Emerging market hot spots struggle with virus / worrying trends in US / China fights an outbreak / Fed signals lower for longer despite economic uptick / markets adopt a brighter tone.
With emerging markets still driving the global caseload of COVID-19, now at eight million, there is reason for concern.
However, the market focus remains on developments in the world’s two economic superpowers.
Exit from lockdown and easing of social distancing is underway in a large number of countries. We are concerned that the scientific criteria that were established to guide this process have not been satisfied convincingly.
The effective reproduction number R(t)[1], which describes the extent to which the authorities have the disease under control, points to a fairly tame drop-off.
Professor Matt Keeling at the University of Warwick summarised the situation across UK regions as follows: “All the ranges are closer to the critical threshold than we would ideally like to see – which means that the epidemic is declining relatively slowly. This also means we haven’t got much wiggle room for additional relaxation of social distancing measures.”
The picture on testing and tracing is also mixed, with the Oxford COVID-19 Government Response Tracker showing a clear variation in countries’ capacity to implement this critical weapon against COVID-19 outside of lockdown. In short, we are worried about the risk of a second wave.
This week saw more evidence that the US economy is bouncing back faster than expected with retail sales data increasing by almost 18% in May. This was far ahead of market expectations and unwound the lion’s share of the decline in April. The data pointed to a shift in behaviour that may persist beyond the pandemic period: online shopping is up by almost 30% on the year.
As with the recent upside surprise on the jobs numbers, we worry that you can have too much of a good thing: if the economy is recovering faster than expected, social distancing is likely collapsing faster than expected and the risks of a second wave are likely rising too.
On the policy front, the latest FOMC policy meeting signalled the pace of asset purchases can rise in response to financial conditions tightening: the Federal Reserve will continue buying government securities and agency debt at least at the current pace to ‘sustain smooth market functioning’.
Central bankers also flagged through the ‘dot plot’ that US interest rates are likely to be unchanged at least until the end of 2022. One could argue that rates are likely to stay this low for considerably longer with the jobless rate still expected to be far from the equilibrium rate in two years’ time and inflation not approaching 2%.
Exhibit 1:
Fed Chair Powell was clear that the US economy had not generated significant inflationary pressure when the unemployment rate had been at historic lows before the crisis, so we are sceptical that the FOMC will raise rates before it has more or less restored full employment.
The Federal Reserve also published details on the securities that it will buy under one of the main credit programmes. The Secondary Market Corporate Credit Facility (SMCCF) will purchase individual securities to create a portfolio that is broadly representative of the outstanding bonds in the secondary market, subject to key criteria –
Market outlook: a brighter picture
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[1] The effective reproductive number is the average number of secondary cases per infectious case in a population made up of both susceptible and non-susceptible hosts. If R>1, the number of cases will increase, such as at the start of an epidemic. Where R=1, the disease is endemic, and where R<1, there will be a decline in the number of cases. Source: HealthKnowledge
Investments in the aforementioned fund are subject to market fluctuation and risks inherent in investing in securities. The value of investments and the revenue they generate can increase or decrease and it is possible that investors will not recover their initial investment. Source: BNP Paribas Asset Management Holding.
