Hot spots in Latin America, India and the Middle East / Brazil charts its own course / will the US see a second wave / caution: US jobs data / more stimulus from the ECB and a German package.
Emerging markets have been driving the rise in new cases, with the global total passing the 7.2 million mark as of 9 June, and Latin America, India, and the Middle East the current hot spots.
Markets have been focusing on developments in the US, both on the exits from lockdowns in states and the possible impact of the large-scale protests over the death of George Floyd on the spread of COVID-19, and on surprisingly solid labour market data.
Brazil stands out
Among the emerging markets, Brazil with more than 37 000 deaths is set to become second only to the US in terms of the cumulative death toll. This comes at a time when an army general with no medical training was confirmed as the third (acting) health minister since the start of the pandemic.
The Brazilian government has announced that it will no longer release the total number of deaths until after a review and is threatening to withdraw from the WHO over ‘ideological bias’. Meanwhile, the exit from lockdown looks potentially premature given a national death toll of more than 1 000 per day for the past five days.
Coronavirus in the US: plenty of reasons for concern
In the US, the picture remains mixed: Utah, Arizona, North Carolina, Tennessee, Georgia, and Arkansas have all reported new cases growing over a five-day moving average. In Arizona, the rise in the cases meant that over the weekend, Arizona’s largest health system reached capacity on ECMO lung machines and warned it is nearing overall ICU capacity.
The three most populous states – California, Florida and Texas – all reported more new cases. Other factors such as widespread COVID infections in the US meatpacking plants continue to boost the growth in new cases: at one pork facility, of the 2 303 team members tested, 591 were positive.
Epidemiologists are concerned over the potential for a spike in cases resulting from the protests against police brutality. There are offsetting factors such as the gatherings being outdoors and protestors generally wearing facemasks. Of course, factors such as gatherings in large groups, the use of tear gas, shouting, and arrests may make the situation worse.
This comes on top of the impact of mobility restrictions being lifted across the states, as reflected in rising hotel occupancy rates, recovering intermodal rail traffic, rising demand for petrol and slightly more traffic at airport security checkpoints. Relaxation of the lockdown measures in the context of the still-worrying infection trends in some states raises the risk of a second wave.
Financial markets may be underestimating this.
Data from the US: stunning jobs numbers, or are they?
On the data front, there is no doubt about the news of the month: the stunning surprise in the US labour market data. Employment for May surpassed expectations by an astounding 10 million jobs. The unemployment rate came in over 5.5 percentage points below expectations. This may suggest the US economy is recovering much faster than expected. We think the story is more complicated.
The cumulative loss of jobs is still enormous. The unemployment rate is far higher than anything seen in the last recession. Almost five million more Americans than normal were classified as employed while they are absent from work. One sub-sector – restaurants – accounted for a large share of the job gains. More broadly, workers who were temporarily laid off earlier this year were hired back, possibly so that employers could quality for converting government loans into grants.
We are concerned that markets are focusing only on the positive. However, these are not normal circumstances. If economic activity is recovering faster than expected, social distancing could be waning faster too, opening the US up to the risk of a resurgence in cases.
ECB: more support, but not indefinitely?
On the policy front, this week saw stimulus news from the ECB and the German government.
The ECB announced a EUR 600 billion expansion of its pandemic emergency purchase programme and extended the PEPP by six months to at least end-June 2021. This implies that the central bank will continue to ease financial conditions actively for at least another year.
The ECB committed to reinvesting PEPP proceeds until at least the end of 2022 ‘to avoid interference with the appropriate monetary policy stance.’ This is in contrast with the reinvestment policy for the pre-pandemic asset purchase programme (APP). The implication is that the PEPP portfolio could go into run-off far sooner than investors may imagine. We would argue that the optimal guidance would be for reinvestment to continue for the near future.
Among the ECB’s new macroeconomic projections, the most interesting aspect was the forecast that core inflation would remain below 1% even in 2022. The message is clear: the ECB is falling well short of its price stability mandate over the forecast horizon. Does this mean that further major monetary stimulus is in the pipeline to close that gap? Or is the governing council relatively sanguine about inflation settling clearly above zero percent, but also clearly below 2%?
German stimulus: leading the way in Europe?
German finance minister Olaf Scholz said the new stimulus package was designed to catapult the economy out of the recession with a ‘ka-boom’. Adopting a slightly more measured tone, the Bundesbank estimated the measures could raise German GDP by 1% in 2020 and 0.5% in 2021.
The EUR 130 billion package amounts to almost 4% of GDP, although on closer inspection, it does include untapped funds from an earlier t stimulus package. It includes an eye-catching temporary cut in VAT from 1 July, EUR 30 billion for long-term investment projects and a EUR 300 payment for every child.
Of course, no sooner had the German government announced the measures or concerns started to build about whether other European countries that enjoy less fiscal space would be able to follow suit. This is why the latest ECB announcement on the PEPP was so important.
- Equity markets had a solid week, with the MSCI World index returning to the level of late February. Equities are still down, though, compared with the end of 2019. The recent gains came in spite of higher long bond yields and reflected a risk-on mood. This could also be seen in the slippage of the US dollar, lower risk premiums on corporate bonds and a narrower risk spread of Italian government bonds over German Bunds.
- Sentiment was supported by a slight improvement in purchasing managers’ data from April to May, fanning market expectations of a bounce in wider economic activity. The optimism radiated back on oil prices, which rose on hopes for an increase in demand. Further support came in the form of the latest ECB measures and the US labour report.
- While the numbers are not, in our view, what they seem, the positive surprise in last week’s US payrolls data has boosted market sentiment. At the moment, the lifting of lockdown restrictions globally is boosting mobility and economic activity. A ‘spring back’ is gathering momentum. It may even be stronger than expected, but we see a significant risk that restrictions are being lifted too early, spawning a second wave of infections.
- Financial conditions are now fully accommodative in the US, supporting the risk-on move and the rebound in the S&P index. Europe still has to catch up further (see Exhibit 1) since, despite the ECB’s expansion of the PEPP, financial conditions are still restrictive. However, the increased stimulus and the now coordinated European Commission proposal reduce a dispersion in European risk. Financial conditions in Europe are now likely to become more accommodative. This could support European equities, credit, ‘peripherals’ and the euro.
- The central bank backstop with ever-growing balance sheets, coupled with expectations of further fiscal stimulus, should continue to prop up markets into the summer. Currently, stimulus outweighs the economic fundamentals, making it the key support for markets.
- No major announcement is expected from Wednesday’s FOMC meeting. However, Fed Chair Powell is likely to refer to discussions on forward guidance and yield curve control in the Q&A session. Announcements on YCC and forward guidance are more likely to come in July.
- As we noted last week, the supporting factors for the US dollar have eroded: carry and growth advantages versus the rest of the world have dissipated and US political risk, once a US dollar supportive factor, has now become a headwind.
- A slow weakening of the USD is expected to continue to produce a stronger backdrop for emerging market carry trades.