Covid-19 - encouraging signs
As of the start of September there have been almost 26 million cases of COVID-19 and 850,000 recorded fatalities.
The US has recorded 6 million cases – around a quarter of the total according to Johns Hopkins University – and the administration’s handling of the virus remains a key issue in the election. The focus has actually been on the evolution of the virus in Europe in recent weeks given a worrying rise in cases, but according to the World Health Organization, there are “encouraging signs” that countries in Europe are learning how to manage the virus:
“Europe has learned how to identify, isolate, quarantine … It’s also identified how to put in place the individual measures so we’ve already seen in some areas of Europe a very rapid reversal in what were some rapidly increasing curves”
Over the last week, the flash release of data on consumer prices in the eurozone in August was the most significant piece of data, with the eurozone falling back into deflation territory as inflation fell by -0.2%, down from 0.4% in July.
In terms of the numbers, the pace of deflation in energy prices moderated from -8.4% to -7.8% in August, with energy prices flat on the month. Meanwhile, the pace of food inflation slowed from 2% to 1.7% and services inflation slowed from 0.9% to 0.7%. However, the major development was in core goods inflation, which stood at 0.2% in June, 1.6% in July and -0.1% in August – a rollercoaster ride driven by a delay in the timing of summer sales this year.
The recent cut in the rate of VAT in Germany has no doubt contributed to the weakness of core inflation. However, given the recent appreciation of the euro, the large margin of spare capacity in the economy and the risks of inflation expectations becoming detached there are good reasons to suppose that it will remain weak in the medium-term.
On the policy front, last week marked the beginning on a new era in US monetary policy and the end of an era in Japanese politics.
Chair Powell used his presentation at the virtual Jackson Hole conference to unveil the key conclusions of the Federal Reserve’s strategy review. The bottom line for investors is that the Federal Reserve will adopt a flexible average inflation targeting framework which in Chair Powell’s words means that:
“following periods when inflation has been running below 2 %, appropriate monetary policy will likely aim to achieve inflation moderately above 2 % for some time.”
This change was widely anticipated and the implications are broadly understood by the market: interest rates will likely stay low for a number of years as exit from the lower bound will be delayed to facilitate that period of moderately above target inflation. However, a couple of key points are worth emphasising.
- Firstly, an important change has been made to the employment dimension of the Fed’s dual mandate. Policymakers will now focus on "shortfalls of employment from its maximum level" as opposed to "deviations from its maximum level". In other words, unemployment can never be too low from a monetary policy perspective unless it is contributing to too much inflation, but you can have too little. As a result, the Federal Reserve would be unlikely to repeat the strategy pursued during the last hiking cycle of raising rates because unemployment appeared to have fallen too low and it was expected that inflation would soon rise. This change was arguably necessary because otherwise concerns about positive deviations of employment from its maximum level would have acted as a brake on efforts to push inflation above the target in order to re-anchor the average rate at 2%.
- Secondly, the new framework is flexible: Members of the Federal Open Market Committee will not constrain themselves to use a particular formula (time period) to calculate the average. Had they done otherwise then at any moment in time, the published formula would have produced a precise target for the cumulative increase in the price level that the Federal Reserve would have had to achieve over the future in order to hit the required average, given the observed behaviour of the price level over the past. As a result, it will be harder to demonstrate whether policy is too tight or too loose ex ante, or whether it has been a success or failure ex post. However, that flexibility comes at a cost. Households, companies and investors should be less confident that the Federal Reserve will deliver 2% on average without the commitment device of a mathematical formula.
Meanwhile, in Japan Prime Minister Shinzo Abe has announced that he will be stepping down as both President of the Liberal Democratic Party and as Prime Minister on grounds of ill health.
It is no secret that Abe has suffered from an incurable inflammatory bowel condition (ulcerative colitis) throughout his adult life. Indeed, the medical condition was the cause of his resignation in 2007. However, his health had become an increasingly frequent topic of conversation in the Japanese media in recent weeks, and in particular the claim that Abe had visited hospital several times in recent weeks.
It is hard to over-play Shinzo Abe’s importance. He has just surpassed the record set by Eisaku Satō as the longest serving Japanese Prime Minister. He has become so personally associated with Japan’s economic strategy for managing demographic change and escaping deflation that everyone refers to the plan as Abenomics. But it is not just economics. Abe has also shaped Japan’s role on the world stage and its relationships with the two global super-powers, China and the United States.
Abe’s successor will be chosen by the Liberal Democratic Party, which is the dominant force in Japanese politics. That process will take place over the next couple of weeks with the chosen candidate being elected prime minister by the lower house of parliament on 16 September. At this stage, Yoshihide Suga is the politician most likely to succeed Abe.
We suspect that the succession will lead to less change in macroeconomic policy than investors may have initially feared. In the short run there is little alternative to the current strategy of the Bank of Japan, unless policymakers are willing to accept a significant correction in the exchange rate and equity prices. Indeed, if anything, the stance of fiscal policy may be eased further. The direction of the domestic reform agenda or Japan’s approach to foreign policy is a little less clear.
Markets - stocks extend positive run
In August stock indices performed very well. The MSCI World Index of stocks in developed nations rose 6.6% in August, the strongest August rally since 1986. The broader MSCI All-Country World index that includes emerging market stocks rose 6.3% in August, its best month of August since 1988.
The S&P 500 index rose 7.01% (its strongest August since 1986 when it rose 7.1%) having, over the course of the month of August, erased the last of its pandemic losses and struck an all-time high. For the S&P, August was the fifth consecutive monthly rise. This represents the longest period of positive consecutive monthly performance for the S&P since 1938.
Stock markets in Germany, France, Italy and Spain rose by between 4 and 7% in August on a euro basis. In Asia, Japan’s Topix rose 8.2% on the month, and China’s CSI 300 returned 2.6% in local currency terms (source of all data is BNP Paribas Asset Management as of 31/08/2020).
This strong run for stocks again raises concerns about a potential discrepancy between market valuations and the still fragile state of the global economy.
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. This document does not constitute investment advice.
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