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Headlines
- US initial jobless claims shot up to an unprecedented 3.3 million, close to the 3 million we were predicting (vs. 1 million consensus)
- Markets shrugged off the news and rallied again for the third consecutive day, leaving the S&P 500 18% above the 23 March close
- Evidence of a potential second wave of contagion in Asia keeps mounting with China banning foreign arrivals
- New policy measures across the world include South Africa announcing QE, and fiscal packages in Singapore ($33.7 billion, 10% of its GDP and the most aggressive response in Asia), and India (a modest $22 billion, <1% of GDP)
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Dire data was again the ‘special of the day’ with US initial jobless claims reaching 3.3 million, blowing past all records and consensus expectations. Markets completely shrugged off the news, rallying for the third consecutive day and leaving the S&P 500 some 18% above the lows recorded at the end of Monday and about 14% up so far this week.
Taken jointly and at face value, the seemingly contradictory macro data and market reaction would suggest that investors have not only fully priced in a sharp recession, but also significantly raised the likelihood of a swift bounceback in economic activity and reduced the odds of an L-shaped recovery. Our assessment is somewhat less benign. As laid out in yesterday’s Recession Watch, the prospects for the global economy have become more bimodal with the chances of both a sharp recovery and a more prolonged and severe slump increasing relative to a U-shaped recovery. In this respect, a VIX still hovering around 60 provides a much more sobering and fair assessment of the level of uncertainty present in markets and the global economy.
It is important to dwell on this point a bit longer as a return of 14% in four days might seem high in absolute terms and relative to the recent large drops, but higher returns than this are theoretically possible around 17% of time when the VIX is at 60.[1] In other words, the market action this week has certainly been a significant move that warrants closer scrutiny, but it is too early to call it a clear inversion in trend.
In particular, the evidence in favour of the hypothesis that policymakers have the virus outbreak covered and everything will be fine is not yet so compelling that we can reject some less benign alternatives. Among these, we would mention the possibility that the positive market action this week might be a short-term, technical pause fuelled by investors covering some of their large short positions accumulated last week, as shown in the chart.
In particular, the evidence in favour of the hypothesis that policymakers have the virus outbreak covered and everything will be fine is not yet so compelling that we can reject some less benign alternatives. Among these, we would mention the possibility that the positive market action this week might be a short-term, technical pause fuelled by investors covering some of their large short positions accumulated last week, as shown in the chart.
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Another, not necessarily mutually exclusive, explanation hinges on a change in investor response to news. Since the GFC, there have been repeated periods when negative surprises about fundamental economic data have been followed by strong, short-term market performance. This ‘bad news is good news’ phenomenon has tended to materialise during periods when policymakers’ actions seemed particularly reactive rather than pro-active in addressing investors’ concerns and dispelling uncertainties. The current period would fit this nicely.
Casting the net wider still, the next two sections list some of the reasons to be fearful and cheerful as we continue to gather information about the most likely trajectory for both markets and the global economy.
Reasons to be cheerful:
The size and breath of the policy response so far is the clearest positive. The US legislative ratified the stimulus which also expands the Fed mandate to participate in both primary and secondary credit markets. This is a big step, possibly as fundamental as TARP and TALF were back in 2008. New policy initiatives continue to pour in from the four corners of the world and can be easily tracked through this useful IMF site. A communique from the G20 also makes the right noises about coordinating on data sharing and policies. Yesterday, Singapore announced a $33.7 billion stimulus (offsetting the -10% QoQ drop in GDP recorded in 2020 Q1), India a more modest $22 billion (<1% of GDP), South Africa opted for a dubious attempt at its own version of QE.
Some good news is also tentatively emerging from epidemiological trends. The growth in the number of fatalities in hard-hit Italy continues to stabilise below recent rates. Greece has also managed to flatten out the contagion curve through a mixture of restrictive policies and, possibly, warmer weather. Even in the US, data from smart thermometer manufacturer Kinsa shows that social distancing might be starting to have an impact in slowing down the incidence of flu symptoms among its 1million users.
Reasons to be fearful:
Whilst we have been broadly impressed by the breadth of policy measures announced, we remain wary that both investors and the public are focusing too much on the magnitudes of the stimulus and a lot less on its swift application. With the current shock, it does no good to have a large parachute if it is jammed and cannot be deployed. The lack of scrutiny in the implementation of the announced policies smacks a bit of complacency and further risks fuelling a prematurely self-congratulatory attitude from policymakers. As former ECB president Draghi eloquently expressed in his FT column and the Danish employment minister outlined in a recent interview, speed is of the essence. There are already reports in the US that the $350 billion rescue package for small businesses might be hitting delays. In the Eurozone, the ECB continues to be the only institution capable of decisive action as individual states remain largely responsible for a fiscal policy shackled by anachronistic constraints and which could greatly benefit from a more coordinated effort. Yesterday, an article by economists Reichlin and Schoenmaker argued that redressing the balance between monetary and fiscal policy in Europe could be as simple as releasing the ESM from unanimity rules that currently subordinate coordination and swift action to consensus building. The bottom line is that the ability of the Eurozone to formulate a common fiscal policy response remains confined to the realm of sterile discussions.
Expectations that the epidemic may be slowing down and be closer to being controlled were dealt a blow as China announced that it would be banning the entry of foreign nationals in order to curtail a second wave of contagion. Moreover, a weekly survey of experts by political website fivethirtyeigth.com suggests that the central case scenario for the US continues to worsen (from 200,000 to 246,000 for casualties). Possibly even more worryingly, the experts’ confidence about this central scenario remains extremely low, with casualties projected to be between 36,000 and 1.1 million with 90% confidence. Another article showcases the power of geolocation data and reveals the true extent of people’s ability to disperse across the world after packing Florida beaches during spring break.
A recent survey of public opinion by Kantar also suggests a wide range of views on how long people in different countries expect the epidemic to last. Interestingly, a staggering 23% and 19% of German and British respondents believe that the recovery will take longer than a year (and 45% and 43% longer than six months). A separate question also shows that a staggering 58% to 82% of household incomes across different countries have already or are projected to be affected by the current epidemic (check out also the questions about policy responses and coordination among countries for some interesting cross country trends!)
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Finally, looking at the slope of the term structure of European investment grade CDS indices highlights how investors have yet to price in a relative level of short-term risk that is comparable to either the GFC or the European crisis of 2010. The idea is that during large shocks investors rightly fear shorter-term risks more than longer-term ones for safer investment-grade companies. Given Europe’s structural challenges, its reactive policy framework and credit markets fault lines, we take this indicator as a strong piece of evidence that more downside in markets could easily materialise.
In this last Recession Watch of the week, I leave you with an interesting piece of market trivia. Stronger demand for sources of vitamin C and disruptions to supply due to working restrictions have made Orange Juice among the best performing assets year to date.
Interesting reading
Fathom forecast scenarios
Economic forecasting is difficult even at the best of times. It is particularly difficult today. At Fathom, we think in terms of scenarios and seek, wherever possible, to downplay point forecasts. A severe contraction in global economic activity through the first half of this year is inevitable – we are facing what French economist Pierre-Olivier Gourinchas has referred to as a ‘sudden stop’, something the global economy has never experienced before. But how long will it last? In our Global Economic and Markets Outlook for 2020 Q1, we set out three scenarios. The first was a V-shaped recovery, in which the number of cases peaks within months and begins to decline, allowing activity by the end of this year to return to normal levels. The second was a U-shaped recovery, where the virus continues to spread, depressing activity until a vaccine is found, but the economic and financial market infrastructure remains in place to deliver a strong rebound when that occurs. The third was an L-shaped recovery. Since we finalised our forecast on 17 March, a number of major economies have placed more severe restrictions on movement, and imposed a temporary shutdown on more industries than we had thought likely. This more aggressive action has caused us not only to anticipate an even sharper contraction in economic activity in the first few months of this year, but to increase the weight we attach to a V-shaped recovery. At the same time, we have also increased the weight we attach to our more severe risk scenario, making the outlook somewhat bimodal. In the event that COVID-19 returns with equal or greater vigour once restrictions that are holding back economic activity are lifted, then a severe financial crisis will be very hard to avoid.
[1] Using a t-distribution with 1 degree of freedom
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