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Now is the time for resilience and correct policy choices.

  • Sunday, April 5, 2020

Governor Jerome PowellThere is a major debate raging over the balance between looking after the health of the public and looking after the health of the economy. Policy makers have weighed up the cost of a global recession and the virus death toll only previously matched by the Spanish Flu of 1918-20 and right now the health of the nation is getting the priority through enforced lockdown and social isolation.

Governments and central banks have stepped in to ‘do whatever it takes’ in order to calm concerns over an economic depression and financial meltdown. Governments have taken on the burden of their respective economies in order to keep them active and able to recover when the virus is in decline.

The US Federal Reserve, led by Jerome Powell have been decisive. They have taken the role of lender of last resort to the whole international payments system and averted a risk to US$ denominated debt that would have particularly hurt emerging economies. The Feds actions have also stabilised credit markets which are so vital to the stability of all capital markets.

Due to the strength of the US$, there has been over the past month a massive flight of capital to the safe haven of the dollar. This has particularly exposed emerging markets with US$ denominated debt. For this reason, the International Monetary Fund (IMF) has been called upon to support emerging economies through the next 18 months with debt repayments.

Many economists, while expecting a V-shape recovery, are concerned about the return of the virus if not effectively controlled by the measures being taken now. This could consequently lead to a W- shape recovery which would require further controls over liberty and greater state intervention.

The lockdowns are necessary to limit the spread of Coronavirus and ultimately save lives, but it is not beneficial to the economy and peoples livelihoods to prolong it more than is necessary. A critical issue will be to avoid a second wave before a vaccine is available if this lockdown is ineffective and ends too early.

The USA is expected to be about 2 to 3 weeks behind Europe in feeling the full impact of the Coronavirus. The lockdown of almost 80% of America particularly the major cities is having a massive impact upon the rate of unemployment. In March, Wall St analysts were expecting 100,000 job losses but the actual figure came in at 713,000. New benefit applicants in the past two weeks were as high as 10 million people, with 6.6 million last week alone. The rate of American unemployment is set to soar. New analysis from JP Morgan is suggesting a US unemployment rate of 16% in Q2. This level of predicted unemployment is far higher than the 9 million that lost their jobs in the 2008 great financial crisis.

While the US Senate has passed stimulus and aid packages to the value of US$5tr which includes direct payment of US$1000 to every US household as well as assistance for business and increases to unemployment benefits, it does not include any furloughing payments. The system of furloughing allows employees to be stood down rather than being made redundant and seek unemployment benefits. This is a key reason for the massive rise in benefit claims applicants in the US.
While we expect that the figures for virus contagion, death rates, unemployment and business failure to rise through April, the impact to the UK economy will be somewhat cushioned by the emergency measures that underwrite wages and the self-employed.

The scale of the impact that the global lockdown is having on the world economy was made clear in recently published economic data that shows the developed world crashing into a deep self-imposed recession.

The UK service sector has reported an 80% fall in activity in March, while across Europe and the USA, similar data was posted. The IHS Markit manufacturing PMI Index of purchase managers confidence in the UK fell to 47.8 in March. Capital Economics are forecasting a 15% fall in output in Q2 as a result of the UK lockdown, while Oxford Economic are expecting Italy and Spain to suffer a severe recession after recording PMI rates at 40.3 for Italy and 45.7 for Spain.

The ECB has supported the bond markets in Spain, Italy and Greece with a €750bn of eurozone sovereign bond purchases and additional liquidity for banks. Even with this investment, EU leaders will need to take further steps which at the moment are being argued over between the Northern wealthier countries and the Southern indebted nations. Italy is particularly hurting as it is being hit by both an economic contraction and an exploding deficit. Italy’s debt to GDP could rise from the current 135% to as much as 155% of GDP over the months ahead. This level of debt is considered as unsustainable for a country that does not control its own currency.

The eurozone is becoming the single biggest danger to global financial stability and the pressure placed upon economies due to the Coronavirus has brutally exposed its structural weaknesses. The eurozone and ECB have not yet resolved the issue of Corona Bonds, where all eurozone nations share the debt incurred in tackling the virus. Meetings have ended in indecision as Northern states are uneasy about taking on the debt of the South. Eurozone authorities are under pressure to agree a joint financial support package very soon. This is a vital agreement in the fight to avoid a U-shape recession.

Several economies in Europe are suggesting that the continent cannot endure a lockdown lasting more than a further two months without inflicting significant economic damage. Beyond this and the cure may have a bigger impact than the problem. World markets are looking at the lockdown exit strategies and the containment of the virus. Markets are all too aware of the impact of a long lockdown.

China’s emergence after two months of lockdown and social distancing is encouraging as is the lift in China’s manufacturing PMI index to 50.1. So, is the fact that Spain and Italy feel they have now hit peak contagion and new cases declining. The UK and US are still to reach peak contagion, which is expected in 10 days in the UK and then about 25 days in the US.

If the governments supply of money to business and households can sustain us through these next weeks and months so that when the lockdown is lifted, normal spending patterns can be quickly re-established then a V-shape recovery can develop. If the economic damage is prolonged a U-shape recession could set in. At this point however, the majority of city analysts are looking at a V-shape recovery.

The emergency fiscal and monetary stimulus will inevitably continue far longer than the lockdown so that the on-going stimulus can lead to a lift in economic activity as pent up demand will surface and a return to growth is seen as a more probable outcome than a prolonged recession.

For now, capital markets look to have found a floor to value and have traded generally upwards and then sideways since 23rd March. Over the past month the S&P 500 stood at 3130 on 4th March, fell to a low point of 2273 by the 23rd March (-27%) to rise to 2488 by Friday 3rd April. (+9.5%). The FTSE 100 likewise over the same periods, lost 26.7% but regained 8.5% standing at 5415 on Friday 3rd April.

No clear direction has been established as markets are still concerned and uncertain. Markets are encouraged by the sheer size of the intervention packages and the impact they will have as they start being felt in the economy over the months ahead. However, the interventions will not stop the rise in death rates and contagion nor unemployment and business failures over the coming weeks. These events will depress market sentiment and will only really improve once we are beyond peak contagion in the US and the lifting of lockdowns across the world.

As the Queen reminded us last night, now is the time for national resilience and correct policy choices.


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Chris Davies

Chris Davies

Chartered Financial Adviser

Chris is a Chartered Independent Financial Adviser and leads the investment team.