Coronavirus: Economic & Credit Market Implications

Here is today’s essential intelligence.

Sustainable fuels are drawing increased investment and gaining importance as high-carbon-emitting industries start transitioning away from oil, gas, and other fossil fuels. As demand for biofuels, renewable diesel, and sustainable aviation fuel looks set to swell in the U.S. this year, some market participants are pressuring policymakers to increase the volume of renewable fuels while others are vying for small refiners to remain exempt from renewable fuel mandates.

Discontent appears to be brewing across the market as producers await the Environmental Protection Agency's finalized Renewable Volume Obligation for 2020, 2021, and 2022 under the Renewable Fuel Standard, according to S&P Global Platts. Industry players are split over whether the EPA’s RFS volumes—20.77 billion gallons for 2022—are too low or too high. Similarly, market participants are divided over whether it will help or hurt the renewable fuel market if the EPA moves forward with its proposal to remove exemptions that allow small refineries with less than 75 barrels per day of capacity to sidestep the program if they can prove that a disproportionate economic hardship exists for their facilities.

As the recovery from the Global Financial Crisis edged forward in the early 2010s, inflation hawks warned about the “certainty” of an imminent spike in inflation following the aggressive stimulus measures taken by global central banks. Unfortunately for the U.S. Federal Reserve and some of its other monetary counterparts, that certainty never materialized, and it then spent the better part of the next decade attempting to stoke what was once thought to be a sure thing.

As we start the second half of 2020, the COVID-19 pandemic continues to expand globally, with confirmed cases exceeding 10 million and emerging markets now the epicenter. The fight to contain the virus remains the priority until a vaccine or effective treatment is found, but progress has been sufficient enough in many countries to allow lockdowns to ease. Consequently, the focus has shifted to assessing the shape of the economic recovery.

The pandemic will likely leave profound scars on the world economy. A deeper hit than initially anticipated in emerging markets, notably for India, is now pushing our forecast to a 3.8% contraction in global GDP in 2020 (worse than the 2.4% previously expected). The dire effect of extended lockdowns on employment and consumer confidence also means that recovery will take longer than expected into 2021-2023, with a permanent loss in output.

The story of the pandemic-driven steep drop in output is by now familiar. Countries imposed strict social distancing measures to slow the spread of the virus and keep cases from overwhelming health systems. Businesses that were able to function remotely moved to working from home, while people-to-people businesses saw an unprecedented collapse of activity. GDP declined on the order of 30% to 40% at an annualized rate for a one-quarter shutdown in China (January-March), much of Europe (spanning the first and second quarters) and the U.S. (April-June).

The U.S. economy regained 1.8 million jobs in July--according to the Bureau of Labor Statistics' (BLS) jobs report--as more businesses gradually returned to normal operations. With a total of 9.3 million jobs recovered since the crisis, this rebound is a little more than fourth-tenths (42%) of the 22.2 million jobs collapse in March and April. Still, the pace of recovery lost momentum across broad industry groups given the impact of surging COVID-19 cases on commerce.

That said, private payrolls (from the government report), at 1.46 million in July (8.2 million May through July), were dramatically larger than the surprisingly small 167,000 increase (7.8 million May through July) reported by the ADP private payrolls report. The two reports often aren't in line on a month-by-month basis, though a 1.29 million gap between the two releases is unusual by any stretch of the imagination. Over the long run, the reports do largely track each other. We'll be watching to see whether the BLS report will be revised down closer to the ADP report, or vice versa.

Latin America is now the global epicenter of the COVID-19 pandemic, with the number of new daily reported infections increasing, or remaining close to recent peaks, in most major countries. In some countries, this has meant the extension of stringent lockdowns, and in others, it has meant a slower relaxation of those measures. Across the board, households and businesses are more cautious. As a result, S&P Global Economics has lowered its GDP projection for Latin America by just over 2 percentage points to a contraction of roughly 7.5% in 2020. We expect growth to be just shy of 4% in 2021. Risks are mostly to the downside and tied to the evolution of the pandemic.

S&P Global Ratings now expects a steeper decline of economic growth in Asia-Pacific in 2020. We forecast a 1.3% contraction this year before growth of 6.9% in 2021, compared with our previous projection of 0.9% and 6.7%. This means our GDP forecast for the region for 2020 and 2021 is about $2.7 trillion lower than before the pandemic began.

Asia-Pacific has shown some success in containing COVID-19 and, by and large, responded with effective macroeconomic policies. This can help cushion the blow and provide a bridge to the recovery. Still, by the end of 2023, we expect permanent damage to the level of output of between 2% and 3%. Risks are more balanced as pandemic curves flatten but remain prominent.

The latest economic data is confirming S&P Global Ratings' view of a severe contraction in the eurozone economy in April and May because of lockdowns to slow the coronavirus pandemic. However, it's a little more pronounced than we expected, with economic activity likely to have dropped 11.4% in the second quarter, after a 3.6% contraction in the first. Therefore, we now expect eurozone GDP to contract 7.8% this year and rebound 5.5% next year (instead of our previous forecast of -7.3% and 5.6%). The services sector is taking the biggest hit because social-distancing measures are constraining consumers' ability to buy. That said, the manufacturing sector has been forced to adjust to a sharp drop in demand for consumer and capital goods as companies pull back investment. External demand has also collapsed, with the global economy facing a synchronized recession because of widespread containment measures.

S&P Global Ratings Research expects the U.S. trailing-12-month speculative-grade corporate default rate to rise to 12.5% by June 2021 from 5.4% as of June 2020. S&P Global Ratings economists think the U.S. economy will see growth in the third quarter, but high-frequency data paints a mixed picture, which is severely challenging the 22.2% annualized growth rate expected this quarter. S&P Global Ratings also saw both an uptick in defaults as well as a historically high number of downgrades and negative outlook and CreditWatch placements in the second quarter. The pace of downgrades and negative outlooks and CreditWatch listings has slowed significantly since April but is still elevated relative to the pre-COVID-19 pace in February.

Although the fallen angels total has reached 40 in the first seven months of the year (six in July alone) the potential fallen angels tally decreased to 120 in July (from a high of 126)--the first decline since the COVID-19 pandemic began to wreak havoc on capital markets.

COVID-19 has not receded in most key emerging markets (EMs) despite governments' efforts, while only few EMs have made progress. Many key EMs have tightened containment measures, delaying phased openings or re-introducing selected measures to contain the spread of COVID-19. These conditions cloud the panorama for a recovery. Downside risk to growth in EMs is also increasing, due to the rising threat of a second wave of COVID-19 infections in several developed economies.

A re-imposition of lockdowns in those economies, as they try to contain a potential second wave, could result in another bout of pessimism towards global demand, trade, and commodity prices, slowing the recovery that many EMs had seen in recent months. The impact of COVID-19 is now showing up in lower ratings and the rising pace in defaults.