Economics and Strategy
Global Pandemic Fears Have Dampened Risk Assets, But Coordinated Policy Action Should Save the Day
Jefferies’ U.S. and European economists recently cut forecasts, highlighting that the economic impact of a pandemic is very different from anything else they have ever seen. Typically in a downturn, an economy loses momentum and a recession builds, instead of being actively slowed while the damage reverberates. We do not appear to be heading for a normal recession, and the U.S. Economics team does not currently forecast a recession this year. While the total effects of COVID-19 are not yet fully realized and may very well have much bigger implications for the rest of the year, Jefferies’ economists also believe that the economy will remain intact and functioning. They also are in broad agreement that what is important now is for both fiscal and monetary policy responses to be measured and prompt. David Owen, Chief European Economist, points out that while we have already seen this in the UK, the ECB needs to demonstrate its complete commitment and unlimited firepower to support the European markets through its new Pandemic Emergency Purchase Programme, as it does not have the luxury of sitting back and letting the politicians deal with this emergency. The policy response in the euro area has so far been lacking.
Christopher Wood, Head of Global Equity Strategy, suggests that the most practical thing governments can do is provide support to small businesses hit by a sudden loss of cash flow. In addition, aside from renewed QE, he believes the Fed’s recent crossing of the Rubicon in terms of explicitly entering the fiscal area will be significant, as it enables the purchase of corporate bonds and loans to businesses. Chris also believes the Federal Reserve does not want to venture into negative rates. However, this calls into question how it is possible to stop bond yields from being driven into negative territory by investors, as has happened in Europe and Japan. To him, the most obvious way to counter this is by a more elaborate version of the Bank of Japan’s yield curve control, where the central bank targets yields at longer-term maturities. He points out that this also means the long-term risk-reward ratio of owning Treasury bonds IS in no longer interesting, hampering the risk-parity trade.
David Zervos, Chief Market Strategist, believes that the Fed’s monetary policy moves have been extremely helpful in provoking aggregate demand and easing short-term funding stress. Recently announced policy sends the Fed firmly into the fiscal arena with the Treasury’s backing. Looking ahead, however, David highlights that the only real policy that can save the day against the virus is something that makes it safe for people to return to work. He points out that one driving force of the unprecedented price action has been risk parity unwinds. The key trigger here was when the 10-year and 30-year gapped to their respective low yields. He believes the combination of QE and risk parity unwinds has been, and will likely continue to be, quite lethal for the long end of the yield curve. As a result, he moved to the sidelines with his preferred risk parity trade structure. Global Equity Strategist Sean Darby points out while fears over the global economy keep credit spreads wide, the dollar has come back in line. He highlights that following the shock and awe of the Fed policy toolkit deployment and the U.S. government’s fiscal stimulus package, his indicators are moving away from deep risk aversion. He recently upgraded the S&P 500 to Bullish within his asset allocation framework.