A fiscal and monetary prescription

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Fiscal and monetary easing was prescribed for the UK economy on Wednesday, leaving investors awaiting co-ordinated responses in Europe and the US to allay market anxiety over the rising pace of Covid-19 infections outside of China.

Beyond the headline-grabbing cut in the UK base rate to 0.25 per cent, the Bank of England unveiled measures that keep credit flowing for small- and medium-sized businesses. Sharply lower bond yields already reflect the prospect of central banks cutting borrowing rates towards zero, or, in the case of Europe, further into negative territory. Here’s a look at the latest rates set by leading central banks via Brown Brothers Harriman.

Lena Komileva at G+ Economics says:

“Cyclical measures are no panacea to the direction of risk during a pandemic, but they will be critical in re-anchoring investor, business and consumer expectations about the magnitude and duration of the economic shock.”

Policies that help businesses endure the likely cash-flow shock from the health crisis are welcome, but government spending will play an important role in helping moderate a broad service sector hit. In that regard, Rishi Sunak’s first UK Budget as chancellor of the exchequer delivered a £30bn fiscal stimulus package, which included measures to counter the shock of the coronavirus outbreak. It marked the biggest rise in government borrowing for 30 years. The end of the austerity policy had long been expected since the December general election, however, record-low gilt yields now provide the government with plenty of cover to deliver increased spending on infrastructure and other areas of the economy. The gilts market, wrote FT’s Tommy Stubbington, took the projected borrowing splurge in its stride.

The UK’s twin easing efforts come as Covid-19 shows little sign of abating outside of China, as shown in these UBS charts. The World Health Organization highlighted the severity of the outbreak after it declared coronavirus a pandemic on Wednesday. 

UBS says fiscal and monetary easing will result in the most expansionary year since 2009 for the global economy and financial system. The bank notes: 

“It will help the recovery to trend starting in the second half of the year, and we expect a full recovery to trend growth in 2021, with only limited permanent global output loss.”

That is certainly the hope given the prospect of much weaker global demand and supply disruption via Europe and North America in the coming weeks. This also casts a shadow over China as the country stages a nascent recovery from the virus. Richard Gao at Matthews Asia notes: 

“Ironically, the market closest to the epicentre, China A-shares, has experienced the least amount of damage. This will likely change in the coming weeks as it becomes increasingly clear that the US and Europe will experience a consumption shock. This will in turn negatively impact orders in China and the recovery that is underway.”

A question for investors is whether the US and Europe follow the template set by the UK. The answer is likely to be yes, but with the risk of a lagging response that may do little to alleviate market stress, let alone stem a deeper economic shock in the near term.

In the US, stimulus delay reflects election-year dynamics between the White House and Congress. The gridlock weighed on market sentiment on Wednesday with Wall Street falling sharply at the open of trading, with the S&P 500 closing 4.9 per cent lower at 2,741. The Dow dropped 5.9 per cent, marking a fall of more than 20 per cent from its high last month — calling time on an 11-year bull run.

A US Congressional recess looms at the end of the week, but due to concerns over flying as the coronavirus spreads, members may not return to Washington as scheduled on March 23. Brian Gardner at Keefe, Bruyette & Woods believes “a fiscal response is more likely than not” but an extended recess means “a fiscal plan would, in turn, be delayed and any delay could eventually lead to inaction”. 

At least there may be some help for taxpayers as the US Treasury considers pushing back the April 15 tax filing deadline (for 2019) to help companies and individuals deal with the economic stress from contagion.

Steven Mnuchin, the US Treasury secretary, said on Wednesday that some stimulus measures should be unveiled within the next 24 hours while others are a week or two away.

As for Europe, Christine Lagarde has thrown down the gauntlet with a warning to EU leaders that the lack of a co-ordinated policy response “will see a scenario that will remind many of us of the 2008 great financial crisis”. The European Central Bank will likely do its bit on the easing front on Thursday (particularly given a strengthening euro), but co-ordinated fiscal measures are what investors want to see. Europe’s Stoxx 600 has extended its foray into bear market territory and has now dropped 23 per cent from last month’s peak, so the recession clock is ticking louder. 

Brad Bechtel at Jefferies notes:

“Lagarde will come with some measures tomorrow [Thursday] and hopefully talk ‘tough’ with a whatever-it-takes type of moment but will the market believe that is enough this time around? Cutting 10bps and adding some QE is not really going to be all that effective and from a signalling perspective it could actually signal how little they have in the tank, if anything.”

The worry is that it will take a much bigger slide in equities and credit before hefty fiscal help arrives in Europe and the US. The concern is that intensifying market turmoil seriously hurts business and consumer confidence, making the task of eventual recovery only tougher and longer. 

Longview Economics make this point:

“Beyond coronavirus, though, markets are now contending with a variety of other challenges including the oil price shock, the rise in volatility, and potential subsequent financial market dislocation.”

Its analysts add that “the speed and magnitude” of the response from policy officials “will be critical and needs to be watched closely”. 

And, as Oxford Economics highlights, “global valuation multiples are still above their post global financial crisis average, and they are well above previous correction lows”.

Quick Hits — What’s on the markets radar

Despite the plaudits for the UK budget, some do question whether a recession has been averted in the coming months. 

Anna Stupnytska at Fidelity International notes: 

“While it may indeed represent one of the ‘most comprehensive’ virus-response packages we have seen globally so far, at least on the headline, the high degree of uncertainty around coronavirus outcomes does make it difficult to gauge whether the new policy measures are going to be sufficient in averting a recession this year.”

The S&P 500’s double bottom at 2,734 holds for now but the earnings outlook suggests this floor will break. Strategists at Goldman Sachs cut their S&P 500 forecast to 2,450 by the middle of the year, which is a drop of about 13 per cent from current trading levels and a drop of 28 per cent from the index’s February 19 peak.

 David Kostin, Goldman’s chief US equity strategist, writes:

“After 11 years, 13 per cent annualised earnings growth and 16 per cent annualised trough-to-peak appreciation, we believe the S&P 500 bull market will soon end.”

Goldman expects the impact of the coronavirus to wane in the back half of the year, with a “fast rebound” in the S&P 500 back to 3,200 — close to where it started the year. “A new bull market will likely be born later this year,” and Mr Kostin adds:

“By year-end, economic and earnings growth will be accelerating, the fed funds rate will be at the zero lower bound, and the impact of any fiscal stimulus will be flowing through to consumers.”

Taking a longer-term view, Leo Hu at NN Investment Partners expects that once central banks have pumped plenty of liquidity into markets, a “low-rate environment means the search for yield will start all over again, suiting higher-yielding EM debt”.

EMBI Global Diversified spreads over the past 10 years

Leo adds: 

“In the past decade, there have been only two other widening moves in EM credit that match the coronavirus-driven sell-off (see figure), and with so much unresolved, there is a good chance that this sell-off will provide the widest entry point. It presents a good moment to add risk, or at least hold current exposure.”

Read more about the impact of coronavirus

The latest figures as the outbreak spreads

How countries around the world are battling coronavirus

How dangerous is the coronavirus and how does it spread?

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