- Relaxing of lockdown measures – so far so good
- Watching for any sign of a rise in the curve
- Stock markets pause after April rally
- Major central banks on hold
- The rate of new cases and deaths continues to slow across Europe, with the UK remaining a laggard on both counts (Exhibit1). Indeed, the UK’s cumulative death toll has now risen to above those of all other European countries, including Italy.
- In the US, new cases have plateaued at around 25 000 to 30 000 per day, while the daily death toll looks to have peaked in mid-April. The US now accounts for over a quarter of all deaths from COVID-19. With some states relaxing lockdown measures the market will be closely monitoring the data on new cases (taking into account an increased testing capacity) and, with a lag, fatalities.
- New cases are on the decline again in North Asia as both Singapore and Japan are getting a grip on the recent outbreaks. Meanwhile, new cases continue to edge higher in larger developing economies such as Brazil, Russia and India. Data on fatalities is particularly concerning in Brazil, South Africa and Turkey, with Mexico, Russia, India and Peru not far behind.
This week, we are highlighting a sobering analysis by the US Center for Infectious Disease Research and Policy (CIDRAP). It outlines three scenarios after the first wave this spring. The analysis is based on the course of previous pandemics:
- The first wave is followed by a series of smaller waves over the next 12-24 months, gradually diminishing sometime in 2021.
- The first wave is followed by a larger wave in the autumn or winter of 2020 – requiring the resumption of extreme lockdown measures – followed by one or more smaller subsequent waves in 2021.
- The first wave is followed by a ‘slow burn’ of ongoing transmission and case occurrence, but without a clear wave pattern.
The conclusion is that: “Whichever scenario the pandemic follows (assuming at least some level of ongoing mitigation measures), we must be prepared for at least another 18 to 24 months of significant COVID-19 activity, with hot spots popping up periodically in diverse geographic areas.”
German Constitutional Court whistles in the Bundesbank
It has been a momentous week on the policy front with the ruling of the German Constitutional Court (GCC) on the ECB’s quantitative easing (QE) programme (the public sector purchase programme, PSPP) and increased tensions between the Trump administration and the Chinese authorities.
The GCC’s ruling was significant because it goes to the very heart of Europe’s response to the pandemic and ultimately to the cohesion of the European project. The Court of Justice of the European Union (CJEU) gave QE a clean bill of health in December 2018, but the German court protested in the strongest terms, describing that ruling as ‘incomprehensible’ and ‘simply untenable’.
It claims that the ECB acted ‘ultra vires’ – beyond its legal authority. Its chief concern is that the ECB did not act ‘proportionately’ in its pursuit of price stability: It did not weigh the mounting costs of the PSPP programme against the potential benefits.
The court was clear: “German constitutional organs, administrative authorities and courts may participate neither in the development, nor in the implementation, execution or operationalisation of ultra vires acts”. That of course includes the Bundesbank.
The court issued an ultimatum: either the ECB provides a detailed analysis that “demonstrates in a comprehensible and substantiated manner that the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the programme” or else the Bundesbank can no longer participate and it should commence sales of the portfolio of bonds it has acquired.
In theory, the ECB can carry on regardless: the Bundesbank may have to comply with the court ruling, but the ECB and the other national central banks do not. Bond buying can continue under the PSPP, even if there is no buying of German Bunds.
Again in theory, the ruling does not apply to the new purchase programme – the pandemic emergency purchase programme, or PEPP – although one might reasonably expect the court to hear a case against the PEPP in the not too distant future.
Mounting US-China tensions
Of greater immediate concern is the escalating tension between the US and China. The chief bone of contention is the US claim that the virus originated in a laboratory in Wuhan. US Secretary of State Mike Pompeo said that “there is enormous evidence that that’s where this began.” Those remarks prompted a furious response by Chinese state broadcaster CCTV: “These flawed and unreasonable remarks by American politicians make it clear to more and more people that no 'evidence' exists.”
Pompeo’s claims are part of a broader attack on China’s handling of the outbreak. For example, he said "We can confirm that the Chinese Communist Party did all that it could to make sure that the world didn't learn in a timely fashion about what was taking place."
CNN cites ‘multiple sources’ in the Trump administration saying that the US is considering retaliatory measures against China, including sanctions, cancelling debt obligations and new trade measures. These tensions risk injecting a fresh source of uncertainty into the global economy at the worst possible moment.
Markets – a FOMO (fear of missing out) equity rally?
April’s rally was widespread, with the major indices reaching their highest levels since 10 March. US markets outperformed: +12.7% for the S&P 500, +15.4% for the NASDAQ, (boosted by tech stocks, which since the end of 2019 lost just 0.9%).
Japan’s Nikkei 225 index rose by 6.7% over the month, while the EuroSTOXX 50 rallied by 5.1%.
On a global level, cyclical sectors tended to outperform at the expense of defensive stocks and financials. Consumer cyclicals and energy led the way.
Central bank policy meetings
Last week saw policy meetings at the Bank of Japan, the US Federal Reserve and the ECB. Here is our analysis of the most noteworthy points:
The Bank of Japan
Policymakers announced new easing measures: purchases of commercial paper and corporate bonds were increased; the (notional) limit on the pace of government bond purchases was removed; and the Bank of Japan’s version of funding for lending was enhanced.
However, the key policy elements were left untouched. This despite the inevitable massive marking-down of the BoJ’s growth forecast: in January, it expected GDP growth of between 0.8 and 1.1% in fiscal 2020; the forecast now stands at -3.0 to -5.0%.
US Federal Reserve
The FOMC meeting was largely a non-event. However, there was a signal that the remaining credit facilities will be up and running soon. For the time being, policy remains in unconstrained mode (‘in the amounts needed’). In our view, it would be a mistake to view the pace of purchases as being on a pre-determined glide path back towards normality.
Chair Powell gave guidance on the use of the emergency toolkit: the Federal Reserve will act “forcefully, proactively, and aggressively until we're confident that we're solidly on the road to recovery” and “as you know, our credit policies are not subject to specific dollar limit. They can be expanded as appropriate, and we can do new ones. So, we can continue to be part of the answer”.
However, Powell was also clear on the limits of what the Fed could do with these powers: that it did not have the authority to conduct industrial or fiscal policy. For those who would struggle to repay any loan, he argued, the answer must come from politicians and direct fiscal support.
European Central Bank
The ECB did not adjust its key interest rates, nor did it increase the envelope of asset purchases under the PEPP. This despite an ECB staff analysis suggesting that output is now expected to shrink by 5 to 12% in 2020 and that sovereign spreads had widened once the initial announcement effect of the PEPP had passed.
The unchanged volume of PEPP should not have been a surprise: it seemed unlikely the council would move quickly to expand a scheme it had just unveiled. We had expected the council to not want to move before discussions in the Eurogroup and EU Council has reached a conclusion.
This week’s verdict from the German Constitutional Court (see above) will further complicate the inevitable recalibration of PEPP.
Asset allocation view
Our set of signposts become ever more important now that valuations have been reset and there is greater two-way risk.
In terms of asset allocation, we continue to be long market risk strategically. We overweight European and US investment-grade credit (financed by government bonds) and are long emerging market and UK equities; long commodities and long EM hard currency debt.
Having lowered our risk exposure tactically with short positions in the S&P 500 and eurozone equities, we are now patiently await a market setback to further increase our risk exposure.
Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.
The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.
Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).
Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.