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Next forum date: Monday 29 June 2020
Headlines
- May UK claimant count reaches the highest since 1993, though rate of increase halves
- ZEW survey points to a strong rebound in expectations about economic conditions in May
- US retail sales surprised on the upside in May (17.7% MoM) even as many states remained in lockdown
- US industrial production posted a modest increase (1.4% MoM) in May
- Fed continued to lend support to credit markets this week. Hard data on US delinquencies does not show any clear alarming signs yet. However, dislocations to credit availability are real just as consumer expectations on income and earnings have remained subdued
- Inflation uncertainty has soared among US consumers possibly fuelled by ballooning government debt and little prospect for higher taxes
Economic data, market trends and easing restrictions all continue to paint an optimistic picture. On the data front, new UK unemployment claimants rose in May by only half the rate seen in April, even as the total figure stood at its highest since October 1993.
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In Europe, according to the ZEW survey, German expectations increased to the most elevated point since 2005 in May, at the same time as the assessment of current economic conditions rebounded from April’s record low.
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Even more significantly, US retail sales surprised on the upside and rebounded by 17.7% in May even as many states remained in lockdown, as highlighted by the significantly weaker sales from food and drink places.
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US industrial production also posted gains in May after hitting lows comparable to 2008 in the previous month.
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Economic surprises (i.e. error) in the US have been extremely high in both directions and a testament to the unprecedented nature of this shock as well as the difficulties in learning definitive lessons from a quickly evolving economic and policy landscape still riddled with unknowns.
Interestingly, economic surprises have been much more symmetric in the US (and developed markets) than in emerging markets, possibly as a result of economists having learnt some of the negative lessons as the pandemic spread to the emerging markets only with a lag.
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In both cases, economic surprises tend to be coincident with short-term (i.e. three-month) equity returns suggesting a degree of caution from a market increasingly pricing in fewer risks.
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We have argued that policy actions have been unquestionably positive and the key engine behind such a swift recovery. At the same time, we also noted that sectors and assets more closely connected with macro fundamentals had significantly lagged in performance. Overall, we also eschewed the temptation of attributing thaumaturgical powers to the Fed, preferring a more balanced assessment around risks going forward. In particular, we have made it abundantly clear that the debate over a V-shaped recovery is to a large extent a debate about the odds of a smooth transition to a new normal rather than a wishful hope of a return to the ‘old’ normal. This distinction is important as we see many signs of how the pandemic has created clear dislocations across economic sectors and agents that are likely to stick around for some time.
Some of these also have the potential to snowball into something more systemically ominous if not addressed correctly (e.g. an L-shaped recovery) and others are probably not even on our radar yet. Credit, in particular, has the annoying habit of having a significant delayed reaction to a shock. For example, in the US, the latest data on delinquencies is for 2020 Q1 and it takes at least 30 days of delayed payments before anything moves on those statistics. Defaults also tend to peak 12 to 18 months after an initial shock. As a result, we could only find very faint signs of an uptick in US delinquency data among non-systemically important banks and in commercial sectors.
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Yet, surveys highlight how there has not been much of a rebound in people’s perceptions of the ease of getting access to credit, at the same time as incomes, earnings and employment prospects have also failed to show a significant turnaround.
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In the US, ongoing swift actions from the Fed to support credit markets have perhaps been sufficient to defuse the risk of a nasty consumer credit cycle. Elsewhere the outlook may be less benign. In Brazil, for example, there has been a 53bps uptick in non-performing loans owed by individuals already this year. This is the highest level in three years, while corporate non-performing loans have remained close to historic lows.
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Prices and price expectations is another area where COVID-19 has also created interesting dislocations. We argued early in the pandemic that market expectations seemed to be excessively pricing deflationary outcomes, particularly in the US. While we have been partly vindicated, the chasm in expectations remains wide and very much alive in consumers’ minds. The chart below highlights how consumer views on inflation in the short term have become extremely polarised between those that expect inflation over the next year to exceed 4% and those that expect it to be negative (although this one seems to have peaked).
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Such uncertainty around inflation can only be partly reconciled by the huge gap emerging between the ballooning of government debt and the absence of any meaningful increase in the expected tax burden. While these two surveys are likely to be too short-term to pick up more permanent changes in trends, it is worth tracking the evolution of both measures alongside inflation expectations as a gauge of credibility of QE policies.
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