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‘The oil price collapse could signal a huge deflationary shock to come': economist

Frances Donald, Manulife Investment Management Chief Economist & Head of Macro Strategy, joins Yahoo Finance’s Alexis Christoforous, Brian Sozzi and Heidi Chung to discuss the market action amid the coronavirus pandemic.

Video Transcript

BRIAN SOZZI: Frances, good to see you a hint. What do you think? Where's your estimate for the jobs report on this coming Friday? By some estimates, we might actually see an increase over 90,000. But by the same token, the report might be pretty useless.

FRANCES DONALD: Yeah, it's backward-looking. The sample size is too far in the rearview mirror at this point. It's about where are we going in April, May, and June, and how deep do we go? But I'll say that I really believe this market has priced in a very severe contraction in Q2.

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We know-- everybody knows-- it's going to be the biggest contraction we've seen in modern economic history. Right now the markets are focusing on, when do we get the rebound and is it enough to unwind everything that we witnessed in the course of Q2?

ALEXIS CHRISTOFOROUS: Frances, what about the effect of oil on this market? I'm putting this to really all of our market guests today. We're hearing from Goldman Sachs we could in fact see negative oil prices. What's the broader implication for the US economy if that were to happen?

FRANCES DONALD: Well, thank you for asking this question, because everyone talks to me about COVID-19 and what the Fed is doing, but this oil price collapse is so significant to the market and to growth. We're not just talking about investment pulling back. This has implications for the US dollar. It is related to a huge deflationary shock that's about to come. And of course, it gives this big divide between EMs who are importers and exporters.

When you have oil price shocks that are of this magnitude, they change the balance of the economies. They are accelerants on top of all the problems that we're witnessing because of COVID-19. I'm struggling to be positive on this market until we see some floor in oil. Even though we have fiscal packages, even though we have monetary policy, I need that oil price to resume. Otherwise, there's a lot of shaky components underlying credit, business investment, and currencies.

ALEXIS CHRISTOFOROUS: So Frances, if I'm hearing you right, you're saying that until we start to see a bottom in oil, equity markets can't really begin to rebuild in a meaningful way? Well, that's right. I have three issues that I want to see resolved before I really get gung ho on this market. We need to see those case counts peak, or at least the acceleration in case counts of COVID-19 peak.

We need to see that the issues in credit markets that the Fed is trying to fix are indeed fixed-- very good news on that front. I will say, I'm very happy to see a lot of those spreads coming in, particularly on corporate credit. But then we also need those oil prices to stabilize, because if we have negative oil, we're running at oil in the single digits, it's really difficult for us to be bullish on our recovery and economic growth, particularly in the United States.

HEIDI CHUNG: Hi, Frances. It's Heidi Chung here. So we have Saudi Arabia and Russia both holding [INAUDIBLE]. Do you think either one of them is going to fold at this point? And if they do, who's going to fold first?

FRANCES DONALD: I don't know. I'm not in the room. And this is one of the ongoing problems. If you're an economist or a market strategist, all of a sudden your issues that you have to grapple with to make your forecasts have to do with what's going on on a geopolitical front, and then what's happening on medical cases. These are totally outside of the realm of understanding what most of us are used to dealing with. So we have to take a day as it comes.

And this is one of the reasons why, until we see some sort of floor-- even on technicals here-- it's difficult for us to be really clear-headed and have understanding of where we're going next.

BRIAN SOZZI: Frances, I've had several sources tell me, give me some wide-ranging numbers for the employment reports for April and May. April, one source told me, might show over 1 million jobs lost on the headline. Another one told me 500,000 jobs. What's your estimate?

FRANCES DONALD: Yeah, so here's how we have to think about this. We typically see the weakness of a recession occur over 11 months. That's the average drawdown we see in growth.

What we're going to witness here is completely out of those regular estimates. We're probably going to see the damage created in a typical garden variety recession or worse occur in two to three months. So it's entirely possible that we do see $1 million-- a million jobs, for example, occur in a compressed period of time.

But what we have to remember is that this economic cycle is very compressed. As much as the drawdown is going to be very, very short-- maybe it's three months instead of 11-- the bounce back should also be shorter than what we've seen historically. So it's not about the depth of the weakness that we see here. It'll be about the duration and how much we unwind.

So point forecasts on non-pharm payrolls right now is not really going to be a helpful market indicator for where we go next. I suspect a lot of it is priced. And it's all going to occur in a very short period of time.

ALEXIS CHRISTOFOROUS: Frances, what about investors' optimism when it comes to some of these health care stocks, like Abbott Labs? Johnson and Johnson today saying now it's working on possibly having human tests of a COVID-19 vaccine as early as September. Are investors getting a little too optimistic about those particular stocks?

FRANCES DONALD: Well, when you were going through the news of the day, I couldn't help but think we have two big headlines today, health care and technology doing very well but those oil prices dropping. This is a really good metaphor for what COVID-19 is going to do to our broad economy. It's going to change our perspective on key sectors.

If you're looking at the economy moving forward, you're thinking about the Fourth Industrial Revolution and the need to expand on telecoms, on that entire infrastructure that's very bullish for that sector. Health care is, of course, going to take up a much bigger perspective for us as we move forward, and energy backing off.

So exactly what we're describing, what we're seeing happening on a day to day, is symptomatic of broad sectoral shifts. And frankly, the way we have to think about the entire economy as a whole, what's happening now is going to change us for many, many years to come.

BRIAN SOZZI: Frances, I spent my weekend going back and reminding myself of what happened to the economy during 2008 and 2009. And into 2009, we did see a spike in oil prices. And I remember feeling, wow, that was very worrisome. Do you think we get that-- I wouldn't say a super spike again, but we get a spike later this year as the economy kicks into gear?

FRANCES DONALD: It's entirely possible. And we may have some resolution of geopolitical contests. And so this is why we have to think about deflationary pressures now and inflationary pressures later down the curve. This is why this curve is steepening, why I love that trade. I think steepeners are a great trade in this type of environment.

But you're right. In the past, we've been concerned about oil prices boosting much higher. Why? Because in the past, the US was better positioned from a consumer perspective to see lower oil prices. But now, the US economy comes out about neutral or even worse off when oil prices fall, because consumers, through their jobs and their income, are now levered to the shale energy patch.

So when we see oil prices fall now, that's actually a negative for the US. Whereas even in 2009, that would not have been the case. Again, emphasis on the structural changes that we're seeing in the economy and how different situations are occurring or are playing out very, very differently than they would have even 10 years ago.

BRIAN SOZZI: All right. Frances Donald, Chief Economist, Head of Macro Strategy at Manulife Investment Management. Real good insights. Thanks for taking a few minutes.

FRANCES DONALD: Thanks for having me.