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.

Combating Recession Risks

Following a volatile last week market attention will remain on trade tensions, measures to combat the risks of recession and will turn to the Jackson Hole central bankers’ symposium at the end of the week. The inversion of the US yield curve has led to growing expectations that the US is heading into recession and has spurred inflows into bonds. As a result US Treasury yields continue to fall and the stockpile of negative yielding debt has risen to well over $16 trillion. While economic data in the US remains relatively firm, the picture in the rest of the world has deteriorated sharply as reflected in weakening German and Chinese trade, against the background of a weak trade backdrop.

There have been some mixed headlines on trade over the weekend – Larry Kudlow, Director of the National Economic Council under President Trump, said yesterday that recent phone calls between US and Chinese trade negotiators had been “positive”, with more teleconference meetings planned over the next 10 days.  Separately US media reported that the US commerce department was preparing to extend a temporary license for companies to do business with Huawei for 90 days. However, Trump poured cold water on this by stating that “Huawei is a company that we may not do business with at all”.  A decision will be made today.

In the wake of growing expectations of recession, attention is turning on what will be done by governments and central banks to combat such risks.  The Jackson Hole meeting on Thursday will be particularly important to gauge what major central bankers are thinking and in particular whether and to what degree Federal Reserve Chairman Powell is planning on cutting US rates further.  We will be able to garner further evidence of Fed deliberations, with the release of the Fed FOMC July meeting minutes on Wednesday.

While central bankers look at potential monetary policy steps governments are likely to look at ways of providing further fiscal stimulus.  Kudlow stated that the US administration was “looking at” the prospects of tax cuts, while pressure on the German government to loosen is purse strings has also grown.  Even in the UK where a hard Brexit looms, the government is reportedly readying itself with a fiscal package to support growth in the aftermath.   Such news will come as a relief to markets, but recession worries are not likely to dissipate quickly, which will likely keep volatility elevated, and maintain the bias towards safe haven assets in the weeks ahead.

A world of lower yields

This is yet another important week for Brexit deliberations as UK Prime Minister May, under pressure to resign, may bring her Brexit deal agreed with European Union back to Parliament.   Parliament could vote on different Brexit options in a series of indicative votes as early as Wednesday, including possible options of a soft Brexit or second referendum.  MPs will decide today whether to take control of the parliamentary agenda.  GBP meanwhile continues its two steps forward, one step back trajectory, but appears to be finding solid demand on any down step.

Also in focus this week will be a number of Fed speakers who will speak at a time when bond yields are sliding globally.  Markets were roiled by growth worries at the end of last week following a sharp drop in German manufacturing confidence (The Markit/BME PMI fell to 44.7 in March from 47.6 in February), which dampened hopes that weakness in the Eurozone economy would be temporary.   Taken together with dovish comments from G10 central bankers, the net result was an inversion of the yield curve and German bond yields turned negative.  Such signs have in the past been associated with the onset of a recession.

Despite a host of factors including lower US yields, a more dovish Fed stance, markets shifting towards pricing in US rate cuts, and restrained USD, emerging market (EM) assets have not benefitted greatly.  EM assets are torn between these factors on the one hand and global growth concerns on the other.  A host of idiosyncratic factors, whether it is political noise and pension reform in Brazil, or the impending Moodys’ review of South Africa this week, Thai elections etc, etc, are also resulting in more discriminatory investing.

US –China trade talks will also continue to be in focus this week, with the US administration’s Lighthizer and Mnuchin schedule to be in Beijing on March on Thursday and Friday to meet with China’s Lie He, who is planned to travel to Washington in the week after.  Structural issues such as technology transfers, state subsidies and intellectual property and the removal of all tariffs, have been stumbling blocks so far.  Latest reports reveal that China is refusing to back down on US demands that it eases restrictions on digital trades.   The absence of progress on trade talks are yet another reason for markets to trade under a shadow.

 

What to watch in Europe and Japan this week

European equuty markets ended higher last week shrugging off some disappointing manufacturing and service sector survey readings. The highlight of the Eurozone calendar this week is today’s release of the February German IFO business confidence survey which is expected to register a small increase from the 110.6 reading in January, supporting the message that German growth is consolidating over Q1 14.

Eurozone inflation readings will be important too, with the flash reading of February HICP inflation released at the end of the week set to record another soft reading of 0.7% YoY, supporting the case for further policy easing from the European Central Bank soon.

While the EUR may benefit from a firm IFO reading any gains will be short lived. Soft inflation will help cap gains in the currency especially given the renewed warning this weekend by ECB President Draghi of more policy action if needed.

Elsewhere, data this week will reveal that the main measure of Japanese inflation appears to be peaking around 1%, with core inflation set to decline over coming months. After last week’s softer than expected Q4 GDP reading the pressure on the Bank of Japan for monetary action and in turn a weaker JPY will continue.

Meanwhile, Japan’s job data is expected to reveal that the unemployment rate held steady at 3.7% in January. USD/JPY will remain support around its 100 day moving average at 101.65.

German election results help the euro

St Louis Fed President Bullard put a dampener on the market’s euphoria in the wake of the Fed’s postponed ‘tapering’ announcement. He noted that the Fed’s decision was “borderline”, implying that the Fed was not far from pulling the trigger to the commencement of tapering. Going forward, the timing of tapering will be highly data dependent and obviously recent weaker data releases and possibly the political complications surrounding extending the debt ceiling and agreeing on a budget, played heavily on the Fed’s conscience. However, there are now plenty of questions about the Fed’s communication strategy. There will plenty of Fed speeches over coming days to provide more clarity although Janet Yellen, front runner to succeed Ben Bernanke as Fed Chairman, appears to be keeping conspicuously quiet.

A bounce in China’s September manufacturing confidence revealed this morning as well as a strong outcome in the German elections for Chancellor Merkel (see below) will nonetheless, help to settle some market nerves as the week commences. Merkel’s CDU/CSU party is set to win close to 42% of the vote, which amounts to a very strong mandate. Nonetheless, she will still fall short of an absolute majority while Merkel’s coalition partner the FDP failed to gain enough votes to pass the 5% threshold to win any parliamentary seats means that a new coalition government will need to be formed. The EUR has reacted well to the result, remaining above 1.3500 versus the USD and looks to set consolidate gains over the short term.

Aside from various Fed speakers there will be several data releases to digest over the week. In the US there will be September consumer confidence, August durable goods orders, new home sales, personal income and spending, and revised Q2 GDP data on tap. Overall US data will be reasonably good, with in particular GDP set to be revised higher. In Europe, aside from digesting the German election result there will be a host of business and manufacturing surveys including the German IFO business confidence survey. Consolidation or moderate improvement is expected to be revealed in these surveys, likely giving sufficient support for the EUR to maintain recent gains.

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