BDSwiss Outlook: Is the Worst Over?
I tend to worry a lot. I wake up in the morning worried I won’t be able to get to sleep that night. I go to bed at night worried I won’t hear the alarm clock in the morning. My natural tendencies were only sharpened in my first job in finance, which was as a bond analyst – bonds do well during recessions, so I was always on the lookout for signs that the economy was likely to crash.
You can imagine then my reaction to the COVID-19 virus. Here was (is) the stuff of disaster movies, not reality. I watched in horror as the virus took its toll on both humanity and the financial markets. I was convinced that this is it.
And yet…much to my surprise, it looks like we may be over the worst, at least economically.
Today’s stunning turnaround in the employment data – with payrolls rising 2.5mn in May, the most on record, and the unemployment rate falling – is only one sign.
Most of the May manufacturing purchasing managers’ indices (PMIs) and all the service-sector PMIs were higher than in April, although all but China remain in contractionary territory, deeply so in most cases.
Although usually the manufacturing PMIs are the more important, because they tend to be more cyclical, this time it was the service sector that was hit the hardest. The recovery in service-sector PMIs in May is therefore a good sign, although clearly the global economy isn’t out of the woods yet.
China was the first country to face the virus and the first to come out of lockdown. Its experience may have guidance to the rest of the world about what lies ahead. Despite plunging to record lows, both the official and the Caixin/Markit service-sector PMIs are back into expansionary territory. In fact the Caixin/Markit version is at the highest it’s been since at least 2013.
Economic surprise indices for the major economies show that the data are generally coming in either better than expected (Canada, Australia, New Zealand) or are missing estimates by less than before (US, Eurozone).
Both the Reserve Bank of Australia (RBA) and the Bank of Canada (BoC) met this week and gave the same sort of cautious appraisal of the situation. The RBA said:
Over the past month, infection rates have declined in many countries and there has been some easing of restrictions on activity. If this continues, a recovery in the global economy will get underway, supported by both the large fiscal packages and the significant easing in monetary policies…(In Australia) it is possible that the depth of the downturn will be less than earlier expected. The rate of new infections has declined significantly and some restrictions have been eased earlier than was previously thought likely. And there are signs that hours worked stabilized in early May, after the earlier very sharp decline. There has also been a pick-up in some forms of consumer spending. (emphasis added)
The BoC said that “In Canada, the pandemic has led to historic losses in output and jobs. Still, the Canadian economy appears to have avoided the most severe scenario presented in the Bank’s April Monetary Policy Report (MPR).” The Bank said Q1 GDP, at -2.1% qoq, was in the middle of what they thought possible. Q2 will of course show widespread collapse (-10%-20%), but “(D)ecisive and targeted fiscal actions, combined with lower interest rates, are buffering the impact of the shutdown on disposable income and helping to lay the foundation for economic recovery…the Bank expects the economy to resume growth in the third quarter” (emphasis added)
I have to admit though that ECB President Lagarde was not so optimistic:
While survey data and real-time indicators for economic activity have shown some signs of a bottoming-out alongside the gradual easing of the containment measures, the improvement has so far been tepid compared with the speed at which the indicators plummeted in the preceding two months. The June Eurosystem staff macroeconomic projections see growth declining at an unprecedented pace in the second quarter of this year, before rebounding again in the second half, crucially helped by the sizeable support from fiscal and monetary policy.
Notice that all three mentioned “sizeable support from fiscal and monetary policy.” As I pointed out back in April (Main Street vs Wall Street), the money that governments are pumping in far outweighs the estimated loss of GDP. The major industrial countries’ central banks have so far pumped in $5.1tn into their markets. By comparison, the IMF’s (admittedly early, preliminary estimate) was for a global loss of GDP of around $3.7tn.
On top of that comes trillions and trillions of dollars of fiscal stimulus – in the US alone this amounts to another $3.6tn that’s been authorized ($1.6tn disbursed or committed, another $2.4tn authorized). This was almost exponentially more money that’s bee thrown at any problem ever before.
Of course none of this would matter if the number of people getting ill was still increasing and the lockdowns had to be continued indefinitely, but transmission does seem to have slowed significantly in many countries and many places are coming out of lockdown gradually. As Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, said, “You don’t make the timeline, the virus does.”
Are we calling success too early? The virus has by no means peaked globally. In fact, it’s just getting started in many emerging market countries, such as Brazil and Egypt. Twice as many countries have reported a rise in new cases over the past two weeks as have reported declines, according to the NYT.
However in the G10 it’s clearly on the way down, with the exception of the US, where it appears to have stabilized at a lower level. With some states just reopening, we’ll have to see how it goes. Florida for example reported 1,419 new cases Thursday, the biggest single-day increase since March.
As for the markets, they seem pretty much convinced. Chinese, US and Japanese stocks are almost back to where they were at the start of the year. Other markets have recovered much of their losses as well.
US investment-grade bond prices are higher than they were at the beginning of the year (thanks in good measure to the Fed’s purchase program, no doubt) while high-yield bonds have recovered most of their losses.
In Europe too, Eurozone peripheral bond spreads are almost back to where they started the year (+34 bps or so).
One amazing point of this recovery is that it’s happened without a breakthrough in vaccines yet. My impression is that investors are convinced a vaccine is coming eventually..
Of course, just because everyone believes something doesn’t make it true. We have no idea what’s going to happen in the future, because we’ve never seen a recession like this before. This time really is different – even the authors of the book by that name, Reinhart and Rogoff, admit that it is. Nobel Prize-winning economist Robert Schilller wrote in the NYT recently that “we shouldn’t be surprised if we see post-pandemic economic weakness over the next decade.”
The markets will want to hear next week what Fed Chair Powell’s view is. I suspect he won’t be that optimistic. Up to now he and his colleagues have worried about a “second wave;” I don’t think they’ll have changed their minds about that. So we can probably expect continued monetary support while the economy gradually recovers --- a good background for risky assets.
On the other hand, the improvement in the economy might persuade one of the US political parties that it no longer has to continue supporting the nation’s workers. A too-early end fo fiscal programs based on too-early enthusiasm could be a disaster.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.