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A Q&A with PGIM Fixed Income’s chief economist on the state of the markets and economy.

March 17, 2020

The growing outbreak of COVID-19 caused a widespread sell-off across financial markets as global supply chains were disrupted, travel and tourism ground to a halt, and everyday consumer activity has slowed with reports of community spread. With the markets in turmoil, Nathan Sheets, former U.S. undersecretary of the Treasury for International Affairs and current chief economist at PGIM Fixed Income, answered 10 questions about what the coronavirus could mean for the global economy.

 

Why did the market fall so far so fast, and are we close to a recovery?

You have the virus, you have people’s reactions to the virus, and the collapse in oil prices—all of that is working its way through the system. It’s likely to be a pretty severe next few months for the global economy, and that’s with monetary stimulus or without it. Investors hate the unknown, and the markets are likely to remain volatile until we have a sense that the virus is contained. In the United States we’re not there yet and may have a long way to go. Given that, there is a fair amount of risk for further downside in asset prices over the next couple of months.

 

Will the COVID-19 impact lead to a global recession?

The key question is, how long will we need to take extraordinary precautions in response to the virus? As the pendulum swings toward greater caution on public health, that comes with an economic cost. If people are staying home, they’re less likely to spend, and demand in the economy is going to fall. In that environment, firms will be unlikely to hire; they may lay off workers. If the effects of the virus are felt for an extended period of time, inevitably that will lead to recessionary conditions. Even if we avoid recession by a strict definition, it’s going to feel pretty rough through the months ahead.

 

How worried should we be about corporate or consumer debt causing wide impact on the market?

In the aggregate, U.S. consumers aren’t particularly indebted. But those in the bottom half in terms of their income do have a fair amount of debt. As long as the labor market remains strong, this group will be able to continue to service their debt. However, if this episode lasts long enough and we see the unemployment rate rise meaningfully, that could have adverse implications for the ability of these households to repay their debt and for the financial system. On the corporate side, a lot of heavily indebted BBB-rated firms were making good progress toward deleveraging, and we saw some of them even upgraded. But if the economy were to slow sharply in a sustained way, they might be vulnerable. Not necessarily at risk of defaulting, but at risk of being downgraded.

 

Should investors be concerned about their 401(k)s?

Given the nature of this shock and knowing what’s driving it, there’s good reason to think that when the crisis passes, the fundamentals of the economy will be solid. The best advice for individual investors is to not look at their statements. What’s happening now is a severe reaction and it’s reflecting uncertainty and liquidity problems. But when it passes, the economy is likely to bounce back. There’s pretty good value being created in the markets even as we’re seeing these declines.

 

Are there sectors of the market that will see less volatility or bounce back sooner?

The decline is so broad-based that pretty much everything has fallen. Globally there will not be many safe harbors. One area where there is dramatic differentiation is across countries. So far, countries in the southern hemisphere have been somewhat less impacted by COVID-19. They have warmer climates, younger populations on average and, in many cases, lower population density than Asia. China’s economy has felt the biggest blow so far, and it is likely to contract sharply in the first quarter.

 

What long-term implications might this crisis have for different industries?

The cruise industry will survive, but cruising may have to be different than it has been in the past—the whole model may need to be reimagined. The question is, will the change be led by the dominant firms today or other firms? The airline industry is down 25%-50%. They have good business models and they will be hit for a while, but will they be hit so hard they need public assistance? That could impact them long term. One of the transformational things that might come out of this is that we may become more dependent on technology that allows us to work remotely, which we’re seeing as social distancing takes hold. That may be good for the tech companies. In the health industry, some pharma company will figure out a vaccine for this and that company will be a winner. But more broadly, for companies that produce equipment people use in medical offices, perhaps we will see growing demand for a more adept and larger pipeline capacity to provide health care, and some of those companies may benefit.

 

What impact will this have on contract workers and those in the gig economy?

With the gig economy, we match up online with a stranger, a service is exchanged, we do it again and are matched up with someone different. Will we see a procession of Uber drivers in our lives as posing an undue risk? We may want to be familiar with people we’re interacting with, which could make it more difficult for the gig economy.

 

What effect will the monetary policy by the Fed and fiscal stimulus from the government have?

The monetary policy stimulus helps support the economy by ensuring there’s not permanent damage done to the economy’s productive capacity. The Fed has now cut the federal funds rate to zero and moved aggressively with a significant quantitative easing (QE) and liquidity package. I’m quite confident that they will do more, if necessary. The Fed is taking out its playbook from 2008 and putting in place many of those policies. Fiscal stimulus will be helpful in supporting demand in the economy, making sure that some of the firms being adversely affected can continue to do business until this period passes.

 

What will it take to bring calm to the markets?

The markets are looking for clear leadership. They need to get a sense that we have a plan of attack on how we’re going to respond to the virus, and that the plan is coordinated across federal, state and local agencies. Ultimately, how bad the downturn gets will depend on the evolution of the virus and what we do to protect our health. Monetary and fiscal policy can dull the pain and help ensure the economy is in good shape on the other side of this difficult time, but it can’t solve it. Every dollar spent putting in place the healthcare tools to respond to this will have an enormous economic payout.

 

What should investors consider right now?

First, don’t panic. Keep your eyes on the long term and recognize that once we arrive at a point where the virus is largely under control there’s likely to be meaningful value in the markets. There’s no way to sugarcoat it—this will be a painful period for investors of all kinds, but the best strategy is to hunker down. I expect that the bounce-back here will be sharper than what we saw after the global financial crisis. Back then, we not only had to address the crisis, but there were still a lot of imbalances, bad loans and other problems in the system that needed to be worked off. Here the cause is a physical contagion, not contagion in the markets.

 

For a media interview with Nathan Sheets, please contact Lizzie Lowe.

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Source(s) of data (unless otherwise noted): PGIM Fixed Income, as of 03/17/2020.

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