Over recent weeks the global economy and financial markets have experienced an unprecedented shock. In recent times there has never been a situation like COVID-19, which has resulted in, not a slowdown in the global economy, but a lockdown.
Financial markets have struggled to process these uncertainties and although there is hope that this does not last long, it will mean significant disruption as a large part of the World’s economy goes into hibernation. This will cause financial stress for businesses, economies and consumers. However, there has been a rapid response from Governments’ and Central Banks’ to try and ensure unnecessary financial stress is avoided, triggering a downward economic spiral. Essentially, there is commitment to a “whatever-it-takes” approach of financial stimulus in order to bailout the real economy.
Financial markets face three key challenges that require separate targeted policy responses. In the short-term, for markets to stabilise investors will need to be more confident these have been addressed.
1. Public health crisis
Many governments have adopted a policy of aggressive suppression in order to slow the spread of COVID-19. Hopefully in time this approach will be successful, but it is uncertain how long the lockdowns will be in place for and therefore how deep the economic shock will be. In order to stabilise, financial markets need to be more confident in the effectiveness and duration of government measures.
2. Global Recession
There will be a severe recession in the first half of this year, but without a full understanding COVID-19’s trajectory it is difficult to estimate whether it will extend further. In order to support the economy through what will be a very challenging period, governments and central banks have launched an unprecedented package of fiscal spending and monetary policy support. If successful these measures will help to offset the economic shock and prevent cascading risks that would deepen a recession (i.e. surging unemployment, debt defaults etc).
3. Financial market stresses
The COVID-19 shock has triggered a wave of investor selling in many asset classes, not just equities, and this in turn has exposed several financial market vulnerabilities. A surging US Dollar and poor liquidity in bond markets have compounded fundamental concerns and increased market volatility. Central Banks have already responded and started to ease these pressures by increasing the availability of US Dollars globally and launching asset purchase programmes to buy government and corporate bonds.
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