In the midst of the worst public health and economic crisis the world has faced since the great depression, with nearly the entire global economy grinding to a halt to stem the spread of the most dangerous virus since the 1918 Spanish Flu, traders and investors face unprecedented uncertainties.
We know that we are all supposed to stay in our houses, to minimise interactions with other people and to follow strict social distancing guidelines. We know that travel, both domestic and global, is restricted. We know that, as a result, we face the most significant, in nearly 100 years.
Beyond what we know about the present, things become much less clear.
Question One: How long will lockdowns and social distancing and international travel restrictions last?
Italy and Spain have already begun to ease lockdown restrictions, albeit gently. Lockdowns in the UK, US and other major economies look set to continue for some time (the UK and France have/will extend lockdowns until May), but lockdowns are expected to be relaxed before summer.
In an optimistic scenario, lockdowns would end by summer, social distancing would be phased out by the end of summer, enabling the resumption of the tourism and entertainment economies, and global travel would quickly return to normal, as would global trade.
But such a scenario would rely on more optimistic public health assumptions. For example, widespread antibody testing (nowhere has managed to do this yet) would be needed to reveal that much of the community has had the virus and is now resistant (we don’t yet know if having the virus makes you immune to it for a second time). Perhaps warmer weather during the summer would reduce the spread rate of the virus, and even if there is a pick up in cases over winter, by that point authorities would be ready to contain any secondary outbreaks. These assumptions are far from given.
Conversely, in a more pessimistic scenario, lockdowns would remain in place for much longer than anticipated, perhaps into/beyond summer, as the spread of the virus proves more persistent than expected. Perhaps lockdowns are eased too quickly, and the rate of spread of the virus starts to pick up again, meaning lockdowns have to be re-imposed. Or perhaps winter sees the virus return with a vengeance, and lockdowns have to be re-imposed in the December, January, February months.
A more pessimistic scenario would rely on more negative public health assumptions. For example, perhaps authorities continue to lack the ability to conduct widespread antibody testing, meaning we still have no idea what proportion of the population has immunity. Or, widespread antibody testing is done but shows that only a small proportion of the population has immunity to the virus. In a worst case, public health scenario, immunity to the virus might be found to be short-lived, or the virus shows signs of mutation, rendering prior immunity useless.
Which way is it going to go? We have no idea! And that takes me onto the next question.
Question Two: How bad will the Covid-19 global recession be?
Today the IMF released its official forecast for global growth; world GDP is seen shrinking 3% in 2020, and then rebounding strongly in 2021 with growth of 4.5%. In terms of forecasts for specific countries, the US economy is seen shrinking by 5.9% in 2020, the Eurozone is seen faring even worse with 7.5% contraction, and the UK is forecast to shrink by 6.5%.
Things are seen as less bad in rapidly growing emerging markets such as China and India; the former’s economy is seen shrinking by only 1.2% in 2020, then rebounding powerfully in 2021 with 9.2% growth in 2021. The Indian economy, meanwhile, is seen shrinking at 1.9% in 2020 and then growing at 7.4% in 2021.
However, the IMF forecasts seem to rely on an important and far from certain assumption; that we see a rapid “v” shaped recovery after global lockdowns are eased.
The “v” shaped recovery narrative, however, relies on the optimistic scenario that I outlined above coming into fruition; i.e. a rapid return to normal life supported by widespread testing and immunity and likely the help of warm summer weather in halting the spread.
The pessimistic scenario outlined above would clearly accompany a much worse global economic outcome.
ING forecasts that in such a scenario, US economic growth in 2020 could be negative 15%, Eurozone growth negative 16.1% and UK growth negative 13%.
What does all this mean for markets?
In working out the answer to the above questions, four things are key to watch in the coming months.
One: Policymakers easing lockdowns, business and travel restrictions and social distancing guidelines.
From a market perspective, the sooner lockdowns are eased, the better, as that means the economy can restart. US equities have in part been rallying in recent weeks on the hope that lockdowns can be ended sooner rather than later as the spread of the virus has slowed.
The sooner we can return to normal, the better for risk FX (AUD, NZD, CAD, SEK, NOK) and the worse for havens (USD, JPY).
Here it is key to track what policymakers and leaders are saying about when they plan to end lockdowns.
Two: How does the rate of spread of Covid-19 respond to the easing of lockdowns?
We have seen the rate of spread of the virus slow down dramatically in China, Europe and the US in recent weeks/months after restrictive lockdowns were imposed. In other words, we know lockdowns work (when the population adheres). We have seen China largely return to normal without a huge surge in Covid-19 cases (at least, that is what they tell us). Can Europe replicate this? What is easing lockdowns restrictions is accompanies by a surge in cases and lockdowns need to be re-imposed (as in the pessimistic scenario outlined above).
If Europe and the US can ease lockdowns without an immediate second wave of Covid-19, this should be a medium-term positive for risk appetite, benefitting AUD, NZD, CAD, SEK, NOK at the expense of havens USD and JPY.
Three: Public Health Developments
Can we do widespread antibody testing to see what proportion of the population has had the virus and have immunity? If so, what results do we get?
In the optimistic scenario outlined above (basically that we are close to or at herd-immunity), this would be risk appetite positive. In the pessimistic scenario of nowhere near herd-immunity/only short-term immunity, this would favour havens.
Four: Economic Data
What does the data say about the economy? So, we start to ease lockdowns, how do various sectors of the economy respond? How does the labour market respond?
The better the economy holds up, the better for risk appetite. The worse it performs and the longer it takes to recover, the better for havens (gold would be one to watch, amid improved market liquidity conditions due to Fed action).
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