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19.03.2020 48

Policy action at the next level, but markets still in search of a 'real' catalyst

Published March 19, 2020

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The essential

  • Where we stand in the crisis and what to watch: Investors have moved from underestimating the severity of the crisis (buoyant markets) to a full global escalation (with the US joining emergency measures) that has led to market disruption and over-reaction. We are still in this over-reaction phase and it will likely continue for some time as the news flow is heavy. It is important to look at China and Italy as leading indicators of what countries can expect. Macro data, unsurprisingly, will be very weak, as we have seen in China’s retail sales and industrial production figures for January and February. What will be vital is that activity resumes after the containment measures. Again, China is our leading indicator. Italy will be crucial in assessing the impact and length of the crisis in Europe, followed by the US. We are still at too early a stage to see big improvements; the next two weeks will be critical to see the effects of the containment measures and to estimate the potential length of the economic contraction. Any positive (or negative) surprise in this sense will move market sentiment. Moreover the activity resumption in China will allow to size the risk of a second-round outbreak.
  • Policy response: For the first time since 2008 authorities are perceiving the need for coordinated global action, as evidenced by the G7 statement in which leaders said that they would “do whatever is necessary” to support the global economy. At the national level, policymakers are announcing backstops and fiscal packages to support their economies and healthcare spending, while major CBs have stepped in to provide liquidity facilities, QE programmes and interest rate cuts. The decision of the ECB to launch a new temporary PEPP (Pandemic Emergency Purchase Programme) worth €750Bln is just the latest in a series of measures to counter the risk for the Eurozone outlook posed by the coronavirus outbreak and to preserve financial stability in the Eurozone, avoiding the fragmentation in the EU financial system that characterised the Euro crisis. We are not at the end of this phase of Central Bank intervention yet: we expect more to come from central banks and on the fiscal side. The aim of the policy mix is to ensure that economies will survive to temporary national lockdowns and eventually preserve financial stability. Higher debt will ultimately be the end game of this crisis, and debt monetisation the likely solution. QE infinity and zero rates are here to stay, if not forever at least for a very long time. Helicopter money has become a real possibility, but it will be another jump into unchartered waters. There is also an opportunity for the Eurozone in this crisis. Unlike the Euro crisis, coronavirus is affecting all countries. The incentive to reinforce the institutional framework of the Eurozone and to move towards Eurozone debt issuance is higher than in the past: we are now in a ‘now or never’ moment for the Eurozone.
  • Market outlook: This is a time when it is too late to sell and too early to buy. Selling now could damage the ability of investors to reach their long-term objectives. Markets will remain volatile in search of a ‘real’ catalyst to trigger the bottom (a clear signal of containment in Europe at a time of coordinated fiscal and monetary push, or the discovery of a medical treatment). In this situation, we maintain a cautious view on risk assets and a strong focus on liquidity. In credit markets, default rates are likely to surge and anew wave of downgrades is likely, especially among BBB-rated US corporates, which could fall into HY territory. At the sector level, energy will be the hardest hit within the US HY issuers as at the same time oil prices are collapsing. Overall, there is still scope for spread widening, but when the dust settles, there are opportunities for robust business models. A focus on companies with good fundamentals will be critical to navigate this phase. In equity markets, the bear market may be an unusual one and probably of extreme magnitude, but it will not be as long-lasting as the one in 2008-09. We maintain a constructive view on the final part of the year, expecting a strong recovery in market prices, along with an improvement in economic conditions.

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