Tracking a COVID-recovery

There are many elements of the COVID-19 pandemic that make it different to other crises.

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One is that most economic activity loss was due to necessary social distancing related restrictions. This caused a rapid deterioration in economic activity, as seen in the record decline in Q2 gross domestic product (GDP). It could also mean, though, economic recovery may be more rapid than usual as restrictions ease.

"Despite Australia’s largest economic shock in decades, markets have been quick to bounce back, bolstered by fiscal and monetary policy support.”

So far, economic data outside Victoria has been positive in Q3. To get an earlier read on the recovery in GDP at a particular point in time, ANZ Research built a high-level Nowcast model for GDP growth, which uses a variety of inputs.

As the crisis phase of the pandemic passes, the indicator should provide an early read on how GPD is shaping up.

Strong recovery in markets

Despite Australia’s largest economic shock in decades, markets have been quick to bounce back, bolstered by fiscal and monetary policy support.

ANZ Research’s Market Valuations Index (MVI) for Australia, which comprises a variety of forward looking financial market variables, suggested by the end of June markets were looking through what was expected to be a very large decline in GDP.

According to the MVI, markets are positioned for a relatively quick recovery – quicker than ANZ Research envisaged. ANZ Research anticipates the level of Australian GDP to sit below pre-pandemic levels till late 2022. So far, though, since the record collapse in GDP in Q2, much of the data have been better than expected.

Tracking economic recovery

ANZ Research’s model runs a principal component analysis (PCA) on variables and uses factor loadings to construct an index value at each point in time.

The idea is to capture the common economic trends across the variables. Comparing the quarterly index to Australian GDP over the last two decades shows it tracks GDP relatively well. There are instances when it overshoots or undershoots, but overall the two measures are co-integrated, suggesting differences do not last.

So far in Q3 it suggests a solid bounce in GDP of around 1.7 per cent quarter-on-quarter.

However, ANZ Research thinks the current monthly value of the index is unlikely to hold and will likely adjust downwards by the end of Q3 as more data is available.

For instance, ANZ Research thinks retail sales fell in August and employment probably went backwards in September. With the introduction and removal of discrete shocks like restrictions, it means more care needs to be taken when extrapolating initial quarterly values for the index from the first month or two. That said, once the first two months of the quarter are available, we’ll have  a good idea of the final quarterly average of the index.

Hot or not

Decomposing the index into individual components provides a gauge of whether parts of the economy or sentiment type are moving relative to their own trends.

As expected, most variables are below trend. Worryingly though, a number are still decelerating.

It is clear how important the fiscal support has been, with retail spending not only above trend but currently accelerating. Continued and further fiscal support will be critical to the recovery, and ANZ Research expects to see more of it come through.

Hayden Dimes is Markets Economist and David Plank is Head of Australian Economics at ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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