Markets scenarios & risks - October 2020

Covid-19 update: the race for a vaccine 

As the northern atmosphere begins to get colder and a second wave hits Europe, scientists around the world have high hopes of finding a vaccine to stop the SARS-CoV-2 coronavirus. At the time of this writing, 40 vaccines are in clinical trials on humans with more than a dozen in the late phase of the approval process, and around 90 preclinical vaccines are under active investigation in animals out of 250 announced candidates. Most specialists expect a vaccine with scalable production capabilities to be available early 2021 or mid-year at the latest. The key factors behind this unprecedented medical search and the likelihood of success are the slow mutation of the virus, the large number of technology platforms being used, and access to almost unlimited funding. The race for a vaccine is in its last laps. Then will come the tough decision of who gets it first.

1. Assessing the recovery

• With the peak of the pandemic now behind us in most of the major global economies (although secondary waves need to be watched), attention now turns to the speed and composition of the recovery.
• High-frequency data suggests a technical recovery, with Europe leading, whilst the US and UK are lagging behind.
• New evidence confirms our take that this is not the V-shaped rebound priced in by the markets.
• We maintain our view that we are facing a long U-shaped recovery, and that it will be late 2021 / early 2022 before global GDP recovers to pre-Covid-19 levels. Even in this scenario, emerging economies recover more quickly (basically a China story) than advanced economies (H2 22).

2. Preference for equities in our tactical and strategic allocation

• Q3 technical rebound doesn’t move economies back to pre-Covid levels. Economic performance will progress along a slow upward sloping catch-up process. We expect the inflation trend to be up and to stabilise around targets in the forecast horizon. US companies’ resilience underpin the ongoing profit recovery in US.
• We therefore confirm the recovery phase as the most likely macro-financial regime in the next 12 months. Still, we maintain a 20% probability for the downside scenario. Near-term risks are tilted to the downside, but in our medium-term radar we see a rotation from credit (HY) to equity.
• Tactical (1 month): Neutral+ exposure to equity and constructive for IG EU (contributing to a long duration). Long gold.
• Strategic View (3 to 6 months): rotation from credit HY into equity. Long gold.

3. Euro’s “risk-on” status

• Market participants pushed the EUR higher and the single currency has confirmed its status as a ‘risk-on’ currency.
• If this trend continues it will become an issue for the ECB, which “carefully monitors developments in the exchange rate, with regard to its implications for the medium-term inflation outlook”.
• Looking ahead, we expect an expansion of the ECB’s asset purchases via PEPP/APP, rather than further rate cuts, which still seem highly controversial.
• The EUR/USD should therefore be range-bound or maintain its mild upward slope

4. Politics will be the main market driver till year-end

• Policies are shaping the recovery trajectory and influencing market participants’ narratives.
• If financial conditions remain as easy as they are, the Fed is unlikely to provide any further easing; nor will other key central banks. As such, markets will be left with economic data and politics, US fiscal stimulus, US elections, Brexit, and, obviously, Covid-19-related news.
• US fiscal policy is still in politically awkward damage containment mode. Unilateral Trump decisions (jobless benefits and eviction moratoriums) have temporarily forestalled the fiscal cliff. But we have little visibility on the Phase 4 bipartisan deal, and the recovery / reconstruction plan will be decided after the election.
• US elections are too close to call in the White House and Senate, though the HoR will probably remain Democratic. The markets’ preference between Trump and Biden remains unclear.