Recession is Inevitable, but How Long Will it Last?

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Avery Shenfeld, chief economist at CIBC.

Clearly, investors, Canadians, just about everyone around the world is going through an economic situation, a financial market situation, that we’ve never seen in our lifetimes. The comparisons are being made to the Spanish flu back in the time of our great grandparents. This is an unheard of economic shock and one with quite a different story behind it.

This will be a recession in the sense that if you simply add up all the economic sectors that are either directly due to government edict or indirectly due to consumer behaviour — seeing massive falls in activity — that accounts for enough of GDP to send the U.S., Canada, Europe, the global economy into a recession for a quarter or two. What financial markets are particularly struggling with is, the great unknown is not the recession, but how long this recession lasts. We don’t really have any clarity on when we will be able to go back to normal living again. That’s one issue.

There are some hopeful signs in terms of countries like China and South Korea having stabilized their case loads and taking the first steps to get back to normal activity. But as yet, we don’t know whether that return to normalcy will also lead to another spike in cases that has to be wrestled down. That’s one of the big fear factors in financial markets.

The second very important issue is that while the economy is hibernating, it will be critical to keep corporate health and personal financial health intact. Which means that governments and central banks are going to have to be creative in making sure that we don’t end up with a wave of defaults during periods where some companies have dropped to zero or near zero, so that we have an economy that’s still intact to emerge when the dust clears on the virus issue itself.

I think we’re going to be watching closely to see as governments around the world bring forward measures, whether they are lending schemes from the government to the central bank to support credit markets. That’s going to be critical to ensuring that the business sector stays strong enough, the household sector stays well-funded while people are at home or unemployed, so that the economy can in fact bounce back. Whether that is in the fourth quarter of this year or next year or sooner, if you want to be optimistic on treatments for the virus, but whenever it is, we need a healthy economy.

The direction of financial markets in the near-term is likely to remain highly volatile. Certainly a period of elevated risk in many assets, not just equities but corporate bonds as well. A time when advisors have to make sure that client portfolios have an appropriate degree of risk. Not excessive, given the potential volatility. But also a time when as we get through the virus, there may be business opportunities and investor opportunities that’ll be worth watching for. For the time being, we’re certainly staying a bit cautious in terms of making bold predictions. Until we really get a sense from the epidemiologist, from the experts on the fight against COVID-19, it’s not really worth listening to too many experts on the financial markets. It’s really a case of the disease and the course of that disease that’s going to determine how the economy ends up doing in terms of how long this recession lasts.

One lesson we learned from the financial crisis, even though that was a very different recession with a very different cause, was that there are a number of tools that can be used to in fact make sure that not only do we have low interest rates on government bonds, but we don’t have soaring interest rates or the lack of credit availability for the business sector or the household sector. We’ve already seen the Federal Reserve, for example, take a number of steps to ensure that commercial paper, financing continues to flow. We’ve seen the Bank of Canada, for example, doing the same thing in the market for BAs. The federal government in Canada has announced a program to buy insured mortgages off of the banks. That will get the banks effectively some low cost funding, enable them to stay engaged in the market and serving their clients.

All of these things are key instruments that will be used to make sure that certainly viable businesses, viable households won’t be cut off from much needed credit just because the financial market is in a state of worry or panic. And the additional steps I think we’re looking for here now are to ensure that individuals and corporates that may not look that viable in terms of financing in the near-term get some special assistance from a helping hand in government. We took a while to learn some of those lessons during the financial crisis that we went through a decade ago, and the fact of that experience being on-hand has helped deliver some of those tools faster this time around, which is certainly an encouraging sign.