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Next forum date: Monday 10 August 2020
Headlines
- Q2 GDP in the US contracted by 9.5% QoQ while falls in Germany, Spain and Italy were in double-digit territory; the overall picture for the first half of 2020 tracks our forecasts quite closely
- US Initial jobless claims came in at 1.4M, a similar level to that of the past five weeks
- The US pulse survey shows that 26.5% of respondents are struggling to make a rent or mortgage payment
Focusing on the peaks and shapes of epidemiological curves in any given country fails to drive a simple point home: global cases and deaths from the COVID-19 pandemic have continued to increase at an almost constant rate over the past two months.
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There are mitigating circumstances. As we have pointed out before, the countries driving the bulk of the increase in new cases globally have shifted over time, with the virus appearing to spread less rapidly in those countries that have already suffered large outbreaks. Nevertheless, there appears to be no hard and fast rule, with both Belgium and Spain seeing a recent pickup in the rate of transmission, perhaps reflecting an element of complacency, despite suffering severe outbreaks through February and March.
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Equally, what can only be described as aggravating circumstances should also be highlighted. Learning from best practice has been woeful at best, making a mockery of the country-level ‘contingency plans’, of international organisations whose primary focus is to put these things in place (without naming names, I think you know WHO I am referring to).
Recent data released by the Office of National Statistics also show that the UK has been the worst affected across many countries in Europe from an excess deaths standpoint followed by Spain, Italy, Belgium and Sweden. While a number of ‘yes, buts’ can be raised here too, the chart makes the point that shutdowns are a blunt tool where timing and coordination is of the essence with probably one true shot at it.
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With that bullet already fired in many places, there seem only two other credible options on the table going forward in the absence of a widely available vaccine: the morbid complacency route or the ‘getting your act together’ through track-and-trace and the minor inconveniences that this solution entails (e.g. the ‘mask debate’ — watch out for a comedic montage playing on the phonics of these two words doing the rounds on social media). It is encouraging that the UK may have learned from previous mistakes and pivoted towards localised shutdowns where deemed necessary.
Short of a vaccine, the adopted ‘solution’ matters not only from a moral standpoint or even from a more prosaic expectation of politicians performing their job. It is likely to matter quite profoundly as it will shape economies and economic policies going forward.
The shape of the recovery has obviously been an intensely debated topic that touches on these policy options. Another one that has become increasingly topical relates to the outlook for inflation. Early in this pandemic we made the point that the mix of supply and demand shocks was creating very different dynamics from a standard recession. Normal recessions dominated by negative demand shocks tend to be deflationary, shorter lived and more easily cushioned through fiscal and monetary policies. Conversely, negative supply shocks are inflationary, require structural adjustments and wash through only over a number of years. The true size and dynamics of these two shocks are not likely to be known for a number of years. At the current juncture, policymakers and investors alike can only resort to an imperfect attribution guided by economic principles, but which is nevertheless prone to various sources of potential error.
In our view, a demand shock is the dominant force at the moment, which the authorities are trying to mitigate using both monetary and fiscal policies aimed at transferring risk from private to public balance sheets. On the one hand, higher public debt, lower rates and more unconventional ‘buyer-of-last-resort’ programmes have ballooned on central banks’ balance sheets.
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On the other, a significant household deleveraging has taken place as a result of an unprecedented economic shock to GDP that has so far tracked our expectations quite closely.
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At the same time, subdued inflation measures across developed markets highlight how deflationary forces have clearly dominated the current juncture.
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The recovery from many of these early deflationary effects may have already worked through the system as highlighted by the quick recovery in retail sales and a number of consumer surveys.
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Yet, signs that not all is on the road to normality abound. Particularly concerning are some signs on the income and employment side of private households. In the US, the new pulse survey from the Census Bureau shows that the share of people reporting difficulty in making rent or mortgage payments has risen to the highest since the beginning of the survey to 26.5%. Separately, Freddie Mac reported the highest increase in delinquencies in June since the GFC. The Fed weekly economic indicator also points to a sluggish recovery across the real economy.
Furthermore, initial jobless claims seem to have levelled off at a still staggering 1.5 million or so new claims per week over the past couple of months.
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While the demand side is relatively well understood, the real risks and uncertainties seem to reside more with the supply-side consequences of this pandemic. For example, a number of sectors have failed to meaningfully normalise even as restriction have eased. Air travel in the US has levelled out and remains 72% below normal levels.
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Data from restaurant bookings and public transport trips have also shown similar stalling trends. Meanwhile a sector that has seen no recovery has been cinemas, where weekly gross earnings are in the thousands of dollars when they used to be in the millions over the past few years.
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At the danger of extrapolating too much from only a few months of data, changing habits could be the culprit behind these disruptions which may render many of these sectors structurally impaired with important repercussions for output and prices. On the price side of this relationship, when US two-year inflation swaps turned negative in March, we flagged this as unreasonable as investors failed to appreciate some of the lingering supply risks. We also showed that clients concerned with future positive inflation surprises ought to consider exposures to oil, gold and silver (and a few other related assets). Over the past month, all of these have seen impressive moves as if inflation concerns have progressively become more consensus.
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In our view, a period of materially above-target inflation in the major economies (above 5% or so) is not our central scenario, but a risk in the short to medium term, even taking into account that the magnitude of the reduction in supply caused by the current pandemic is underappreciated. The massive fiscal support measures that we have seen, combined with ultra-loose monetary policy can only give rise to a sustained pickup in inflation if monetary policy becomes subordinate to fiscal policy, and we enter a world of fiscal dominance.
As a customary lighter hearted Friday concluding remark, I would point to an unequivocal piece of evidence arguing in favour of a V-shaped recovery thanks to untapped sources of pent-up demand. One of my esteemed Fathom colleagues is taking the plunge and again climbing the property ladder after over a decade of trying to find the perfect entry point. Alternatively, the pandemic may have altered his preferences. The regret risk associated to the latter explanation is probably lower. Time will tell.
Interesting reading
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