Host Of Central Banks In Focus

Well, last week, tech stocks had their worst week since March, with stability far from returning.  While the jury is still out, most still view the pull back in tech stocks as a healthy correction following a prolonged period of gains, blaming increased options activity over recent months for the magnitude of the decline. The buy on dip mentality is likely to continue to prevail, though tech stocks have not yet show any sign of wanting to make a convincing pull back.   

Signs of nervousness are clear; equity volatility remains elevated, but many investors are still sitting on healthy gains over recent months.  Given the low cost of funding, low returns in government bonds, alongside continued strong demand for stay at home electronics and a vaccine that could still take months to arrive, it is hard to see the tech sector falling too far.   

The fall in the pound sterling has been quite dramatic over recent weeks, both against the US dollar and euro.  Fears over a collapse in trade talks with the European Union have intensified.  The sudden waking up of the market to these risks has been provoked by the prospects that the withdrawal agreement with the EU will be torn up, prompting threats of legal action by the EU.

Time is running out to get a deal on the table before the end of the Brexit transition period at the end of the year, but UK Prime Minister Johnson has said that the internal market bill is necessary to prevent “a foreign of international body from having the power to break up our country.” The new legislation is already facing a rebellion in parliament. Against this background its hard to see GBP rally, with the currency likely to be particularly volatile over the coming weeks.

Attention this week will turn to several central bank decisions, with monetary policy makers in Poland (Tue), US (Wed), Brazil (Wed), Japan (Thu), Indonesia (Thu), Taiwan (Thu), South Africa, (Thu), UK (Thu) and Russia (Fri) all scheduled to announce their decisions.  After months of policy easing globally, this week will look rather boring, with none of the above likely to ease further.   

The Fed FOMC meeting will likely capture most attention, but there is potential for disappointment if the Fed does not provide further details on its shift to average inflation targeting in its forward guidance, even as the accompanying statement and Chair Powell’s press conference are likely to sound dovish. The US dollar has continued to stabilize, aided by the drop in GBP, but a dovish Fed could limit further upside in the short term. 

Aside from central bank decisions attention will be on US election polls, which take on more importance as the election creeps closer.  US fiscal stimulus talks have hit a wall, with little chance of progress this week, while US pressure on China and Chinese companies is likely to continue to be unrelenting as elections approach.  On the political front the race to take over Japan’s prime minister following the resignation of Shinzo Abe will conclude this week (Wed).   

Data, Earnings, Central Banks and Virus Cases In Focus

Risk appetite took a turn for the better at the end of last week despite an array of the usual suspect risk factors (accelerating Covid-19 cases, US-China tensions, rich valuations). This kept the US dollar under pressure given the inverse relationship between equities and the USD over recent weeks.  Market positioning continues to show sentiment for the USD remaining negative (CFTC IMM data revealed that aggregate USD speculative positions have been net short for 15 out of the last 17 weeks, including the last 5).  Increasingly risks of a US fiscal cliff as stimulus programs run out, with Republicans and Democrats wrangling over more stimulus and US Presidential elections will be added to the list of factors testing market resilience in the days and weeks ahead.

This week there are several key data and events including China June trade data (Tue), China Q2 GDP (Thu), US June  CPI (Tue), US June retail sales (Thu), Australia June employment data and several central bank decisions including Bank of Japan (Wed), European Central Bank (Thu), Bank of Canada (Wed), Bank Indonesia (Thu), Bank of Korea (Thu), and National Bank of Poland (Tue).  Aside from economic data and events the path of virus infections will be closely watched, especially in the US given risks of a reversal of opening up measures.  Last but not least the Q2 earnings season kicks off this week, with financials in particular in focus this week.  Low real yields continue to prove supportive for equities and gold, but very weak earnings could prove to be a major test for equity markets.

On the data front, Chinese exports and imports likely fell in June, but at a slower pace than in the previous month, China’s Q2 GDP is likely to bounce, while US CPI likely got a boost from gasoline prices, and US retail sales likely recorded a sharp jump in June. Almost all of the central bank decisions this week are likely to be dull affairs, with unchanged policy decisions amid subdued inflation, although there is a high risk that Bank Indonesia eases.  The EU Leaders Summit at the end of the week will garner attention too, with any progress on thrashing out agreement on the recovery package in focus.  Watch tech stocks this week too; FANGS look overbought on technical including Relative Strength Index (RSIs) and more significantly breaching 100% Fibonacci retracement levels as does the Nasdaq index, but arguably they have looked rich in absolute terms for a while.

There has been plenty of focus on the rally in Chinese equities over recent weeks and that will continue this week.  Last week Chinese stocks had their best week in 5 years and the CSI 300 is up close to 19% year to date.  Stocks have been helped by state media stories highlighting a “healthy” bull market, but the rally is being compared to the bubble in Chinese stocks in 2014/15, with turnover and margin debt rising.  At that time stock prices rallied sharply only to collapse.   However, Chinese equity valuations are cheaper this time and many analysts still look for equities to continue to rally in the weeks ahead.  China’s authorities are also likely to be more careful about any potential bubble developing.

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.

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.

Central Banks and Governments Act To Combat COVID-19. Will It Be Enough?

In just a few weeks the world has changed dramatically.  What was initially seen as a virus localised in Asia has spread throughout the world with frightening speed.  The shocking destruction that COVID-19 has wrought globally in both health and economic terms will not fade quickly.  The virus is destroying complacency in all areas.  Total and complete lock down is becoming key to arrest the virus’ ascent, but many have yet to change their ways, believing that they will be ok.  How naïve is that!

Governments and central banks are finally coming to grips with the economic and health costs, but also the realisation that even in many developed countries, they are woefully unequipped to deal with the health crisis that is unfolding.  Global policy makers and the public at large has gone from a phase of denial, to outright panic and increasingly into fear, which then brings forth the most aggressive responses.

Unfortunately, the lack of global cohesion amongst policy makers has meant that responses have largely been piecemeal and uncoordinated.  Two of the biggest super powers, the US and China, have despite a now forgotten about Phase 1 trade deal, become increasingly acrimonious in their dealings with each other.  This, at a time when the world is looking for leadership, is proving to be major impediment to dealing with the effects of the virus.

It is not all bad news in term of co-ordination.  Central banks globally appear to be acting in unison, even if accidently, in terms of slashing interest rates, aggressively increasing quantitative easing, flushing the financial system with US dollar liquidity and easing some of the regulatory burden on banks.  This has helped to improve market functioning, which increasingly appeared to be breaking down over recent weeks.  It may not however, prevent further pressure on asset markets given the destruction in economic  activity globally.

Unprecedented times call for unprecedented measures.  Governments are now stepping up to the plate.  Massive fiscal stimulus plans are being ramped up around the world.  G7 economies have pledged to do “whatever is necessary” and to co-ordinate actions though much has been un coordinated.  US lawmakers are currently deliberating on a stimulus package worth over a $1tn though this could rise significantly in the weeks ahead, Germany is planning to create a EUR 500bn bailout fund, and the UK has announced an “unprecedented” multi billion pound package of measures.  These are but a few of the various stimulus measures being undertaken globally.

China has yet to announce a major stimulus package, but has instead opted for more incremental measures as its economy begins to recover following a major lockdown.  However, just as China’s supply constraints are easing, demand is weakening sharply as economies globally shut down.  The implication is that China’s recovery will not be a quick one either.  More stimulus is likely.  Recent reports suggest China will step up special bond issuance for infrastructure spending, but more is likely.

Overall, the economic shock is just beginning as the health shock is intensifying.  We will need to brace for more pain in the weeks and months ahead.  We can only hope that the measures announced so far and yet to be announced alongside with strict adherence to health recommendations will be sufficient to prevent deeper and longer lasting damage.  The jury is still out.

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