Exits from lockdown proceed with no major upsets / Stock markets remain cautiously positive / For now the ‘wall of money’ from central banks has quashed volatility.
As of 27 May, the global COVID-19 caseload has climbed to over 5.5 million and the death toll is now above 350 000.
The focus is firmly on the exit from lockdown. It is unclear how far and how fast the authorities can relax their containment measures without prompting a resurgence in the caseload, or for that matter, what the tolerance is for rising cases and fatalities before the authorities are forced to reverse course.
The speed limit will vary across countries and through time. Countries where the test and trace capacity is higher, where the level of acquired immunity is higher and where the compliance of the general public with the public health response is higher are better placed to exit lockdown at a faster pace than their peers.
Greater tolerance for fatalities, economic necessity or the electoral timetable may also influence the exit strategy, but the public may take matters into their own hands if they conclude that the measures are being relaxed too far, too fast. That is, the public may refuse to show up at the workplace or on the high street even when they are allowed to do so.
The US economy is gradually exiting lockdown, but scientists at Imperial College warned this week that the epidemic is still not under control in much of the country. The reproduction number (R0), which measures the average number of people that each infected person transmits the virus to, is currently above one in 20 to 30 states, typically in the south and mid-west. Here, the epidemic is still developing.
The conclusions of the paper underline how the exit strategy and the return to normality is likely to be a drawn-out and painful process.
Meanwhile, the Chinese authorities are going to extraordinary lengths to keep control of the virus. Quarantine measures were introduced in Jilin province, home to over 100 million people, to contain an upsurge in cases.
President Xi Jinping reportedly made it clear to party officials in Hubei province than they must not ‘ruin the hard-won achievement’ and allow a second wave in Wuhan. The authorities have reportedly tested almost seven million people in less than two weeks in Wuhan in response to the emergence of new cases.
According to press reports, companies in Wuhan have been testing all their employees before they return to work because they fear that their entire operation will be shut down if there is even one positive result at the workplace.
In terms of economic news, the data was deeply disappointing this week if taken at face value. The purchasing managers’ index (PMI) remains the market’s favourite indicator of global activity, being published on a consistent basis for many countries and far in advance of official data on GDP.
Indeed, some investors take the PMI as a reasonable summary number on the global business cycle. This indicator appears to suggest that the global economy was sinking deeper, into a depression, in May. We are quite sceptical.
Looking at preliminary PMI data for May, the absolute value of the indicator rose on the month, but the net balance remains far below the 50 mark. This implies that there was a severe contraction in activity between April and May.
Indeed, the composite PMI for the eurozone in May remained below the trough seen during the Global Financial Crisis. That seems almost impossible to square with what we know was happening to the economy over this period.
It would seem companies are not answering the question that is posed to them. Rather than describing how output has changed on the month, it appears likely that many companies are reporting how output compares to some normal level of production. A reading worse than the trough of the GFC would make sense on that basis.
Turning to developments on the policy front, the main news came from the National People’s Congress (NPC) in China, or to be precise, it was the absence of an announcement of a stimulus package for the economy on a scale that some analysts had been expecting.
The authorities broke with tradition and did not use the NPC to post a target for GDP growth in 2020 and instead put the priority on stabilising employment, aiming for an unemployment rate of 6%.
The fiscal stance is shifting, with the headline deficit rising to above 3.6% of GDP (breaching the 3% convention) supplemented by RMB 1 trillion of issuance of central government debt. The ‘prudent’ monetary stance is also set to shift to encourage growth in deposits and total social financing.
Still, if one of the key signposts that the market was monitoring was the announcement of ‘mega stimulus’ at the NPC, then it will have been disappointed.
Meanwhile, the Chinese proposal for a new national security law for Hong Kong has triggered fresh tensions. It challenges the ‘one country, two systems’ equilibrium since Hong Kong has been responsible under its Basic Law for drafting national security legislation.
The Trump administration is weighing its response, which could well include sanctions. China has already signalled that it would respond with ‘all necessary countermeasures’ to what it considers an interference in Chinese internal affairs.
Because this is a crisis where everyone is an innocent victim of an exogenous shock (the virus). The downturn itself is government-made: locking down the economy to protect it from a health crisis. This is important to understand because it means there are few moral hazard arguments to restrain spending and keep support safety nets wide.
For corporate debt markets, this implies that only moderate deterioration may quickly be met by more policy support. The policy easing since March has been successful in reducing volatility and stabilising the credit cycle.
The next several quarters should see subdued company risk appetite with specifically few mergers and acquisitions or share buyback activity. The cost of credit has increased vis-à-vis the cost of equity and this historically points to active deleveraging. Instead, companies are saving, like everyone else, hoarding cash.
Over time, central bank QE is the ultimate ‘wall of money’. Leading central bank programmes already total USD 4 trillion and they are not finished yet. This excess liquidity may find its way into financial assets, particularly when the liquidity hoarding ends.
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