Global Daily – Eurozone GDP revision + US election update

Euro Macro: Deeper double dip but stronger upswing – Although we have long incorporated a double dip recession in our baseline scenario for the eurozone economy, the new lockdowns mean that we now incorporate a deeper recession than previously expected. The contraction we now expect in Q4 of this year and Q1 of next year is much less severe than in the first half of this year (a little under a third of the GDP drop that we saw then) but is still a deep recession from a historical perspective. So that was the bad news. The good news is that we now expect a stronger economic recovery from 2021Q2 onwards as vaccine developments should allow a somewhat speedier lifting of restrictions. Still, while our conviction on a near term double dip remains high, our assumptions on vaccine developments are of course surrounded by uncertainty. Below we explain our new scenario and the assumptions behind it in more detail.

Not all lockdowns are equal – A key difference between the current lockdown measures compared to the previous ones in March-April is that people that are not able to work from home (e.g. in construction and industry) will be allowed to continue to go to work. Also, non-essential shops are allowed to remain open in most countries and regions, although sometimes with more limited opening hours. Moreover, day-care centres and schools are allowed to remain open, which also enables more people to continue working than during the first wave of the pandemic. Finally, (air) traffic between eurozone countries has been restricted less severely than during the first wave of the pandemic. All in all, the current restrictions are more targeted at further limiting social interaction between people by closing (or seriously restricting the opening hours) of restaurants, cafes and museums and by prohibiting sports, leisure and cultural events.

Not as deep as H1 When assessing the blow to the economy from these new lockdown measures it is important to note that the sectors that will be hit were already functioning well below full capacity before the new lockdown measures became effective, as activity had remained limited by social distancing regulations. Therefore, the contraction in activity will be less severe than during the first lockdowns. Another difference is that the global manufacturing sector is still in a recovery phase and will not be hindered by the lockdown measures this time, while there will neither be serious supply chain disruptions stemming from China. Manufacturing will also slow due to an expected cut back in capital spending plans, but the sector should be more resilient than it was earlier this year. All things considered, we expect GDP to contract by almost 4% qoq in Q4.

Stronger recovery next year as restrictions lift – Looking further ahead, we expect that some of the most stringent measures that have recently been taken will be softened somewhat from the end of Q1, albeit very gradually to prevent a new (third) wave of the virus. As there will be a negative base effect from the drop in GDP in November, we expect GDP to contract in 2021Q1 despite a modest rise in monthly activity during that quarter. As from the middle of next year onwards, GDP growth is expected to jump higher on a more sustainable basis, as lockdown measures are expected to be unwound further, a vaccine becomes available and the impact of global monetary and fiscal stimulus kicks in (we set out our assumptions about the timing of a vaccine and the lifting of restrictions below). On an annual basis, GDP should drop by around 7.5% in 2020, grow by almost 3% in 2021 and by almost 5% in 2022.

Huge spare capacity remains – At the end of 2021, the level of GDP should be around 2 percent below the pre-pandemic level and around 5% below the trend-level. By the end of 2022, the level of GDP should have returned to approximately pre-pandemic levels, but there will continue to be a sizeable gap between actual GDP and the trend-level. As such, we continue to take the view that core inflation will get stuck close to zero over the medium term (even though a recovery in core and headline inflation is likely over the next year or so). We will give a detailed update on our inflation projections next week.

Indicative path for Eurozone restrictions

Vaccine and restrictions timelines – The path for the economy next year depends critically on the duration and strictness of restrictions imposed by governments and when and how quickly they will lift these. This in turn depends on virus trends, the government reaction function to them and on the development and effectiveness of vaccines and therapeutics. Above we have set out an indicative path for Oxford’s Stringency Index for the eurozone. The index peaked at a level of just above 80 at the end of April when hard nationwide lockdowns were introduced and subsequently fell to a low of around 50 over the summer and early September as economies opened up.

With the new round of new but softer lockdowns, the index level will likely rise to 65-70. We judge that that current restrictions will last through to around the middle of Q1 of next year. This is based on the judgement that governments will be cautious to move to the exit until they have a high degree of certainty that virus trends have been sustainably brought down to very low levels. This is due to the experience from the first exit, which arguably was too quick given the subsequent second wave.

In Q2 the index goes back down to the previous low, while in Q3 we are assuming a more substantial opening up. This is based on the view that an emergency vaccine will be available at around the turn of the year, which will be administered to vulnerable groups and key workers. With significant immunity established for these groups by the end of Q2, we think the authorities will have the confidence to lift restrictions to a greater degree than we have seen so far during this pandemic. However, in the absence of a fully-licensed vaccine (which we assume will only be available towards the end of next year), restrictions will likely not be lifted entirely. Some degree of social distancing will likely remain, which will limit capacity in restaurants and shops and large events. Travel will resume, but enhanced safety measures (such as face masks) will remain in place. A complete return to ‘normal’ is seen in the second half of 2022, once a vaccine has been widely administered and a significant degree of immunity has been achieved. Only a vaccine, in combination with non-pharmacological measures (face masks, social distancing) and therapeutics, will allow for a complete return to ‘normal’. (Aline Schuiling, Daniel Ender & Nick Kounis)

 US Politics: Biden presidency looks more likely – Since our last election update yesterday morning, the likelihood of a Biden presidency has increased following his narrow win in Michigan. Michigan was also an important test case for the theory that the final vote counts (mostly of postal votes) would be favourable to Biden, because a much greater proportion of Biden supporters appear to be voting by post than Trump supporters. This bodes well for Biden in the remaining six uncalled states, and indeed at the time of publishing, Trump’s lead in Georgia has narrowed to just 15,000, with a further c.60,000 votes from mostly Democratic urban areas still to be counted. Biden would need to win just – for instance – Georgia and one other state in order to reach the 270 electoral college votes required for the presidency.

Trump launches legal challenges in three states – President Trump has meanwhile launched legal bids to halt vote-counting in Pennsylvania, is seeking a recount in Wisconsin, and challenged the handling of ballots in Georgia. Trump’s best chance of legal success is probably in Pennsylvania, where the move to allow postal ballots arriving after election day to be counted has been controversial, and where some justices in the state have said that it may violate the Constitution. While such a case could ultimately end up in the Supreme Court, as we discuss above, Biden would not necessarily need to win in Pennsylvania to secure the presidency.

Slimmest of Democrat Senate majorities is just about possible – Meanwhile, although it continues to look more likely than not that the Senate remains in Republican hands, a key race in Georgia has opened up the possibility for the slimmest of Democrat majorities via run-off votes. Of the two seats up for election, one is already close enough to trigger a run-off vote, while another is on the cusp of being so. Should both seats flip Democrat in a runoff vote (which would take place in January), the Senate would be split 50-50, and – assuming a Biden presidency – Biden’s VP Kamala Harris would cast the deciding vote.

What will the election outcome mean for pandemic-related stimulus? – As we discussed in yesterday’s Daily, the lack of a ‘blue wave’ election outcome would significantly reduce the prospects for major spending plans of Democrats being implemented, even with a Biden presidency. However, we do not think it would dim the prospects of stimulus entirely, and we expect a sequel package to the $2trn CARES Act to be passed in the coming months. This could happen during the looming lame duck session of Congress, perhaps something bare bones attached to a continuing resolution, which will be needed before 11 December (when government funding is due to expire). Failing that, we are likely to see something more comprehensive in the early part of 2021. Republicans and Democrats had been locked in negotiations on such a package in the run-up to the election, suggesting there was clear political will on both sides for some stimulus, with the question mark only on the size of the package. With the pandemic now resurgent across the US – in both Democrat and Republican states – we expect the pressure for additional relief will be difficult to ignore. With the election out of the way, Democrats and Republicans are likely to find it somewhat easier to strike a compromise deal. (Bill Diviney)