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Facing up to uncertainty – three economic scenarios

13 May 2020

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How the Covid-19 crisis unfolds over the coming weeks and months depends on a number of variables. Faced with this uncertainty, Fidelity’s Global CIO Andrew McCaffery and Anna Stupnytska, Head of Global Macro and Investment Strategy, give their base, bull and bear cases and the associated implications for the global economy.

Our base case for the outcome of the Covid-19 crisis resembles a ‘U-shaped’ recovery, defined by a gradual lifting of lockdown measures as we move into summer, but continued social distancing for the rest of the year and some form of restrictions at different times for at least 12 months. This will plunge most of the world into recession in 2020.

Inflation will face downward pressure from falling consumption and low energy prices, and it could be some time before it rises. As economies recover, there could be some firming in inflation as pent-up demand is released, commodity prices recover, and supply chains continue to be disrupted. But the direction of inflation, and whether it is kept under control – not too high or low – largely depends on policies and stimulus from the authorities. Data points on real-time online prices, commodity prices, inflation expectations, durable goods orders and the functioning of supply chains will be important indicators of the trajectory of inflation.

We expect a severe worldwide impact of the crisis on employment. Unemployment is rising rapidly almost everywhere, most notably in the US, which has flexible labour markets, no wage subsidy mechanisms, and more dependence on small and medium-sized enterprises for employment. The magnitude of the problem in the US could pose systemic risks that drain households of their savings, increase leverage, and hurt consumer demand. The political willingness and ability of the US government to introduce a transformative rebuilding and jobs programme will be key to avoiding a long period of economic malaise.

As we move beyond the pandemic into exit strategies from the lockdowns, it will be important to track quantitative and qualitative data points closely to identify which economic scenario is developing – our base case, or something better or worse.

Upside case (10%)

A more positive outcome, but the least likely, is a V-shaped recovery, where the global economy will bounce back in the second half of 2020, supported by stimulus. This optimistic scenario requires the pandemic to be largely over in May, so that economies can exit lockdowns in quick succession and resume full activity in the second half of the year.

An effective vaccine, widely available in the medium-term, could form part of the scenario but crucially, policymaking must be swift and effective. Markets should function smoothly, facilitated by easy financial conditions, and existing fiscal support must be implemented and distributed well to cushion the fallout from the pandemic and speed up recovery. To minimise regional risks, the European Union needs to agree a comprehensive package using the full range of instruments at its disposal, and international organisations such as the World Bank and the International Monetary Fund will have to co-ordinate programmes to help manage health crises in emerging markets.

Downside case (30%)

We think the downside scenario is relatively more likely than an upside case and we give it a 30% probability. Investors should be on their guard. In this scenario, new cases of the virus start declining in May, but once economies reopen there are subsequent waves of infection that prove difficult to control. Emerging markets that lack the resources to contain infections adequately could pose a risk to other countries. These follow-on threats could derail the return of normal activity and lead to more lockdowns.

These events imply a deep economic contraction throughout the world as continued economic restrictions would choke off any recovery. In this scenario, a liquidity crunch could develop and, together with solvency issues, trigger a wave of defaults in corporate and sovereign bonds. Emerging market countries are particularly at risk of rolling crises. The economic damage could be exacerbated if central banks run out of policy tools.

Note: these scenarios are not intended to be exact growth forecasts, but rather illustrations of potential outcomes based on particular assumptions about a number of variables, including the pandemic trajectory, lockdown exit strategies, policies and associated multipliers, corporate and consumer behaviour. Given significant uncertainties related to the Covid-19 pandemic outbreak, these scenarios are subject to change. We will be revising growth numbers and probabilities continuously, as signals evolve and more information becomes available

Read more on this in Fidelity’s latest whitepaper: The new economic order

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This content is for investment professionals only and should not be relied upon by private investors.

The value of investments and any income from them can go down as well as up and you may not get back the amount invested. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The value of investments in overseas markets may be affected by changes in currency exchange rates. Investments in small and emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Investments should be made on the basis of the current prospectus, which is available along with the Key Investor Information Document and current and semi-annual reports, free of charge on request, by calling 0800 368 1732. Issued by Financial Administration Services Limited and FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity, Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. ED20 – 150

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