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The IMF Delivers a Reality Check. Will Italy and Spain Deliver Brussels Another?

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Through the early part of the European session today, we saw the majors give up gains from Tuesday.

A run of 5 consecutive days for the CAC40 and EuroStoxx600 had come off the back of fresh optimism.

This optimism was not from hopes of a less severe impact of COVID-19 on the economy but on countries reopening for business.

Once more, however, the markets and governments appear to be ignoring China’s model.

This time around, with China now dealing with returnees infected with COVID-19. This coincides with a number of U.S States looking to loosen confinement measures.

For the EU, the likes of Spain, Italy, Germany, and France will also be looking to get their economies up and running.

It is perhaps not too surprising when considering the IFM’s latest economic forecasts for the current year.

The Forecasts and the Markets

The fixation on the COVID-19 numbers ahead of the IMF‘s forecasts was evident in the markets. Even the worst economic indicators on record had not been enough to stall the global equity market rebound.

Just as investors were preparing for the earnings season, the IMF delivered its reality check.

If investors were thinking that the global financial crisis was bad, the IFM figures are preparing the markets for far worse…

The global economy contracted by 0.1% during the global financial crisis. For 2020, the IMF has forecast that the economy will contract by 3%. To make matters worse, the U.S is forecast to contract by 6%, and the Euro area by a whopping 7.5%.

Somewhat surprisingly, it has taken the IMF to remind the markets of what lies ahead. It’s not just the current spread of the virus that must be considered but also the longer-term economic impact.

It goes without saying that, the greater the contraction the less likely a V-curve rebound will be.

For that very reason, the IMF poured cold water on those projecting a V-shaped economic rebound in the U.S.

Service sector economies are certainly at the mercy of the virus and the lockdown measures taken by governments. But manufacturing and export economies are unlikely to be better off. A marked surge in unemployment, by levels never seen before, means that demand for just about everything will take time to recover.

So, when factoring the growth outlook, unemployment and the fact that borders will remain closed for some time to come, some pullback is due.

Fiscal and Monetary Policy Support

When considering the measures taken by governments and central banks to combat the effects of COVID-19, the EUR should be on a much less steady footing.

EU Finance Ministers managed to agree to a €500bn package for member states. Throw in the forecasted 7.5% contraction for 2020 and that support looks particularly small. Even more so when you consider the support delivered by the FED and the U.S administration.

On the face of it, it’s not too surprising to see the Dollar on the move and for the European equity markets to see red.

It remains to be seen whether this is the beginning of the big correction, however. Much will depend on what is in store from a monetary and fiscal policy perspective.

For Italy and Spain, forecasted contractions of 9.1% and 8.0% respectively will once again raise the possibility of a break from the EU.

Years of austerity followed by an economic meltdown will have voters demanding more support from Brussels. A failure to deliver will undoubtedly lead to the talk of a breakaway once more.

At the time of writing, the EUR was down by 0.66% to $1.09070. After having visited $1.14 levels in March, is the EUR facing the prospect of a return to sub-$1.06 levels?

Any chatter from Spain, Italy and possibly from Germany on the viability of the EU project and we may even see parity against the Dollar…

The worse economic meltdown since the Great Depression certainly warrants more than the March sell-off. After all, that sell-off came well before the markets had any sense of what economic mayhem COVID-19 has created…

This article was originally posted on FX Empire

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