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Next forum date: Monday 1 June 2020
Economic data continue to provide evidence that the worst may be behind us even if the actual numbers are not even remotely close to any definition of ‘normal’. For example, yesterday we learned that the UK claimant count jumped by 856k in April. This amounts to 2.3% of the workforce in one single month.
Yet, more traditional, forward-looking economic indicators such as the ZEW survey in Germany (also released yesterday) show a clear divergence between current and expected conditions with expectation firming up around a swift recovery to pre-COVID-19 conditions.
In financial markets, large drops in volatility appear to further validate this consensus. This is promising as a swift return in confidence among consumers and investors alike is probably a necessary condition for any recovery to take hold. But it is also potentially bad news, particularly for markets, if expectations run too far in one direction given the prevailing significant and irreducible uncertainty associated with a disease that is leaving medical experts still with more questions than answers.
Even if expectations seem to be quickly converging towards a path consistent with a swift normalisation, there remain notable disparities in how people, countries and assets are responding to the COVID pandemic. For example, a recent BIS paper neatly demonstrates how similar policies aimed at reducing the spread of the virus may have drastically different economic impacts across Europe. France, Italy, Spain and Greece appear significantly more at risk of seeing longer lasting disruptions in employment relative to Germany, Northern Europe, the UK and even most of Eastern Europe because of a greater prevalence of small businesses in vulnerable sectors (e.g. hospitality, tourism). This heterogeneity is important for gauging the potential permanent damage to certain economies. It should also prove invaluable to policymakers in constructing more targeted policies addressing supply as well as demand constraints. In this regard yesterday’s announcement of a European €500bn rescue fund is a step in the right direction even though full details are still a little vague.
A very recent survey from YouGov demonstrates another example of persisting dispersion in public opinion across countries. It shows that sentiment has not yet bottomed out in a significant tail of mostly EM countries, which also chimes with reports of Brazil’s healthcare system being close to collapse.
The same survey reports significant discrepancies between global (getting worse) and domestic (getting better) perceptions in a number of economies where COVID had an early and/or significant impact (Italy, Australia, China, Vietnam, Malaysia and Thailand). A normalisation of these second-order expectations is likely to be especially important for markets if the current rally is to be sustained.
In markets, we have previously highlighted the polarisation between assets lagging due to their higher exposure to macro fundamentals and those that have rallied hard because of greater exposure to liquidity measures. This week weaker data on US home permits validated the macro side of this story, as homebuilders remain among the most macro-exposed equity sectors and have also significantly lagged the broader market
Inflation markets are another corner of the investment world with interesting dispersion in expectations. In spite of actual inflation having come down decisively across both sides of the Atlantic (today UK CPI fell 0.2% MoM and only rose 0.8% YoY in April), COVID (and oil-related) disruptions appear to be affecting US inflation expectations much more permanently than those of the UK.
The charts below show, separately for the US and UK, the one-year inflation rate at different horizons as implied by swap markets at the beginning of the year and as of two days ago. While investors believe the impact of COVID to be clearly deflationary, it seems to be much more temporary and smaller in nature in the UK than in the US.
The race for a vaccine: warp speed or parallel universe?
The most expectation-shifting development of the week so far has been the announcement that biotech company Moderna has been fast-tracked for stage 2 vaccine trials. According to Google trends, interest in the word ‘vaccine’ among news articles is likely to surpass that recorded during the swine flu outbreak in 2009.
Beside the immediate impact on shares prices of biotech companies, the likelihood of a vaccine is of huge importance for the global economy, and for sustaining market valuations increasingly underpinned by hope as much as fundamentals.
In this respect there are genuine reasons to be optimistic. First of all, the international race to develop a vaccine seems only just short of the race for the moon in the 1960s (or the more sobering nuclear bomb parallel offered by President Trump) in terms of intensity and resources. The aptly named ‘operation warp speed’ is likely to be more than a non-subtle reference to the US and its track record of delivering groundbreaking technological innovation under severe time constraints. At the very least, it seems sensible for investors not to bet against the US when it shows a clear commitment. Moreover, according to various regularly updated sources (here and here), there are as many as 159 separate vaccines efforts currently in development across the world with 7 at the stage 1 testing phase and 5 having attained stage 2 (human tests). Historically, looking at all drug developments, the probability of success for a vaccine trial to move from stage 1 to approval is one of the highest at 33%, rising to 42% after reaching stage 2. Even short of a vaccine, there are reasons to stay optimistic, as the hurdle for repurposing existing drugs that have mitigating effects on the worst side effects (e.g. see both this report and this trial currently taking place in France) is significantly lower than a full vaccine, and these developments are perhaps just as important. Finally, this article cites two studies that hint at the potential for developing long-term immunity to COVID and find that being previously infected with other coronaviruses may have helped some people avoid being infected by COVID-19 altogether.
Given all this, it might be tempting to seal the optimist case as closed. However, it would be a dereliction of my duties as a ‘two-handed’ economist not to offer a slightly less rose-tinted version of reality, particularly on the vaccine. Given the efforts underway and base rate probabilities, the prospects for a vaccine seem a matter of when rather than if. However, timing is fundamental when it comes to the economy and socially starved crowds, but it also comes with a healthy dose of caution.
The same study detailing the probability of success of various drugs conditional on development stage highlights that “the median clinical trial durations are 1.6, 2.9, and 3.8 years, for trials in Phases 1, 2, and 3, respectively”. Vaccines also generally spend significantly longer (almost two years) in stage 1, possibly explaining the overall higher success rate relative to other drugs, but also perhaps underlining the greater difficulty in finding solutions of wide applicability.
Taken together, it seems difficult to assign a base rate forecast much greater than 5% to the probability of a vaccine being approved within the next twelve months by simply eyeballing and cumulating the distribution charts of historical precedents (see Fig. S15 on p. 26 here). Perhaps even more pessimistically, the stage 2 trial from Moderna that got markets excited this week is based on technology (mRNA) that holds a lot of promise (also here), but it has not yet been successfully used to commercially develop any vaccine on any disease.
Overall, it seems to us that consensus may be confusing optimism about the development of a vaccine with the reality of developing one fast enough. Whilst unquestionably rooting for a speedy solution, finding effective ways to manage the worst side effects of COVID while avoiding a second wave remains the most likely path to something resembling normality.
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