What is happening in the economy is certainly not normal. It is not a typical economic cycle crisis in which a decrease in output growth is observed and eventually it leads to a reduction, leading then to a recession. This epidemic started out creating aa supply shock as well as its value chain having a strong potential to drag demand back. Most likely, its duration will be short and the recovery possibly fast, however the magnitude of its negative effects is still unpredictable.
In any crisis, monetary and fiscal policies tend to be the weapons used to mitigate their potential consequences. However, the greater the climate of uncertainty regarding the future, the lower its potential effect.
Several central banks have already reduced their key interest rates, but without their desired outcome. Although these measures have the potential to increase aggregate demand in the economy, these political initiatives have been interpreted as an "emergency" in the markets. Certain companies will most probably benefit from reduced interest rates - both those that currently have variable rate loans and others that do not have loans and need to get loans, will now be able to do so at lower rates. The big problem here is that the rates will probably be slightly lower than they are today. The positive impact of these monetary stimuli is very small and as a consequence, the positive mood it brought to the markets lasted just over an hour.
On the demand side, as countries take measures such as closing schools or the cancellation and restriction of business and sporting events and as people, manipulated by the present uncertainty, start to stop travelling, to reduce their consumption and have more difficulty paying their loans; fiscal aid from governments is becoming increasingly urgent.
All of these measures will probably not be sufficient to prevent a negative economic impact from the virus, but they can certainly help to delay and mitigate its potential effect.
As far as the financial markets are concerned, what has happened so far is that there have been two bloody weeks and aggregate declines in the main equity indices of around 20%. Although there are specific sectors that are being most affected (such as the aviation or the energy sectors), all are penalized - the proof of this is that the money has come out of all Exchange Traded Funds (ETF 's). The possible defaults that may exist can be both due to solvency problems (e.g. consequence of the reduction in the price of the barrel) as well as lack of liquidity (e.g. substantial reduction in demand).
It is interesting to look at the debt market as it is possible to understand what can be expected in the future. In particular, in the United States, the yield on 30-year government bonds is below 1% for the first time and has also reached the level in which the 2-year yield was about two weeks ago. In Portugal, the same has not happened and the slope of the yield curve has become steeper since the last two weeks.
The expansion of American monetary policy not only contributes to the decrease in the interest rates on short-term debt, but also to the entire fall in the curve. On the European side, it will be interesting to see if the same will happen with the possible intervention of the European Central Bank (ECB).
In spite of this fact, the yield curve of most countries has fallen across all maturities and this indicates that we may be closer to a recession or at least to a long period of economic stagnation.
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