Recession is inevitable, but how long will it last?

Covid-19 has halted the economy, shaken financial markets and introduced uncertainty into everyday life. But two things are clear: a recession is inevitable and market volatility will continue.

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Sector shutdowns account for “enough of GDP to send the U.S., Canada, Europe [and] the global economy into a recession for a quarter or two,” said Avery Shenfeld, chief economist at CIBC, in a March 17 interview.

In a report on Friday, Shenfeld and colleagues Benjamin Tal and Royce Mendes forecasted that second-quarter real GDP in Canada could fall by 15% to 20% at annualized rates, or 4% to 5% on a quarterly basis — “a record dive.” Unemployment could “spike to over 9% by summer,” they wrote. “The picture for the U.S. economy isn’t much different.”

While recession is a clear call, the extent of the fallout isn’t.

The course of the coronavirus will determine how the economy performs and how long the recession lasts, Shenfeld said when interviewed.

“Until we get a sense from the epidemiologists on the fight against Covid-19, it’s not worth listening to too many experts on the financial markets.”

In the near term, markets are expected to remain “highly volatile,” he said, with both equities and corporate bonds facing elevated risk.

“Advisors have to make sure that client portfolios have an appropriate degree of risk — not excessive, given the potential volatility,” he said.

Once the virus clears, “there may be business opportunities and investor opportunities that’ll be worth watching for,” he said.

Factors affecting recession

While no one knows when the world will return to normal, Asian countries offer some first positive glimpses.

“There are some hopeful signs in terms of countries like China and South Korea having stabilized their [coronavirus] case loads and taking the first steps to get back to normal activity,” Shenfeld said.

At the same time, “we don’t know whether that return to normalcy will also lead to another spike in cases that has to be wrestled down,” he said. “That’s one of the big fear factors in financial markets.”

Another unknown is whether fiscal and monetary policy will be successful at enabling the economy to bounce back once the virus clears.

“While the economy is hibernating, it will be critical to keep corporate and personal financial health intact,” Shenfeld said. “Governments and central banks are going to have to be creative in making sure we don’t end up with a wave of defaults.”

Policymakers have responded quickly. Canada’s fiscal measures include a direct transfer of up to $27 billion for individuals and small businesses, and $55 billion in tax deferrals.

Some measures used by central banks during the Great Recession have been reinstated. The Federal Reserve has renewed its commercial paper funding facility, whereby it makes short-term loans to qualifying firms, and its program to provide liquidity for money market mutual funds. Canada’s central bank has likewise implemented new or expanded credit and liquidity facilities.

“One lesson we learned from the financial crisis […] was that there are a number of tools that can be used to make sure […] we don’t have soaring interest rates or the lack of credit availability for the business sector or the household sector,” Shenfeld said.

That experience “has helped deliver some of those tools faster this time around, which is certainly an encouraging sign.”

The various measures implemented are “key instruments” to ensure “viable businesses and households won’t be cut off from much needed credit just because the financial market is in a state of worry or panic,” he said.

On Monday, the Federal Reserve said it will buy as much government debt as necessary to help weather the crisis, removing any dollar limits.

More action is expected from Canada’s policymakers, including the central bank.

“The reality is that the central bank has an unlimited capacity to provide the system with liquidity and allow commercial banks to extend credit,” Shenfeld and his colleagues wrote in the CIBC report.

“Look for the Bank of Canada to cut the overnight rate by a final 50 basis points, bringing the target in line with where the Fed has already gone,” the report said. That would put the central bank’s overnight target at 0.25% in the second quarter.

To transmit lower rates to other borrowers, the central bank could follow up with a quantitative easing program aimed at mortgage bonds, provincials or even corporate issues, the report said.

For full details, read the CIBC report.

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