Till debt do us part

Till debt do us part



We recently published our Counterpoint 2020 Mid-year Outlook against the backdrop of a global health crisis and an unprecedented economic contraction. Just as extreme was the monetary and fiscal policy response. These events, despite their unusual trigger (a pandemic), seem to follow the pattern of past cycles to a much greater extent than one may think at first sight. So historical analysis of what happened during prior recessions can help us shed some extra light on what’s likely to happen going forward – not just in the near future, but also over longer horizons.

How normal is this cycle? We think quite a bit, for three reasons:

First, the conditions that existed at the start of this year shared many characteristics that preceded other recessions: low unemployment, rising inflation, high market valuations, low volatility, confident consumers and an inverted yield curve, just to name a few. Of course, most of these late-cycle characteristics applied to the US. Europe, with less inflation and more spare capacity, was closer to a mid-cycle economy.

Second, the way the market bottomed in March relative to still deteriorating economic data was also similar to prior recessions – reflecting the forward-looking nature of financial markets, which tend to anticipate economic developments captured in lagging statistical releases.

Third, the way economic data are behaving looks relatively normal too. It takes six months for manufacturing activity – as measured by the US ISM index – to return to expansionary territory from the lows. Several past cycles have seen this happening within three or four months. The latest crisis turned out to be the sharpest and most likely shortest of all, taking just two months from the trough in the ISM to get back to signal expansion, but the pattern appears rather common.

"A sharp and short recession" infographic


The global economy will run an average deficit in 2020 of 10% of GDP, according to the IMF, even if the second half of the year sees a gradual recovery as economies, albeit unevenly, continue to reopen – as we forecast. Rich-world public debt could run to USD 66 trillion, which might be 122% of GDP by year-end. The increase in both government debt and budget deficit is much bigger this time around than during the global financial crisis.

Governments that want their debt burdens to diminish must tread one of three broadly defined paths. First, they can try to pay back the loans. Second, they can decide not to pay, or agree with creditors to pay less than they owe. Third, they can wait it out, rolling over their debts while hoping that they shrink relative to the economy over time.

The likely constraint on paying off debt is that such a strategy requires some mix of raising taxes and/or cutting spending. Public appetite for paying off pandemic debts through a return to such austerity seems likely to be limited.

The second option – defaulting or restructuring debts – is very rare in advanced economies (though not in emerging markets). This is because they’re so integrated into global financial markets that they have huge problems if capital providers lock them out as a bad risk.

Rich-country politicians unwilling to shift away from spending and towards taxing, or to face the consequences of an outright default, are likely to choose policies ensuring that the economy’s real growth plus inflation stay above the interest rate the government pays on its debt. That allows the debt burden to shrink over time.

"Large increases in public sector leverage" infographic


Growing out of the debt really isn’t easy. This is because the pace of real growth and inflation that would be needed to inflate the debt away seems very unlikely to materialise anytime soon. Take Italy as an example (although this applies to a lot of countries, and not just to those at the peripheral fringes of the euro area). The shaded areas in its debt sustainability matrix tell us a clear story.

Here’s how it works:

The combination of nominal growth and primary budget balance (i.e., the overall budget balance excluding interest expenses) in green are the “bad” ones. They’re those where, for a given level of government debt relative to GDP and for the interest rate that Italy pays on its stock of debt, the debt/GDP ratio rises. The smaller area in yellow shows the “good” combinations where the debt falls.

To lower its debt burden, Italy would need to move northeast in that table, i.e., it would have to grow much faster in nominal terms than it has ever done. Or it would have to tighten the fiscal belt even more than it did during the global financial crisis over a decade ago – which seems very unlikely too.

The way to read this table is as follows:

With GDP shrinking by 10% this year and a primary budget deficit of 7% of GDP, the table shows that Italy’s debt/GDP would rise by about 25 percentage points this year alone, to approximately 160% – a very high number.

Basically, Italy would have to engineer a configuration of growth, inflation and budget balance such that it moves from the bottom right of the debt sustainability matrix to the top right. At best, a return to pre-crisis growth and inflation rates of 1% each, and a primary budget surplus of 1% of GDP, would deliver a negligible debt/GDP reduction of a little over 0.5% – a shaky stabilisation of the debt trajectory.

So what’s left is the interest-rate lever. Importantly, if interest rates rise, then the yellow area shrinks, thus making debt sustainability even more challenging. If rates fall, then the yellow area expands, making debt sustainability easier.



Pandemics, like natural disasters, offer a unique opportunity to study how economies work. They are like a randomised control trial, but at a much larger scale, with microbiology – the virus outbreak – providing the natural assignment mechanism. Specifically, we can use history as a guide to compare the average macro path after a pandemic against its predicted route if there had not been a pandemic.

A recent research paper by the San Francisco Fed does just that. It studies the path of real interest rates following major pandemics across time and geographies. Its key conclusion is that these pandemics have long-lasting economic effects. Following a pandemic, it looks as if real rates decline for years thereafter. Two decades later, real rates are about 150 bps lower had the pandemic not taken place.


To us, this makes sense, as this is the first-ever recession by decree. So it’s natural that many major governments are looking to fill the hole in incomes created by the sudden stop in economic activity following widespread lockdowns and the fallout of the health crisis. As higher fiscal deficits and debt levels could cause concerns about fiscal sustainability, thus pushing real and nominal interest rates significantly higher, monetary and fiscal policies act in a coordinated fashion to prevent this outcome – often successfully, history suggests.

As debt levels are already very high and getting higher, this seems even more applicable this time around. In an effort to ensure that this doesn’t push bond yields significantly higher, central banks will likely fund the stimulus measures of governments so that they can borrow at affordable rates and do whatever it takes to repair their economies – for as long it takes.


This fiscal dominance of monetary policy is likely to be a lasting legacy of this crisis, as high debt burdens and large budget deficits will require ongoing support. In turn, this implies that debt monetisation, yield curve control and negative rates are all likely to be part of the policy toolkit for years to come.

Therefore, nominal and real interest rates are likely to stay at very low levels for an extended period. Monetary policy is stimulative when real rates are negative. With inflation so low, this requires very low nominal rates. This means discounting cash flows using lower rates than in past cycles, which boosts the present value of risk assets.

Within these assets, the concept of “equity duration”, which measures the sensitivity of an equity price to changes in the discount rate, is useful. Long duration equities are more sensitive to interest rate movements relative to short duration equities. Growth stocks are longer duration than value stocks and, therefore, are likely to continue to benefit more from falling interest rates in real terms.

In the fixed income space, issuers will likely have an incentive to roll expiring higher-interest, short-term debt into lower-interest, longer-term issuance, thus locking in lower debt-service costs for an extended period. This applies to risk-free assets too: we wouldn’t be surprised to see the return of very long-term, quasi-perpetual sovereign bonds.


Globally confirmed cases of Covid-19 have now exceeded 12.8 million, up from approximately 11.4 million seven days previously.

This week we further build out our understanding of Covid-19 in the world’s largest economy by looking at the progression of the US case fatality rate (number of deaths / number of confirmed cases).

Such topics weigh heavy on all of us at Quintet. However, as investors and fiduciaries of wealth, we must consider these developments and their likely impact on both economies and markets. We demonstrated in the 27 April Counterpoint Weekly that because deaths from Covid-19 lag diagnosis by several weeks, the case fatality rate would, all else equal, increase over time, even if the pandemic were to be contained and no new cases were to be recorded. However, the US data is not following this model. Its case fatality rate has been falling since mid-May.


The optimistic interpretation of this chart suggests Covid19 has become less fatal to those who contract it – perhaps due to improvements in medical care. Such statements must be treated with caution as both numerator (number of deaths) and denominator (number of confirmed cases) in the case fatality equation contain imperfect data.

We’ll start with the denominator – the number of confirmed cases. The official figures fail to capture all people who have Covid-19 yet remain undiagnosed. Therefore, as testing coverage improves, and more mild cases are identified, the official case fatality rate falls, giving the impression Covid-19 has become less fatal. In the US the number of tests has increased, which has probably contributed to the fall in the case fatality rate.


The numerator – the number of deaths from Covid-19 – must also be treated with caution. Inevitably, there are deaths caused by Covid-19 but not documented as such. The US, like many countries, has experienced what data scientists call “excess mortality”. This is the number of deaths in excess of what would be expected from factors such as seasonality and demographics. In March and April the US experienced a significant amount of unexplained deaths. If these deaths were attributable to Covid-19 then, during this period, the case fatality rate was understated.


Currently the US is no longer experiencing abnormal excess mortality, beyond what is explained by Covid-19. This gives us confidence that the current reported mortality figures are broadly accurate. Consequentially we draw confidence from the decline in the number of Covid-19 attributed fatalities.


As fiduciaries of wealth, when we view this sensitive data through an investment lens, we acknowledge that the data is imperfectly recorded. Despite this, we observe that the decline in the number of deaths, excess fatalities and the case fatality rate are all incrementally positive for the future health of people living in the US. This development is encouraging for the US’s economic recovery and supports our increasingly positive outlook for investment returns.

Daniele Antonucci - Chief Economist & Macro Strategist
James Purcell - Group Head of ESG, Sustainable and Impact Investing
Bill Street - Group Chief Investment Officer

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