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Headlines
- US initial jobless claims blew past another record to reach 6.65 million, more than doubling last week’s level
- With 37 million jobs potentially at risk in the US, we are likely to revise down our expectations for global growth further from our already bearish central projection of a 9% hit to economic activity from COVID-19 spread across Q1 and Q2
- Markets rose again, shrugging off the US initial jobless claims figure thanks to a surge in oil prices after Trump fuelled hopes of a truce in the Saudi Arabia-Russia ‘oil supply war’
- Fault lines are clearly appearing between markets that can access liquidity facilities and those that cannot; we reiterate that a market bottom is not yet behind us
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Providing further evidence that when it rains, it pours, this week’s US initial jobless claims were more than double last week’s 3.3 million reading, reaching a new record high of 6.65 million.
The consortium that maintains the U.S. Private Sector Job Quality Index (JQI) estimates that as many as 37 million US jobs could be at risk from the pandemic or roughly 31 million more than have been lost so far. Even more worryingly, some of the largest sectors (e.g. restaurants where over 5 million jobs are at risk) appear particularly vulnerable to a more permanent shock stemming from a protracted shutdown.
A comparison of electricity consumption relative to the average of the past three years across European countries shows that Spain and Italy are showing clear signs of a slowdown relative to France and Germany, while the UK has only started to contract more visibly over the past few days. This data also confirm how Sweden stands out from everyone else as discussed in Tuesday’s Recession Watch.
Today’s release of the services PMI demonstrates how lockdowns are so far disproportionately affecting the services sector and are broadly well correlated with the trends in electricity consumption highlighted above. The situation in the manufacturing sector is more nuanced. For example, the March release of the manufacturing PMI survey shows that Sweden suffered the largest monthly drop among the selected six economies, while those countries, like Italy and Spain, which have been in lockdown the longest have also suffered relatively more. This suggests that any idiosyncratic response to the epidemic, like the Swedish one, might matter little in the face of a global, protracted shock and widespread acceptance that containment policies are necessary.
Mounting evidence regarding the scale of the lockdowns that have taken place across many economies means that we are likely to revise down further our forecasts for the initial hit to global GDP from COVID-19. We will lay out a more comprehensive analysis in a note set to be released on Monday.[1]
On the market front, last week’s rally paved the way for a week of introspection with little clear direction. Up days in equity markets are not convincingly accompanied by large drops in volatility with the VIX consolidating around the 50 level.
One significant development was yesterday’s 24% rally in oil prices following a tweet by President Trump about a potential truce in the ‘oil supply war’ between Saudi Arabia and Russia worth a potential 10 million barrel per day reduction in output. Whilst the gains in the oil price are a welcome development, there are reasons to believe that it might not be as impressive as it may appear, and oil might require more than a tweet to sustain a change in fortunes. In particular, a 24% or higher one-day move can be expected about 13% of the time when annual oil volatility is a mind-boggling 163% as per the current OVX index.
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Second, and more substantively, it is not entirely clear how genuine the Russia and Saudi Arabia spat about supply might be. Among the most geopolitically important marginal oil producers, the country with the most to lose from a large slump in oil prices is actually the US and its highly leveraged shale gas industry. The last time that Saudi Arabia tried to go it alone to take out US shale output by oversupplying the market in late 2014, it was forced to reverse course just over a year later. Since then, a few things have changed with MBS securing his grip on power and the country adding to its coffers with Saudi Aramco’s ‘privatisation’ proceedings. Both of these increase the chances that a replay of the 2014 tactic might be more successful, particularly if covertly coordinated with another large supplier sharing not dissimilar geopolitical and market share goals, such as Russia.
Elsewhere, investors seem to be eerily rummaging through the ruins of the quickest bear market in history, sifting through the rubble for good deals, assessing fault lines and structural stability across asset classes. In particular, we believe the market has bifurcated between assets and regions that have a more explicit policy support and those that don’t.
For example, the past four weeks saw the largest ever liquidity injection from the Fed as its balance sheet swelled up by record amounts through the resumption of asset purchases and additional QE operations.
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This has created a large disconnect between securities that the Fed may accept as collateral and those that it does not. For example, the premium investors demand to hold bonds issued by REITS (a proxy for non-agency MBS not usually accepted by the Fed as collateral) relative to agency MBS (which are routinely accepted by the Fed) jumped to around 300bps from 55bps as early as 4 March. A similar blowout can be observed between BBB rated bonds and agency MBS up until a couple days after the Fed announcement that it would accept corporate bonds as collateral. The premium on BBB bonds has visibly dropped since then, while that on REITS has fallen significantly less.
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Among regions the change in fortune has been even more dramatic. The chart below shows how before the Fed intervention, investors were disproportionately punishing BBB rated US corporate debt relative to its EM counterpart. Since then, the reversal in fortunes has been striking with BBB EM corporates quickly trading at a significant discount, very likely as a result of a lack of backstop facility that compares with the Fed firepower.
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All these subtle relative movements among assets suggest that things may be as calm as the eye of a tornado. As a result, we believe that all these emerging fault lines together with a deteriorating macroeconomic environment will be tested along with policymakers’ resoluteness. We continue to recommend treading very carefully and using the current environment to improve the quality and resilience of portfolios.
As the usual piece of Friday trivia, I wanted to highlight Turkmenistan’s effort in redefining what a government’s priorities should look like in it its effort of containing the spread of the virus. In an (self-defeating) attempt to avoid looking weak, President Berdymukhamedov banned the word ‘coronavirus’, while people wearing masks or actively discussing the virus in public are reported to have been arrested.
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.
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[1] Get in touch on enquries@fathom-consulting.com to know how you can access our full range of research.
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