potentially be reversed, thus reducing the need for central bank finance.
If anything, there is actually a risk of deflation. Already we have seen a dramatic decline in the prices of oil and other commodities. Mass unemployment will likely mean downward pressure on wages. And although there have lately been shortages of some consumer staples (toilet paper, for example), early data indicates that inflation has decelerated. Even when recovery comes, the deflationary trend will likely be reversed only gradually. Thus, my view is that investors are correct in betting on low inflation. Moreover, they have a good track record. Back in 2008 when some political and business leaders warned of coming inflation, the breakeven rate remained suppressed—and rightly so. Inflation in the decade that followed was historically low.
One question that might be asked is whether the coronavirus crisis will undermine globalization. The answer is that this has already happened. Many countries have already engaged in protectionist action related to the crisis. Several have imposed restrictions on exports of medical supplies, drugs, and food. These include the United Kingdom, Brazil, India, Turkey, South Korea, and Russia. The intention of such policies is to assure adequate supplies, but the reality is that such action usually results in shortages. Restrictions by one group of countries could drive up global prices, compel other countries to follow suit, and thereby result in shortages. Of course, one could argue that this is merely a short-term effect of a temporary problem. Yet we have already seen political and business leaders argue that the pandemic has exposed the fragility of global supply chains. The inference is that supply chains ought to be brought home to ensure against disruption. In addition, the shutdown of factories in Europe and the United States will mean that when demand revives, it will likely be initially filled by imported goods from Asia that have been waiting to be shipped. The asynchronous nature of the revival of supply chains could spur protectionist sentiment.
Meanwhile, some of the challenges to globalization that preceded the coronavirus crisis remain. These include the continuing high level of US tariffs on Chinese goods, continued US tariffs on steel and aluminum, continued US threats of protectionist action against the European Union, and US refusal to allow the appointment of new members of the Appellate Body of the World Trade Organization. The coronavirus crisis could provide the US administration with added support for these policies. Even if President Trump is succeeded by former Vice President Biden next year, Biden (who is more of an internationalist) will likely face significant pressure within his own party to be tough on China and other trading partners.
In the early days of the global financial crisis in 2008-09, the leaders of the G20 issued a statement indicating that they intended not to resort to protectionism in the midst of the greatest economic crisis since the Great Depression. Their view was informed by the experience of the Great Depression when countries engaged in beggar-thy-neighbor trade policies that exacerbated the downturn. The G20 countries largely adhered to the sentiment expressed in their statement, thereby avoiding a worse crisis. In the current crisis, however, there has been no such statement and countries have already imposed restrictions on trade and migration. Supply chains have been disrupted. Global cooperation has largely been absent. In part, this reflects the requirement that each country shut down its economy and isolate its people in order to suppress the virus. The danger now, however, is that this could become a longer-term problem of limiting global economic integration, thereby likely slowing economic growth.
Kate Hardin, Deloitte’s Executive Director for Energy and Industrials Research, and Anshu Mittal, Senior Manager and leader of Oil, Gas & Chemicals Research, analyze events and risks in the energy sector.
In late April, WTI crude oil futures prices for the May delivery contract fell below US$0/bbl and even reached –US$37/bbl as traders squared off their contract positions to avoid taking delivery of the oil. The perfect storm of demand decline, oversupply, and storage shortage contributed to this price collapse. Firstly, the pandemic-related decline in economic activity reduced global oil demand by about 30 million barrels per day (MMbbl/d) in April. Secondly, the OPEC+ agreement on supply cuts of 9.7 MMbbl/d was not enough to offset the decline and would become effective only after May 1. Thirdly, US crude exports have fell amid high inventories, high levels of floating storage, and increasing freight rates. Together, the three factors contributed to full storage facilities at Cushing, Oklahoma, in April, sparking the sell-off of contracts for physical delivery at Cushing. Although WTI prices have marginally recovered and are currently trading above US$10/bbl, the factors that led to this price drop are still in play and may affect prices ahead of May 19 when June delivery contracts are due.
The storage scarcity will not be resolved quickly—with about 160 million barrels of oil already held in floating storage, there is a possibility of negative prices repeating in June unless global lockdowns ease and production shut-ins happen. The US Energy Information Administration’s oil storage utilization rate of 76 percent indicates that some capacity is still available, but some of this may have already been leased or committed, limiting the storage available for financial contract holders. In fact, there is some concern that the storage shortage could also affect Brent futures—the highest crude price marker—inflicting significant derivative losses for traders worldwide. For example, South Korea, which has the fourth-largest commercial storage capacity of 30 million barrels in the Asia Pacific region, has already run out of storage space.
Production levels are expected to fall in May, which may help avoid another precipitous price drop. Saudi Arabia’s planned output cut of 3.5 MMbbl/d will eventually ease some pressure on global storage, and all eyes will be on the compliance rate of other OPEC nations. Based on recent announcements, upstream oil and gas companies have lowered their 2020 capex guidance by over 25 percent, amounting to about US$80 billion. In the United States, production is already slowing as reflected in the US rotary rig count, which has fallen by over 40 percent to 465 rigs since March. Based on initial announcements, US tight oil production is expected to drop by more than 300 kbd in May, with a few companies completely halting their drilling and production.
The third area to watch is global oil demand that remains depressed by COVID-19-related lockdowns and stay-at-home mandates. The pandemic has so far defied oil’s usual demand growth inelasticity of only 1-3 percent annually. A longer-term question is how enduring the “new normal” of remote work will prove—will many commuters opt to continue working from home, depressing refined product demand? Will commercial flights serve far fewer holiday and business travelers given widespread caution about travel and exposure?
The interplay of weak demand, oversupply, and storage shortage suggests an implied global oil stock buildup of 14.4 M/bbld in May compared to the 2019 average of 0.5 MM/bbld. This explains why WTI crude futures over the next three months remain below US$25/bbl. This continued price weakness could significantly challenge the economic viability of many oil and gas companies, especially independent US shale operators. We believe the widening gap between their fair and book values could trigger significant impairments and technical bankruptcies, perhaps even higher than the 2015 levels. So far, the international oil companies (IOCs) are faring better due to their strong financial position and a few IOCs even plan to maintain their dividends despite the downturn.
By contrast, the oilfield services segment is feeling intense pressure. Already faced with cost compression of 37 percent in the 2015-2016 downturn, the ongoing fall in drilling activity and rising cancelations of onshore and offshore projects have reduced the size of the US oilfield services industry by more than 50 percent since the COVID-19/OPEC+ era started. Contract cancellations and lower transportation fees due to production shut-ins are also affecting pipeline operators, whose debt is trading at distressed levels. Refiners are feeling the pinch as well in the form of a significant impact on capacity utilization and working capital. Refiners may report considerable inventory losses in Q2 2020 due to the reduced value of purchased crude oil and stored petroleum products.
The situation is bleak across the entire oil and gas value chain, and the unique price-plus-demand downturn has pressured the industry into the survival mode. The three areas to watch remain production cuts from key producing regions, supply response in economies tentatively reopening in the coming weeks, and the impact of high storage.
The US economy contracted at an annualized rate of 4.8 percent in the first quarter, the sharpest decline since the global financial crisis more than a decade ago. The degree of decline for the entire quarter masks what happened at the end of the quarter. It is likely that the economy grew at a healthy rate in January, perhaps less so in February due to the impact of the disruption of Chinese supply chains, and then contracted sharply in March—but mostly in the second half of March. Moreover, much of the data gathered by the government in March came in the first half. A helpful comparison might come from examining data from neighboring Canada, where the economy often tends to mirror that of the United States. Unlike the United States, Canada compiles monthly GDP data. The latest report indicates that real GDP fell 9.0 percent from February to March. Thus, we can reasonably infer that the decline in US GDP for the first quarter largely reflected what happened in March. Moreover, the number probably underestimates what happened because the lion’s share of the US decline took place near the end of March, when many state governments ordered lockdowns. As such, it remains reasonable to expect a catastrophic decline in US GDP in the second quarter.
Let’s take a look at the details of the US GDP report. First, consumer spending fell at an annualized rate of 7.6 percent, the worst since 1989. This included a 16.1 percent decline in durables that mostly reflected a very sharp drop in spending on automobiles. However, there was a 6.9 percent increase in spending on non-durables and reflects the anticipatory hoarding of consumer staples that took place early in the crisis. Consumer spending on services fell 10.2 percent, largely reflecting a decline in spending on medical care. Households avoided doctor’s visits and discretionary medical procedures. In addition, there were big declines in spending on restaurants, transportation services (air travel), and recreation services (movie theatres, amusement parks, etc.).
Regarding investment, there was an 8.6 percent decline in non-residential business investment, including a sharp drop in spending on business equipment, especially transportation equipment. Surprisingly, there was a very big 21.0 percent increase in spending on residential investment. It is likely that this number was compiled before the second half of March. We do know, however, that there has been an abrupt drop in housing market activity that is likely to show up in the Q2 numbers.
As for trade, both exports and imports declined in the first quarter. However, there was an especially sharp 21.5 percent decline in exports of services. This reflects a decline in tourist revenue from overseas travelers involving air travel and hotels. Exports of goods fell only modestly. Imports of services fell at a rate of 29.8 percent, in part indicating that Americans were not traveling to other countries.
The European Union (EU) reported record-breaking Q1 GDP numbers. For the EU overall, real GDP fell 3.5 percent from the previous quarter, or at an annualized rate of 13.3 percent. In the 19-member Eurozone, real GDP fell 3.8 percent, or at an annualized rate of 14.4 percent. Thus, Europe’s economy shrank three times as fast as that of the United States (which was down 4.8 percent annualized in Q1), reflecting an earlier effort to suppress social interaction to stifle the spread of the virus.
The European numbers are the worst since the EU started compiling such data in 1995. In addition, three major European economies reported their growth figures. In France, real GDP fell 5.8 percent, or at an annualized rate of 21.3 percent, the sharpest decline in the French economy since 1949. It was driven by a stunning 17.9 percent decline in consumer spending, or an annualized rate of 54.6 percent. In Spain, GDP fell 5.2 percent, or at an annualized rate of 19.2 percent. And in Italy, GDP fell 4.7 percent, or at an annualized rate of 17.5 percent. Germany has not yet report GDP numbers for the first quarter, but did report that, in March, retail sales fell 5.6 percent from February. Given that the decline in GDP in France, Spain, and Italy was worse than in Europe as a whole, it can be inferred that the decline in Germany and other Northern European countries was not as bad. This makes sense given that the worst outbreak and the earliest lockdowns took place in Southern Europe.
Michael Wolf, a global economist at Deloitte, provides an analysis of Japan’s response to the COVID-19 crisis.
The rate of COVID-19 infection in Japan is slowing after the country issued a state of emergency earlier in April. Even at its peak, the number of new cases relative to the size of the population in Japan was less than half the peak number South Korea saw more than a month earlier. As of April 30, the number of daily new cases was running below 2 per million, far below 74.5 per million in the United States and 15.6 per million in Germany. Still, Japan’s Prime Minister Shinzo Abe is planning to extend the state of emergency to at least the end of May, perhaps slightly longer.
Extending the emergency declaration may seem like an abundance of caution given that places with far higher rates of infection like the United States and Germany are already beginning to loosen their respective lockdowns. However, higher rates of infection in Japan could prove especially disastrous. An unchecked virus that is particularly fatal for older populations is likely the number one concern for the second-oldest nation in the world. Even with relatively low rates of infection, some of Tokyo’s hospitals are already overwhelmed. These low rates of infection have also allowed Japan to target clusters of transmission rather than implementing widespread testing and tracing methods seen elsewhere. This method of virus containment might prove less effective should higher rates of infection emerge, perhaps during a second wave.
Japan has also struggled to keep workers home. Just 18 percent of Japanese respondents to a YouGov poll said they didn’t have to commute to school or work despite 80 percent of them expressing fear of contracting the virus. Traditional business operating practices are partly to blame. Japanese companies rely more heavily on hard copies of documents, are more likely to use fax machines, and use hanko, a stamped seal that serves as a signature. Less-defined job roles in Japan relative to some other countries like the United States may encourage more frequent communication that can be difficult when workers are not in the same physical space. Government officials are working to reduce these barriers to telework, with Prime Minister Abe now having practices like using hanko reviewed to encourage more remote work.
Japan’s heavy reliance on cash transactions is also creating challenges to keep consumers at home. Just 20 percent of payments in Japan are cashless. By comparison, nearly all payments are cashless in South Korea and about two-thirds are cashless in China. Reliance on cash payments, which Japan’s elderly population strongly prefers, requires consumers to either risk infection while shopping or forego discretionary spending altogether. In the near term, this could have negative consequences for both health and economic outcomes in Japan. However, the crisis also presents an opportunity to hasten Japan’s efforts to dramatically raise its cashless payments. Indeed, Japan wanted to double the cashless ratio by 2025 and had implemented incentives like rebates at the end of last year. A move toward a more cashless society could raise productivity in some sectors and spur more data-driven marketing and sales.
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