Reopening economies: more haste, less speed
It is important to put the relative success in suppressing the spread of the virus in context. It has been achieved through placing many societies in lockdown. Now, a number of countries are preparing to exit the shutdown. Plans vary from place to place, both in terms of the pace and the extent to which measures are relaxed and the detail available in the public domain.
For example, consider the following:
- France: Prime Minister Edouard Philippe announced a plan to begin reopening the economy from 11 May – with implementation varying from region to region. Companies will be encouraged to persist with teleworking. Public transport will resume. Schools will reopen gradually from 11 May, albeit with social distancing rules limiting class sizes. Cafes, restaurants and venues which host large numbers of people (such as cinemas) remain closed. Large gatherings of more than 5 000 people will remain prohibited until September.
- Spain: the prime minister announced a multi-stage exit plan to be completed over six to eight weeks, with the pace of implementation varying from province to province. It allows for a gradual reopening of society – from restaurants and cinemas to places of worship – often subject to social distancing restrictions (for example, restaurants’ capacity is limited to a third). Long-distance travel may still be prohibited and face masks would be ‘highly recommended’ when public transport resumes.
The motivation for the exits is clear. In the words of Edouard Philippe: “We must protect the French without immobilising the country to the point where it collapses.”
Watching for a fresh spike in the curve
However, there is a real risk of a second wave erupting as the extreme measures are lifted. That is, the caseload could start to rise rapidly again. That may force a cessation of the exit measures at the very least and potentially the re-imposition of stricter measures that would cause renewed economic stress.
Indeed, Jasmina Panovska-Griffiths, a senior research fellow and lecturer in mathematical modelling at University College London, argues that these multiple waves are a characteristic feature of this kind of pandemic.
“The 4 major flu pandemics of the past century – the Spanish flu, Asian flu, 1968-70 Hong Kong flu and swine flu – came in several waves, too. The 1918 Spanish flu pandemic that killed more than 50 million people hit in three waves, with the second killing more people than the first.”
A second wave is not inevitable. Governments can calibrate their exit strategy carefully to control the spread of the population to suppress the spread of the virus. Not every country will be able to relax measures at the same pace.
Mass testing remains an important signpost
The capacity of the authorities to conduct diagnostic testing and contact tracing on an industrial scale to catch new cases as they emerge will likely prove a key constraint on exiting any restrictions.
In some cases, it is possible that the virus has already affected enough people that the population is approaching herd immunity, so that the virus can no longer spread easily from person to person. Sweden's ambassador to the US has claimed that Stockholm may soon approach this situation.
However, the consensus among scientists is that the majority of the population in many countries will need to be exposed to the virus before herd immunity is established. Current estimates suggest that even in the urban hotspots such as New York City, we are far short of herd immunity.
Markets switch into risk-on mode
The evolution of new cases and in particular new fatalities in countries which exit lockdown is a key sign-post for the market. The faster those countries can ease the quarantine measures, the sooner they can resuscitate their economies.
With much of the global economy still in lockdown, concerns about a second wave may still be rife among investors, while a vaccine is still elusive.
However, news of falls in the number of new COVID-19 cases and a move towards a relaxation of lockdowns in some countries has given a more optimistic tone to markets over the last week. For example, the US S&P 500 equity index erased roughly half of the loss sustained between 14 February and 23 March. In our view, late March was certainly not the right time to sell risk assets.
A key week for central banks
This week, ending 1 May, is a key week for central banks – the Bank of Japan (BoJ) met on Monday, the Federal Open Market Committee (FOMC) meets today and the ECB on Thursday.
• The BoJ on Monday removed the numerical guidance of JPY 80 trillion per year on its JGB government bond purchases. While, by itself, this does not imply a loosening of monetary policy as the BoJ's current yield curve control (YCC) framework already allows for unlimited JGB purchases, it does have an important symbolic value. By buying “without setting an upper limit,” the central bank might strengthen the impression in the market that it is moving towards debt monetisation, pointing to a potential direction for other central banks. This action should keep the yen lower and prevent yields from rising.
• A reassertion by Fed Chair Powell of his ‘whatever it takes’ approach is expected along with an assessment of the economic outlook and the Fed’s response. This scheduled FOMC meeting is the first since the emergency actions taken through inter-meeting decisions on 3, 15 and 23 March. We expect Mr Powell to announce the expansion of the USD 500 billion MLF (state & local government) and the USD 600 billion MSNLF/MSELF (SME) facilities. These are yet to be launched and should further help improve access to US dollar liquidity.
• The ECB may also send a strong message – namely that it is ready to increase the PEPP asset purchase envelope to buy BB rated bonds if needed. This is a potentially important move in view of the recent increase in bond risk premiums. The ECB’s decision last week to relax its collateral eligibility criteria to include BB paper paves the way for this next step. This announcement was key in underpinning support for ‘peripheral’ eurozone bonds.
• The European Union Council last week failed to provide a definitive answer to the question of how the fiscal bill of COVID-19 will be split across the EU. It did agree in principle to set up a ‘recovery fund’. However, there was no agreement on the size, funding, distribution and timing. Hopefully, the council will agree on some of these points by the next meeting on 6 May. Lack of agreement on the ‘recovery fund’ remains a key risk for Europe, the euro and ‘peripheral’ bond markets in particular.
• Oil continues to trade weak, especially ahead of the next WTI futures contract expiry. We see this putting pressure on the external accounts of oil producers the GCC, Colombia and Mexico. However, it should be good for the trade balances of Japan, Turkey, India and South Africa. This should continue to drive up dispersion in emerging markets.
• The continued rise in jobless claims in the US is pointing to double-digit unemployment rates. This could imply a significant rise in mortgage and other consumer loan delinquencies, potentially greater than that seen in 2008. While the fiscal injection through the CARES Act should help alleviate some of this stress, the effectiveness of the current support programmes remains to be seen.
• Latest data out of Asia, where we are seeing lockdowns being lifted, still points to continuing weak consumer activity as people remain wary of taking public transport and engaging in activities that could bring them into contact with a high number of people. This could be a good pointer to the economies of those countries that are looking to partially lift their lockdowns.
• Earnings season continues, with analysts repeatedly cutting their estimates. There have been positive surprises, but the market is more focused on the prospect of economies reopening and earnings recovering in 2021. As a result, equities have continued to trade at record high price/earnings multiples. Given what futures are telling us about dividends and volatility in 2021-22, these multiples look challenging.
Asset allocation view
In summary, we believe our set of signposts will 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 recently entered an overweight position in 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.
However, we also lowered our risk exposure tactically with short positions in the S&P 500 and in eurozone equities ahead of more news on the economic damage caused by the virus and given the risks associated with the exit strategies from lockdowns. We are now waiting patiently for a market setback to increase our risk exposure again in the near future.
 Also see Coronavirus: when should we lift the lockdown? on https://theconversation.com/coronavirus-when-should-we-lift-the-lockdown-136473
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).