After a brief bounce in the markets on Tuesday after the US Federal Reserve (FED) announced further support in asset purchases, concerns returned to an increase in infection rates in certain states in the US and also Beijing, where schools have been temporarily closed once again after a spike in cases. The case growth in the US highlights the fragmented approach taken to the pandemic, with each state taking responsibility for lockdowns and re-openings. The original epicentre of the pandemic in the US, New York, is well on the way to reopening, with restaurants due to open again on Monday. Meanwhile, case growth and hospitalisations are rising at an accelerating pace in Texas, California and Florida. While there remains no political appetite to return to national lockdowns or such like, the lack of response in some states means that the pandemic will likely weigh on sentiment for some time as new cases start to accelerate.
Central banks have once again been to the fore this week, with the Bank of England (BoE) meeting yesterday delivering an increase in quantitative easing (QE), albeit at a lower level than many expected. The Bank increased QE by a further £100 billion, but intends to spread out their asset purchases to the end of 2020 and in doing so it means that the ballooning government budget deficit is now over 100% of GDP for the first time since 1963. BoE Governor Andrew Bailey played down the easing in the pace of QE, stating “we are slowing from warp speed to something that by any historical standards still looks fast”. The minutes of the meeting showed no further discussions on negative interest rates and noted that some of the recent data had not been as bad as feared when the Bank met in May. While the Bank thought the recession may not be as deep as previously feared, further falls in inflation and the potential for persistent damage from the pandemic on the economy justified additional QE.
In the US, FED Chair Jay Powell told Congress that in spite of indicators pointing to a stabilisation or a rebound in economic activity, “the levels of output and employment remain far below their pre-pandemic levels and significant uncertainty remains about the timing and the strength of the recovery”. The Bank of Japan also met this week and made no change to policy in line with expectations. They did however announce that their monetary stimulus measures relating to the pandemic had now passed $1 trillion as a result of increased take-up of a government loans scheme funded by the central bank.
Meanwhile, the European Central Bank announced the results of their latest lending operation for eurozone banks. The TLTRO 3 (targeted long-term refinancing operation) saw banks borrowing a record €1.3 trillion from the ECB at negative interest rates. This has allowed them to borrow for 3 years at a rate of minus 1 percent (below the deposit rate). This is effectively a subsidy for banks and will allow €765 billion of previous TLTRO loans to be repaid, with the balance being used for lending or buying government bonds – a profit making trade given the difference between the borrowing costs and the interest rates on government bonds. The so called ‘frugal four’ of the Netherlands, Austria, Sweden and Denmark look set to push back against the plan, which requires unanimity, with Dutch Prime Minister Mark Rutte calling for a “realistic level of spending” and for loans rather than grants in the Recovery Fund. The talk of a Recovery Fund has led to a more positive view being taken on European assets in recent weeks and while a conclusion to talks is unlikely today, a further meeting in July could see a compromise reached. It has been another week that serves to remind us that the central banks continue to be in “whatever it takes” mode.
Brexit was back in the headlines and after talks with European Commission President Ursula von der Leyen on Monday, Prime Minister Boris Johnson said “the faster we can do this the better, we see no reasons why you shouldn’t get that done in July”. Any deal that avoids the UK leaving the transition period without reverting to WTO terms will be welcomed, though equally any deal that is agreed in the space of 5 weeks given that comprehensive trade deals normally take upwards of 5 years is likely to be a very basic one. It is already clear that the UK intends to, for at least the first six months, use ‘light touch’ customs checks (basically none) to avoid chaos at ports, though the EU ambassador to the UK has already declined to reciprocate, meaning that as things stand, all UK goods going into the EU will be subject to full customs controls and checks. The key point to watch out for will be if a joint text from both sides can be agreed by the autumn (to leave time for ratification). Such a text would likely be more complicated than the Withdrawal Agreement and as far as the EU is concerned will need to honour the commitments made in the Political Declaration agreed by the UK last year. If there is no text by the EU Summit in October, then a ‘no deal’ exit will be likely. This will not be a simple process, and is one made even more complex by both sides having to also deal with a pandemic and economic recession at the same time. A positive conclusion to the talks would remove a year-end tail risk all the same, and potentially see UK assets find favour from global investors after several years of being unloved. But there will be plenty more noise and uncertainty in the short term.
As we saw in parts of April and May, markets have become a little range bound and are unable to find enough support to move back above the high points achieved a week ago. Our base case remains that good news on drug testing and an easing in European infection rates is already priced in, so we probably need some further good news (ideally from a stabilisation in US infection rates) for the market to move meaningfully higher. Having said that, there remains support for the market at current levels. This week we have seen a lot of geopolitical noise from India, China and North Korea, however the news flow appears not to have caused too much upset and the tailwinds of liquidity from the central banks remain ever present.
A pause in the market rally given the speed and strength of the rebound from the March lows should not come as a surprise, though we should also remember that there remains a near-record amount of cash in portfolios as per the Bank of America Merrill Lynch Fund Manager’s Survey, as well as trillions of dollars in money market funds that have missed out on this market rally and remain on the side-lines ready to be brought into action should the news improve.