The second wave of the COVID-19 epidemic has forced many governments to make difficult choices (curfews, lockdowns) as they try to contain the number of new infections. Hopes for additional fiscal and monetary stimulus is supporting financial markets.
France has imposed a curfew for nine big cities including Paris, covering nearly 20 million people. Comparable measures have been taken in Belgium and Slovenia and are expected in several Italian regions. Wales and the Republic of Ireland have moved to a lockdown for two and six weeks respectively.
The curbs are, however, less stringent than last spring since schools remain open and far fewer businesses have been forced to close. Countries that during the summer managed to limit contagion, but now face a second wave, are putting in new restrictions. German and Dutch leaders have called on people to limit social interaction.
These decisions reflect the rapid deterioration in the health situation. Europe was particularly hard hit, but the rise was also seen in the US, where the number of new daily cases reached its highest since early August. Hospitalisations and deaths may look low even as the infection curves turn up, but it must be noted that it can be several weeks between contamination and worsening symptoms. A seasonal factor might also be at work, but epidemiologists are not yet in a position to decide this issue.
Without the numbers improving significantly in coming weeks, governments may have to take more drastic measures, even as real-time mobility indicators have started to ebb.
The impact of renewed restrictions on activity is particularly important for Europe, where the recovery already appeared to be fragile as early as September, i.e. before the second wave arrived.
In China, GDP grew by 4.9% year-on-year in Q3 after 3.2% growth in Q2, falling short of expectations (5.5% according to Bloomberg). However, hard data for September was better than expected: retail sales continued to rebound, while industrial production grew by 6.9% after 5.6%. If this positive trend holds, monetary policy can remain neutral, but disappointing growth would result in action by the central bank, which still has ample room to manoeuvre. Indeed, activity in China has so far picked up with smaller stimulus than elsewhere.
US data on manufacturing activity was mixed. Industrial production remains below its September 2019 level, while manufacturing surveys for New York and Philadelphia have sent contradictory signals. Friday’s purchasing managers’ data will provide fresh clues. The housing market has continued to benefit from low interest rates. Homebuilder confidence hit a record in October. Builders have pointed out that the concept of ‘home’ has taken on renewed importance for work, study and other purposes.
The second debate between the two presidential candidates is scheduled to take place on Thursday with new rules intended to allow for a more serene (and more audible) discussion than on 29 September. Given Joe Biden’s lead in the polls – the Democrat advanced significantly after the first debate – Donald Trump’s strategy could be decisive less than two weeks before the election.
Given the potential divergence between results from mail-in voting and in-person voting, particularly in the six swing states, the outcome may not be known immediately after polls close. A contested election is likely to increase market volatility and to lead to safe-haven flows if the 2000 election is any guide.
From an economic policy of view, the main question is over the composition of the Senate. A Democratic majority would allow a large fiscal stimulus package to be adopted quickly. The House of Representatives’ ‘HEROES’ bill gives an idea of what a ‘Biden stimulus’ could look like. In his first year, 9% of GDP would be pumped into the economy. Aid for households (jobless benefits, stimulus cheques) and firms would make up the bulk of the spending, complemented by longer-term measures on healthcare, education, etc.
Such a large package could pose a challenge for bond markets as under its new monetary policy framework, the Fed is less likely to raise policy rates in the face of a massive spending increase and rising inflation. Relative to 29 September, the 10-year Treasury note yield has already risen by 14bp to 0.79% on 20 October, while 5-year inflation expectations in five years are up at 2.17% from 2.04% (see exhibit 1). Uncertainties over the outlook for the pandemic and the lingering scars of recession, particularly for employment, have limited movements in rates though.
Over the past week, global equities have fallen by 1.5% (MSCI AC World index in US dollars at the close of 20/10). The US S&P 500 fell by 2% in five trading days. It is up by 2.4% from the end of September on the back of strong economic data, a rather good beginning for the earnings reporting season, and – Democratic – expectations of fiscal stimulus before the election. The eurozone EuroSTOXX 50 index dropped by 1.2% in five trading days to be up by 1.9% since the end of September.
While there are many sources of short-term volatility, we remain constructive on risky assets in the medium term given that economic policies to support activity are likely to be strengthened.
Long-term European bond yields fell notably, including in ‘peripheral’ markets. On top of worries about the growth outlook, there are strong expectations that the ECB would increase its asset purchases by the end of the year. The EU issued its first bonds to finance the short-term SURE – Support to mitigate Unemployment Risks in an Emergency scheme. It sold EUR 17 billion of bonds in the face of a colossal EUR 233 billion worth of subscriptions for the AAA social bonds.
Investors’ appetite for further issues is likely to remain significant as these supranational securities are eligible for the ECB’s purchases.
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 views expressed in this podcast do not in any way constitute investment advice.
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