Economics and Strategy
While the Global Recovery Might be Slowing, Central Bank Policy May Keep Markets Buoyed
With several months of post-COVID recovery now behind us, Jefferies’ U.S. and European economists remain focused on improving data and policy actions. In the U.S., Chief Economist Aneta Markowska highlights the consumer spending snapback in May, which raised hopes for a V-shaped recovery. However, in her view, there are two issues that still make a V a long shot: the premature withdrawal of fiscal support, and the risk of a second wave of infections. While a new round of stimulus is likely coming, Aneta expects it will probably be incremental compared to the CARES Act. Meanwhile, COVID is now spreading aggressively through Sun Belt states and appears to be slowing retail traffic. As a result, she expects the momentum to slow in late summer, turning the V into a swoosh-shaped recovery.
Similarly, Chief European Financial Economist David Owen points out that though his real time indicators all now point to a recovery being underway, based on the trajectory of unemployment and bankruptcies as the year progresses, recovery is highly uncertain. What is known for sure is that the national governments and both Central Banks (BoE and the ECB) are coordinating fiscal and monetary policy to try and shoulder much of the burden. There are clearly risks that some countries don’t recover as quickly as others. However, the introduction of the Recovery Fund suggests that the European policymakers are being more vigilant about this risk than they have been in the past.
Christopher Wood, Head of Global Equity Strategy, suggests that while there are legitimate reasons for concerns about COVID-19 second waves, the reality is that any renewed concerns about the pandemic will, under Pivot Powell, trigger more dramatic easing in response to any resulting stock market weakness. In this sense bad news on the pandemic will again prove to be good news for equities even if that news triggers initial sell-offs. What the stock market, and growth stocks in particular, really need to worry about, is if the virus essentially burns out sooner rather than later. In this context, V-shaped recovery expectations will return to the market with a vengeance along with yield curve steepening. At that point Pivot Powell will likely seek to announce “yield curve control” in the sense of introducing price controls in the Treasury bond market, which will mark the formal introduction of financial suppression in the American financial system and, with it, the likely ending of the deflationary era and the beginning of a new inflationary one.
David Zervos, Chief Market Strategist, also expects that if the U.S. economy and stock market deteriorate further the Fed will certainly do more QE via U.S. Treasuries and agency mortgage securities. That said, he highlights that these policies could lower real yields and raise inflation expectations, leaving nominal yields unchanged. If inflation expectations rise up, which almost surely will happen after a large-scale QE operation, David expects long-end yields would rise and the yield curve should steepen. To that end, he continues to prefer his ‘spoos and sigs’ trade, balancing his new risk parity trade with investment grade corporate issues that fall within the Fed’s 13.3 wheelhouse. Recently, David also suggested adding some risk-off hedges that would pay out in a negative-rate scenario. Specifically, he proposed Eurodollar calls that would benefit were the Fed to go deeply into negative rate territory within the next 12 to 18 months.
Global Equity Strategist Sean Darby maintains the most bullish outlook, stressing that the ongoing tightening in corporate credit spreads and policy easing comes alongside a record level of U.S. economic surprises. He expects equity investors to move away from bond proxies and companies with high solvency toward value and growth alike. In Sean’s view, the fact that the Organization for Economic Cooperation and Development (OECD) lead indicator has turned alongside vertical rises in economic surprise indices suggests that earnings expectations are likely to rise over the next few months.