The risk is that markets get too far ahead of the macroeconomic situation, particularly as infection and hospitalisation rates are still rising in the US and much of Europe. Chancellor Merkel today said Germany must go into a hard lockdown before Christmas to curb the spread of coronavirus.
The yield on 10-year US Treasuries has fallen back to 0.94%. It touched 0.98% last Friday, its highest level since the market ructions in March, as investors moved out of safe haven debt. The S&P 500 and NASQAQ indices meanwhile remain close to all-time highs.
Policy makers at work
Brexit talks have so far failed to break the current impasse. The market is now waiting to see if the latest meeting between Boris Johnson and Ursula Von Der Leyen will lead to a compromise and hence a deal. A no-deal remains a distinct possibility, but the consensus view is that the economic and political cost of a no-deal will bring both sides to a last minute agreement.
Besides Brexit, the European Union (EU) 2021-27 Budget and the EU Recovery Fund will be under discussion at the EU Summit this week. Given Poland’s and Hungary’s current veto of the Recovery fund, if a deal is not found, it is likely the EU will take the fund off-budget using voluntary guaranties, thus circumventing the veto.
US labour market raises concerns
In the US, private sector job growth was slower than expected in November at 345 000 (vs 540 000 in Bloomberg consensus, which in normal circumstances would be a sizeable miss). Although the US unemployment rate fell from 6.9% to 6.7%, it did so for the wrong reason, some unemployed people gave up looking for work and thus exited the labour market.
This leaves the US economy down almost 10 million jobs since February. At the current rate of job creation it would take until mid-2023 to recover all the lost ground in the labour market.
Next spring/summer is likely see a burst of, potentially very rapid, hiring in those sectors poised to benefit from widespread deployment of the vaccine (restaurants, leisure). Nonetheless, the state of the US labour market has again led Federal Reserve Chair Powell to urge Congress to err on the side of over-stimulating the economy with fiscal policy, rather than risk under-stimulating it.
Perhaps spurred on by Chair Powell’s comments, perhaps in response to the worsening Covid situation, policymakers in the US Congress have edged a bit closer to striking a deal over a new round of fiscal stimulus. They hope to complete their work before Congress breaks for Christmas.
Both the size and content of the package are still being negotiated. Yesterday the Trump administration made a new fiscal stimulus offer worth USD 916 billion to congressional Democrats.
Observers have generally expected the US Congress to eventually pass another stimulus package, although opinions have differed about when and how large it would be. If something does pass before Christmas, it would be earlier than most commentators have expected, but if the cost comes in significantly closer to USD 500 billion rather than USD 1 trillion it would also be smaller than most would have projected.
Democrats view this latest negotiation as a stepping stone to the possibility of more stimulus after President Elect Biden is inaugurated on 20 January 2021. But unless Democrats win both the Georgia runoff elections in early January, they might well find the US Senate refusing to pass anything other than an incremental package (if even that) once there is a steady stream of Americans getting vaccinated in the new year.
Waiting for the ECB meeting
Tomorrow the governing council of the European Central Bank (ECB) holds the final monetary policy meeting of 2020. As coronavirus vaccines are close to being approved and delivered across Europe, the ECB might be expected to adopt a more upbeat outlook in the economic forecasts. However, the prospect of a downturn in the fourth quarter means the ECB will probably lower its growth outlook for 2021. Investors will also focus on whether the ECB cuts its inflation forecasts.
ECB President Christine Lagarde and other ECB policymakers have already signalled that they are highly likely to increase the central bank’s stimulus measures in an attempt to ease the continuing economic damage caused by the coronavirus pandemic and lockdown restrictions.
We expect clarification on the following areas of ECB policy tomorrow:
- Expansion of the Pandemic Emergency Purchase Programme (PEPP)
Launched this spring as the virus took hold across Europe this quantitative easing programme aims to buy up to EUR 1.35 trillion of bonds. It is scheduled to run until June 2021. However, in view of the new wave of coronavirus infections and restrictions, the ECB is likely to expand the size and timeframe. Currently there remains EUR 600 billions left to spend. It is possible the ECB expands the programme by up to EUR 500 billions and extends PEPP to the end of 2021 or even to June 2022. This would potentially enable the ECB to buy around 70% of all bonds issued by eurozone governments next year, equivalent to and 150% of net issuance after redemptions.
- Extending lending to banks
The second element of the ECB’s response to the crisis is lending money to banks at ultra-low rates to facilitate provision of credit to the economy. Through its targeted longer-term refinancing operations (TLTRO) the ECB has lent almost EUR 1.5 trillion to banks at rates as low as minus 1% on the condition that banks maintain lending levels. This programme is due to expire in March 2021. The ECB has indicated it is likely to be extended but clarification is expected tomorrow on a possible lowering of the interest rate. We see little prospect of the ECB cutting its headline deposit rate tomorrow below minus 0.5%.
Our view is that the ECB is already implementing yield and spread control. The ECB is basically running short on ammunition and relying on good fortune and accommodative fiscal policy to reflate demand, even if this keeps pumping up asset prices.
Exhibit 1: An inconvenient rally – In recent weeks the euro has climbed above USD 1.21, its highest level since 2018 (graph shows change in exchange rate EUR/USD for the period from January 2018 to 08/12/2020).
Source: BNP Paribas Asset Management as of 09/12/2020
The rally in the euro mostly reflects a weaker US dollar but remains a concern for the ECB as the stronger euro puts downward pressure on inflation by lowering import prices. The stronger euro potentially negates reflationary benefits from fiscal measures in response to the pandemic.
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.
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.