At an oil refinery in Deer Park, Texas. Over the weekend, Russia and Saudi Arabia started an oil price war that has sent the price of crude plummeting. Photo / AP
There are rare moments when the world economy seems to be reconfiguring itself beneath our feet. These can be startlingly fast bursts, not obvious to people who are just going about their business, but glaringly so to those who interpret the moves of financial markets.
March 2020, it is now abundantly clear, is one of those moments.
Already, it appeared that chunks of the U.S. economy would have to reduce operations or shut down entirely to try to slow the spread of a novel coronavirus, especially in travel-related businesses. Then over the weekend, Russia and Saudi Arabia began an oil price war that sent the price of crude plunging by the most it has in three decades — which could cause widespread bankruptcies in the American energy industry.
The exact scope of the economic damage the United States faces is still an open question, and there may yet prove to be significant disruptions without full-scale recession. But market activity on Monday indicates that some very gloomy possibilities are becoming more likely.
Sunday evening in the United States, Asian markets opened for the week with implausibly large moves in some of the world's most important measures of economic and financial conditions. The numbers that flashed on traders' screens seemed to be evidence of a world economy realigning itself.
Ignore the steep sell-off in stocks — that is an effect, not a cause, of the disruptions remaking the global economic outlook. What matters now are bond yields and commodity prices, the two most vivid indicators of a shifting landscape.
These market prices are telling us that a recession is becoming more likely in the United States this year, and that it will probably leave scars on the economy for years to come. Worse, it looks like predictions of a 'V' shaped downturn with a quick, sharp rebound are probably off base.
"We've reached the tipping point where things are feeding off of each other," said Julia Coronado, president of MacroPolicy Perspectives. "We're going to lose a chunk of activity and then we'll grow out of it. That's the good news. But are we going to boom out of it or crawl out of it? Crawling is looking more likely."
Not only do futures markets indicate the Federal Reserve will cut its short-term interest rate target more in the coming weeks, but the yield on 10-year U.S. Treasury bonds also fell below 0.4% briefly, and the 30-year bond now yields below 1%. Those numbers strongly suggest the Fed will have to keep rates near zero — or conceivably below zero at some point — for a very long time.
The oil price rout — a barrel of West Texas Intermediate Crude was at $32.46, down 22% in a single day and around half its level at the start of the year — implies trouble to come in the American oil patch.
Cheaper oil will create benefits for U.S. consumers and for oil-consuming industries. But as the shale gas industry has grown and the United States has become a net energy exporter, the balance has changed in how cheaper energy affects the economy.
The pain of cheap oil will tend to be highly concentrated in oil-producing locations, and will have an outsize impact on capital spending. (Spending on energy is a major driver of demand for heavy industrial equipment.) A telling indicator: Shares of Halliburton, the leading maker of energy equipment, were down 35% in midmorning, compared with about 7% for the overall market.
The United States has experienced something like this before, in late 2015 and early 2016, when a drop in commodity prices caused an economic slump that was most pronounced in the oil patch and in heavy industry.
In that episode, the overall United States economy kept humming along because consumer spending and service industries were mostly unaffected. What makes the outlook for 2020 seem so different is that the oil price swoon is coming at the same time coronavirus appears likely to wallop those sectors.
The damage is still highly uncertain. But if more large gatherings like conferences and concerts are cancelled, and more people decide they will not fly this summer and stay home more generally, it's likely to cripple the consumer-driven side of the economy.
That means that workers who serve those industries will be in danger of furloughs, lost hours or layoffs. "This is unusual in that it may prove faster acting than past downturns," said Jay Shambaugh, director of the Hamilton Project at the Brookings Institution. "The drop in oil prices and drop in financial markets alone, and when you add those to the impact of the virus and the hit to global demand, at some point that has spillovers to the U.S. economy."
Companies affected by the coronavirus spending freeze would, like their counterparts in the energy business, be at risk of default.
Years of aggressive lending practices by businesses could come back to bite them, and a few high-profile bankruptcies could trigger a broader reassessment of risk among lenders that means even healthy businesses have trouble rolling over their loans.
The downside of the aggressive borrowing by corporate America in the last decade is that it makes companies more brittle — less able to withstand the occasional hiccup in demand, or problem with supplies. It appears 2020 will be a test of their resilience and whether debt loads have truly become excessive.
In effect, plunging energy prices caused by geopolitical machinations are combining with coronavirus to put numerous major industries under pressure in ways that could bounce off one another — through financial markets, to the economy, and back again — in unpredictable ways.
The news isn't all bad. Lower oil prices really are good news for consumers; lower bond yields will translate into lower mortgage rates; and the big market moves Monday will probably get the attention of policymakers and coax a more aggressive response.
"If the virus doesn't spread too widely in the United States, or if a natural peak were to occur in the infection rate, the economic damage could be contained," said Megan Greene, a senior fellow at Harvard Kennedy School. "A massive fiscal stimulus would be huge at this point."
In other words, avoiding some of the more dismal possibilities might take some mix of luck and a strong public policy response.
Written by: Neil Irwin
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