Vaccine is a wild card for the economy

Putnam Fixed Income Team, 07/22/20

  • We believe a vaccine will be supportive of risky assets even if the economic benefits take longer to materialize.
  • We are still far from herd immunity as policymakers continue to grapple with lockdowns and contact tracing.
  • Policymakers and businesses will need to find a balance between boosting economic activity and containing the coronavirus.

To understand the trajectory of the global economy and the myriad of positive and negative data surprises, we need to discuss the virus. Over the long term, things really are pretty simple: In our view, normal life will return only when the virus ceases to be a threat. We believe that this, in turn, could happen in one of three ways: Herd immunity will develop through the natural progression of the disease; a successful vaccine could be developed; or the virus could mutate into a less harmful form or be seen as relatively harmless.

What is herd immunity for COVID-19?

In the short term, the virus can be controlled through lockdowns, contact tracing, and isolation. Still, the economy can’t function normally on that basis. Herd immunity is probably a bit further along than the official data on cases indicate. There are quite a few studies that suggest this. There’s the New York City study on antibodies. Scientists have also been sampling wastewater and finding much higher levels of SARS-CoV-2 (the pathogen that causes COVID-19 disease) than would be consistent with the number of reported cases.

Even so, with a virus as transmissible as SARS-CoV-2 we would need something like two-thirds of the population to have the antibodies for herd immunity to become effective. We are nowhere near this even on wildly optimistic calculations. We believe developing herd immunity through the natural course of the disease will take quite a while.

The vaccine race

There are people who are optimistic about the prospects for a vaccine. Economists attach a lot of importance to incentives as they can motivate rapid development. Currently, there are at least 125 vaccines being developed. Three are in Phase 3 trials. In China, a vaccine was approved for limited use and is being given to the Chinese military. For a vaccine to accelerate achieving herd immunity, there needs to be progress on the scientific, regulatory, and manufacturing fronts.

For a vaccine to accelerate achieving herd immunity, there needs to be progress on the scientific, regulatory, and manufacturing fronts.

Making a vaccine that is safe and effective has proved impossible for some infections and relatively straightforward for others. The easing of regulatory barriers helps with the timetable, but it is difficult to imagine a large enough supply of a vaccine being available in the near term. Although we are optimistic on this front, it will be difficult to see how it is a story for the economy in 2020. At the same time, in our opinion, any good news on this front will be supportive of risky assets even if the economic benefits may take a lot longer to materialize.

The virus remains harmful

So, we come to the final aspect: the possible mutation of the virus and the threat it poses. According to various reports, the virus is mutating fairly rapidly, but not into a less harmful form in the way that the 2003 SARS virus did. So, we believe it will remain broadly unchanged in medical terms. Deaths were — and remain — mostly concentrated among the elderly and those with other medical conditions.

What really matters for the economy, however, is how policymakers and the public perceive the threat.

Estimates of the death rate from the virus continue to drift lower. What really matters for the economy, however, in our opinion, is how policymakers and the public perceive the threat. We believe understanding this is the key to seeing where the economy is now and where it might be going, in the absence of herd immunity.

The state of the economy

Policymakers around the world imposed lockdowns in the early days of the outbreak. The private sector’s behavior changed in response to the perceived risks and the movement restrictions. Businesses encouraged staff to work from home, cancelled conferences, and restricted travel. Households shifted their spending patterns, avoiding the types of economic activity where the risks of disease transmission seemed to be high. This initial set of responses caused dramatic collapses in economic activity.

As indicators trickled in, we witnessed a spectacular economic drop. This is true of China, Brazil, Europe, the United States, and many other places. It is also the case that most countries saw real progress in their virus data; as economies collapsed, so did the patterns of social interaction that allowed the virus to infect so many people. The economic collapse was the result of the policy measures, the behavioral response, and their interaction.

One important question in this context is what households respond to: Are they more worried about case counts, hospitalization rates, or death rates? As we look at the data, case counts seem to matter most. We believe the recovery will struggle to maintain a decent pace until households perceive much lower risks from certain types of employment-generating activity.