Monthly Macro Outlook : Hysteresis is becoming mainstream

Macro

Christopher Dembik

Head of Macro Analysis

Summary:  This is quite surreal. Despite facing the worst economic crisis since WWII and growing risks related to the US-China trade war, the stock market has performed extremely well in the quarter that just ended. The Dow Jones and the Nasdaq recorded their best quarterly performances, respectively since 1987 and since 1999. The explanation for why the equity market is in such a strong position is related to the continued and massive inflow of central bank liquidity since the beginning of March (along with the global fiscal stimulus, reaching a total of about 20% of world GDP) and the belief in a V-shaped recovery. While central banks should remain the main stabilizers of financial markets in the summer period, the risk of market downturn is not negligible due to the strong disconnection between the market and the real economy and trade skirmish between the United States and China following the passing of the Hong Kong's security law this week.


China : Timid signs of recovery

Over the past few weeks, there were new modest signs of recovery in China. The authorities have refrained for quite a while to open widely the credit tap, but it seems that things have changed. Based on the evolution of total social financing (TSF), which corresponds to the broad measure of liquidity and credit in the economy, China’s stimulus is finally arriving, but it will take time before it hits the rest of the world – at least 6 to 9 months. The 12-month rolling sum is reaching a new record, at 22tr CNY (Chart 1), and it is likely to increase further in coming months as the PBOC is adopting a fine-tuning policy to ease monetary policy and access to credit. In its most recent move, taking effect from today, the PBOC has decided to lower the interest rates of reloans supporting agriculture and small firms by 0.25ppt and to lower the rediscount rate by 0.25ppt to 2%.

The stimulus is already benefiting the economy, but at a slow path. This is bright clear that there is no V-shaped recovery in sight and that the economy will take time to get back to normal. The official NBS non-manufacturing PMI rose to a 7-month high of 54.4 in June from 53.6 in May and the manufacturing PMI edged higher to 50.9 from 50.5 in the previous month. In order to have a V-shaped recovery, PMI data close to 100 would have been necessary – which is not the case. Looking into details, new export orders keep falling (Chart 2) but less than in previous months, which tends to indicate that global trade stabilization is about to materialize on the back of the reopening of the economies of China’s main trade partners. For the time being, Chinese firms are mostly focusing on destocking and cost reduction to increase profitability, which translates into less imports and falling employment. The rise in unemployment will probably be one of the top issues for China in the coming years. Adding to that the grim outlook for the service sector, notably for catering and restaurants, which confirms that there is no demand-side recovery yet, reflecting the importance of the hysteresis effect on the economy.

That being said, we think the worse is certainly already behind China on the economic front, supposing the coronavirus epidemic remains contained and that the new strain of influenza recently found in pigs in the country with pandemic potential won’t lead to a new outbreak.

Rest of the world : The great divergence

In the rest of the world, things are looking challenging and uncertainty remains like in China regarding the evolution of local consumption. But like in China, recovery is slowly happening in parts of the world that are reopening from the great lockdown. Looking at fatalities per capita, most of Europe, with the notable exception of Sweden and the United Kingdom, is doomed to reopen further the economy while evidence is growing that the United States will have no other choice but halting reopening, following the recent example of Arizona that closed bars and cinemas again. In the short-term, it appears obvious that countries that will be able to reopen the first will have a competitive advantage on others.

In the United States, the health crisis is reaching worrying levels, with a strong increase in contamination in Florida, Texas and California (Chart 3). The states of New York, New Jersey and Connecticut record one of the highest mortality rates per capita at global level. The V-shaped recovery narrative is also facing a major setback. The ECRI weekly leading indicator, which has proved to be a very reliable indicator to assess the evolution of the economy in COVID times, is turning down again (Chart 4). We believe that Chair Powell perfectly summarized the situation when testifying before the Committee on financial services of the U.S. House of Representative on June 30: “The path forward for the economy is extraordinarily uncertain and will depend in large part on our success in containing the virus. A full recovery is unlikely until people are confident that it is safe to reengage in a broad range of activities”. In other words, the outlook for unemployment is also very grim in the United States. Based on the LendingTree small business survey (May 2020), only 50% of small business say they are bringing back all employees all hours once they will be able to reopen. The risk is that long-term unemployment will rise, thus increasing further preexisting social and racial tensions.

In Europe, the health crisis is broadly contained and downside risks are slowly vanishing. As expected, the German government and the Bundestag have backed the ECB's bond-buying program, thus preventing a political crisis from emerging in the middle of the summer regarding the participation of the Bundesbank. In addition, statistics confirm that the credit channel is still wide open, which differs strongly from normal recession, with euro area bank loans to corporate over the past three months increasing the most since the euro was created. It is mostly due to the implementation of state guarantee schemes for loans in many euro area countries. However, the Union is not out of the woods yet. The risk of divergent recovery within the euro area is real with Southern European countries at risk of massive wealth and job destruction due to their strong exposure to tourism that could ultimately lead to a debt trap. As it is also the case for China and the rest of the world, we will have more visibility from September on the path of the recovery once the tourist season will be over in Europe and that all companies will be able to assess the real cost of the pandemic on their business.

Calendar of July 2020

July 2: NFP report covering the month of June.

Around July 8: Cabinet reshuffle in France and announcement of new stimulus package.

July 17-18: Physical EUCO meeting in Brussels to discuss the European recovery fund “EU Next Generation”.

July 29: FOMC meeting. No major announcement expected.

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo Markets is a registered Trading Name of Saxo Capital Markets Ltd (‘SCML’). SCML is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo Markets assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.