Fed, ECB, BoJ In Focus This Week

Three major central banks meet to decide on monetary policy this week, but after massive and unprecedented actions over past weeks, there is likely to be little new in terms of additional policy measures announced by the US Federal Reserve (Fed), European Central Bank (ECB) and Bank of Japan (BoJ) in the days ahead.  Key data this week include US Q1 GDP, the April US ISM manufacturing survey and China’s April purchasing manager’s index (PMI).

The Fed has thrown everything but the kitchen sink at Covid-19 to combat the severe economic and market impact emanating from the virus.  This included aggressive rate cuts, unlimited asset purchases (Treasuries, MBS), purchases of commercial paper, loans to small businesses, easing rules for banks and provision of US dollar swap lines with other central banks to help ease global USD demand pressures.  Aside from some fine tuning, there may not be much else the Fed will do at its meeting on Wednesday. Meanwhile the US ISM survey (Fri) is likely to post a sharp decline (consensus 37.0).

Markets have reacted well to the measures announced and implemented so far, but as noted there is a growing disconnect between the rally in equity markets over recent weeks and rapidly worsening economic data.  US Q1 GDP data (Wed) this week will likely reveal some of the damage, with a 4% q/q annualised fall in GDP forecast by the consensus. Q2 GDP will be even weaker however, as most of the weakness in activity will have taken place in April and will have likely continued into May and June.

The ECB continues to face pressure to do more as Eurozone activity continues to plunge.  So far the main thrust of the ECB’s measures are EUR 750bn of bond purchases and loosening of restrictions on such purchases.  However, sovereign spreads, especially in the periphery (especially Italy) are under pressure and the ECB may need to act again soon though perhaps not as early as the meeting this Thursday.  The ECB will also likely shift the onus of further easing to fiscal, especially the proposed “recovery fund”, which continues to fuel major divisions between European countries.

Last but not least the BoJ meeting on Monday will probably be the most active in terms of new measures, but on balance they will probably do little to move markets.   At the last meeting the BoJ significantly increased the amount of ETFs they would purchase, which to some extent has helped the Nikkei 225 rally over recent weeks.  At this meeting the BoJ is unlikely to alter its negative interest rate policy, but is likely to remove its JPY 80 trillion cap on JGB purchases and announce an increase in corporate bond purchases along with other measures to ease credit.

On the data front China’s official manufacturing PMI is likely to remain around or just above the expansionary threshold of 50 as much of China’s supply side of the economy opens up.  However, the ability to retain expansion at a time when global demand and therefore China’s export markets are collapsing, will prove difficult.  China’s authorities appear to be increasingly realising this and have stepped up support both on the fiscal (via special bond issuance) and monetary side (targeted cuts in various rates), but so far the scale of easing has been limited and Q1 growth was especially weak.

Look Past The Data At Your Peril

Markets have been willing to look past weak economic data despite the spate of dire economic releases recently, even as economic forecasts have been not been revised as aggressively lower as they should have been.  Reality may come back to bite. It is one thing to look past the data, but a reality check may lie beyond.

Economic forecasts continue to come in below expectations in the US; the Citi US Economic Surprise Index (a measure of data releases relative to consensus expectations) fell to a record low last week.  Among the key releases last week was US weekly jobless claims, which revealed another 5.245 million Americans filing first time claims for unemployment insurance. The total has now reached over 22 million, highlighting that the US jobless rate could reach above 15%.

Weak data has had little bearing on equity markets, which continue to rally on signs of virus curve flattening, expectations of economic re-opening, stimulus measures and vaccine hopes.  For instance the S&P 500 is now almost 30% above the lows set on March 23 having rallied strongly over recent weeks. This week attention will turn to Q1 corporate earnings though the signals will be more difficult to discern as increasingly companies are withdrawing forward guidance and ranges for earnings expectations look very wide.  Against this background earnings outliers are likely to provoke a bigger response.  Key earnings this week include IBM, P&G, Netflix, Snapp, ATT, Delta, and Intel.

Sentiment will also be directed by moves to open up economies.  However, this is likely to be a very drawn out process, suggesting scope for disappointment. For example, in Harbin, China, a new cluster has recently forced the authorities to reverse opening up measures. In the US there has been growing demonstrations against lockdown measures. Some states are about to ease restrictions, but they only account for a small proportion of GDP.  While there is a growing push to open up economies to avoid further economic pain, to do so prematurely, would threaten to inflict a new wave of infections.

Meanwhile oil is continuing to garner plenty of attention and unlike stocks, maybe more reflective of the economic pain ahead, with prices continuing to slide, and near term prices for West Texas Intermediate (WTI) trading at major discounts to later contracts. Fears that storage facilities in the US will run out of capacity are keeping the pressure on near term prices despite the OPEC+ deal to cut 9.7mn barrels a day of output.  Demand fears are adding to the downdraft on prices, with China’s Q1 GDP data, which revealed that growth fell by 6.8% y/y, highlighting the intensifying demand pressures on crude.

Everything But The Kitchen Sink

Since my last post there has been an even bigger onslaught of fiscal and monetary stimulus measures globally in an attempt to combat the devasting health and economic impact of COVID-19.  Fiscal stimulus in the US will amount to over 10% of GDP while the Federal Reserve’s balance sheet is set to grow further from an already large $6+ trillion at present as the Fed throws everything but the kitchen sink to combat the impact of the virus. There is already preparations underway for another phase of fiscal stimulus in the US.

Europe meanwhile, has struggled to agree upon a package given divisions between the North and South of the region, but eventually agreed upon EUR 500bn worth of fiscal stimulus while the ECB is undertaking renewed asset purchases in a new quantitative easing programme.  Many other countries have stepped up their efforts too.  All of this will provide an invaluable cushion, but will not prevent a massive economic downturn, nor will it stop the virus from spreading.

Markets have attempted to look past the growing economic risks, spurred by data showing that in many countries the rate of growth of coronavirus cases has slowed, including in those with a substantial number of deaths such as Italy and Spain.  Even in New York, which has been the epicentre of COVID-19 infections in the US, there are positive signs though it is an ominous sign that the US has now recorded the most deaths globally.

This move towards flattening of the curve has fuelled hopes that many countries will soon be able to emerge from lock downs.  In China, which was first in, most of the manufacturing sector has opened up, while there has even been some relaxation of measures to constrain movement of people.  The net result of all of the above last week, was the biggest weekly rally in US stocks since 1974.

While the 25%+ rally in US equities since their lows is reflecting this optimism, there is a major risk that this is a bear market rally given the risks ahead.  Economic growth estimates continue to be revised lower and the IMF’s revised forecasts scheduled to be published this week are likely to show a global economy on the rails, with growth likely to be at its worst since the Great Depression according to the IMF’s Managing Director.  Emerging markets, which do not have anywhere near the firepower or health systems of developed economies are particularly at risk.

At the same time earnings expectations have yet to reflect the massively negative impact on corporate profits likely in the months ahead; Q1 earnings to be released in the days ahead will be closely watched.  Not only are earnings expectations likely to be revised substantially lower, but many companies will simply not survive and many of those that do could end up in state hands if they are important enough.  Separately there is a risk that shutdowns last longer than expected or once economies begin to open up there another wave of infections.  These risk have not yet been fully appreciated by markets unfortunately.

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