Last week saw a headline grabbing rally in equity markets. Despite this, there is still considerable near-term uncertainty about the outlook for markets. This is highlighted by the continued low level of bond yields, reflecting the global recession that we are probably already in and policy rates that have fallen to close to zero, or below, across most western economies.
Given the still highly uncertain health and economic outlook, it would be premature to suggest the near-term direction of markets. As we have stated before, it is only when we are past the worst on the health issue can we become more positive about economic prospects. Currently, the economic outlook reflects a collapse in global demand.
Still far from clear is how deep and long the economic downturn will be. It seems like an eternity ago when, earlier this year, markets viewed this as primarily an Asian-focused crisis that was expected to be characterised by a ‘V-shaped’ outlook; where an economic downturn across China and Asia in Q1 would be followed by a rebound later this year.
Now, markets are discounting a global recession; this is a ‘U-shaped’ profile, with the world economy contracting sharply in Q2, remaining weak and possibly even contracting again in Q3, before recovery in Q4 and through next year. Some expect a rapid rebound, others a more gradual one, but in many respects that may depend on the length of the downturn and how much permanent damage it triggers. The longer and deeper the downturn, the harder it may be for an immediate rebound. However, because of the uncertainty about the health outlook and because the actions to contain the virus through lockdown have had such damaging economic consequences, there is a genuine fear of a slump, or depression, namely an ‘L-shape’. It is hard to predict with certainty.
There is still a considerable lack of understanding about the virus. At one extreme, the vaccine gap raises the risk that the health issues could continue into 2021, with constraints on travel and economic activity lasting for some time. Against that, the health and economic policy response globally to date, with more to come, may yet be able to fill the vaccine gap later this year, although it would presumably take time for production on the scale required to ramp up. Meanwhile, the economic policy stimulus, to date, has already been considerable although more is likely to be necessary.
The boost from global policy measures
A key focus for markets has been the unveiling of further massive economic policy measures across the globe. Centre stage has been the US approval of a $2 trillion stimulus. Its imminent implementation will see cash payments sent to most Americans, plus significant aid for business. This package has been sizeable and simple, with the aim to get money quickly to those whose income has evaporated overnight. It is a positive step. The big challenge in the US is about the scale of the health issue, and how they will respond to the surge stage in coming weeks, or months.
Also, in a virtual G20 conference last week, political leaders across the globe committed to do whatever it takes to both stem the spread of the virus and also provide economic stimulus. President Xi called for enhanced global macroeconomic policy coordination. While welcome, it is noteworthy that most countries are being driven to take action because of domestic pressure, including Germany, which has unveiled large fiscal stimulus. All these measures, globally, are aimed primarily at limiting the economic hit from the virus, with the hope that there might be an economic rebound later this year.
Financial markets are keeping a close eye on China and the rest of Asia, the region impacted first by the virus. Attention has focused on two conflicting aspects. Following the economic standstill in the first few months, there is scrutiny on whether genuine signs of economic recovery will emerge, particularly in China, where the economy appears to be in the early stage of recovery, after the lockdown has been lifted.
The other focus is on the health data and reports that Asian countries could see a second wave of the virus, imported by visitors or nationals returning from Europe, or as economies return to normal and people travel freely again. Clearly the best scenario for sentiment about the global economy would be if Asian economies could recover, albeit gradually, without a reoccurrence of the virus.
That is the market expectation. It also helps feed expectations of a global economic rebound before year-end. Yet, Japan’s decision to postpone the Olympics until 2021 highlights both the uncertainty and the long time it may take to return to some sort of normality.
Naturally, the markets are paying close attention to the health data. The lack of understanding about the virus has contributed to considerable economic uncertainty. Indeed, some are fearful that the virus takes hold across Africa, where health care systems are unlikely to cope. Or in India, where the scale of the densely crowded population poses a challenge to containing the spread of the virus.
In these scenarios, markets would then become concerned about a second wave of the virus appearing in other countries at some future stage. This, again, would focus attention on not only when a vaccine might be available but whether it could be produced in sufficient scale to be widely available in western and Asian countries to prevent a second wave.
The impact on growth
The most likely scenario is a collapse in GDP in the US, UK and European economies in Q2, mirrored by significant increases in unemployment, which along with the collapse in demand and revenues, effectively acts as a brake on growth. Policy easing in most cases is being aimed at limiting the extent of the downturn, offsetting deflationary pressures. Q3 should be better than Q2 but is still likely to be weak. Recovery is possible in Q4, but not guaranteed, and the scale of it may be heavily influenced by whether the current vaccine gap has been addressed and thus by expectations as to whether there may be fears of a second wave in the west next winter linked to the virus.
The economic cost associated with the virus is high, reflecting the consequences of lockdown. Many western economies face the risk of sharply higher unemployment, evidenced by news of a huge 3.3 million rise in weekly jobless claims in the US. In the UK, too, there has been a surge in claims for universal credit. About 5.6 million, or one in six of the UK labour force are in sectors most exposed to the economic lockdown, and although not all will lose their jobs, unemployment will soar.
Economies with flexible labour markets like the US and UK face a greater danger of large-scale unemployment, which helps explain the speed and scale of the policy measures in both countries.
The UK has unveiled another fiscal policy package. This was the fourth in the last few weeks. The first was the Budget, which unveiled a sizeable future increase in infrastructure spending. The second focused on aid to firms, with its centrepiece being a £330 billion lending facility focused on investment grade companies. Other firms, however, have since voiced some concern about their ability to access help, so it is likely that there will be further tweaks to improve the execution of policy, and also whether the focus should be on grants, as opposed to forcing more debt upon firms.
The third and fourth UK packages have been targeted on people. The centrepiece of the third was a job-retention scheme for those in employment, with the Government offering to pay 80% of the wages of workers who will now be furloughed for a few months, but who might otherwise have been sacked, in order to save jobs. The fourth stimulus package provided support to the self-employed, but its biggest problem is the delay in getting money to those large numbers in need. The likely scale of the collapse in demand justifies as well as explains the approach taken, although further measures may yet be needed. As a result, the UK will join all other western economies in seeing a sizeable rise in government debt to GDP ratios.
Finally, while government measures have grabbed the headlines, the markets have been supported and reassured by the actions of central banks. In the UK, for instance, monetary policy has been supportive, with policy rates cut to 0.1% and Quantitative Easing boosted by £200 billion. Most significantly for the markets, the US Federal Reserve has continued to add liquidity and assistance, fulfilling its commitment to provide “unlimited” measures.
There is still considerable uncertainty, but bond and equity markets have appeared to take some heart at least from the global macro policy response that continues to be both unlimited and unconventional.
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