Summary: Asian stocks rounding of Thursday’s trade with a cautious tone and indices across the region trade mixed. This amidst the ongoing combative stance upheld by Washington and Beijing as the US/China relationship visibly continues the slow burn deterioration, with acrimonious rhetoric on the rise as US election campaigns heat up. Although with the liquidity driven narrative intact, it seems only a matter of time before the relentless dip buyers step in again.
The mounting virus death toll in the US, deaths hit their highest level since May 29, also weighing as investors deliberate virus concerns with fresh fiscal support and ongoing central bank accommodation. This ahead of a deluge of quarterly earnings tonight, with reports from Twitter, Southwest Airlines, American Airlines, Blackstone Group, Roche, Intel, Unilever, Canadian Pacific, Hyundai and Mattel. Alongside US jobless claims data, subject to a degree of upside risk as the rampant virus and paused reopening’s/reimposed restrictions has likely led to stalling jobs rebound and increased job losses.
The mounting US/China tensions form part of an ongoing long-term structural separation between the two superpowers, to which COVID-19 has acted as an accelerant. The post-pandemic blame game only serving to re-ignite pre-existing hostilities. The ideological differences and political fragmentations that drove the original US/SINO confrontations are on full display and the tectonic shifts like, the East/West divide, Splinternet, and supply chain relocations we talked about when trade tensions first emerged are now coming to fruition. The phase 1 trade deal was a face saving agreement and is largely smoke and mirrors, a deal in name only. The purchase commitments were always ambitious even prior to the pandemic denting global growth and collapsing demand. The disentanglement between the two nations will be ongoing for many years to come. But this presents a dilemma for investors, the left tail risks are high but the headlines are noise, hence often times the initial move is faded. The slow burn is very hard for risk assets to trade unless we get clearly defined developments. However, the structural separation remains a ticking bomb and the risk of a definitive breakdown is highly asymmetric, particularly as US consumers (the voter base) begin to turn their backs on China. The upcoming election then provides increased impetus to elevate the geopolitical frictions if they play to US voter support, which is as ever a rolling calculus.
In Australia, all eyes were on the July Economic and Financial Update (JEFU) and the COVID-19 induced wartime deficit revealed by treasury today.
Federal Budget: Data suggests the federal budget was $85.8 billion in deficit (4.3% of GDP) over the past year (2019/20). The Government expects a $184.5 billion deficit (9.7% of GDP) in the current year – the highest in 75 years or since WW2.
Upside risk to these forecasts are significant given an inordinate degree of uncertainty remains as it relates to the virus itself altering the validity of forecasting metrics, alongside a flattening recovery curve that may disappoint treasury expectations, unknown impacts on consumer and business behaviour, labour market dislocations and the need for more fiscal spending. Unemployment is likely to remain high for a prolonged period, and continued, targeted income support vital to combat the demand hit. Although retail spending has remained resilient, it is too early to take this data and extrapolate it forward. In addition, the lift in retail spending should not be confused with what has been a big hit to household incomes and household consumption expenditure. A large part of the retail spend has likely been repurposed from other consumption sectors. Retail sales account for around a third of overall consumption which is more than 50% of final demand, and early access to superannuation has been a real wildcard. The impact of this scheme on discretionary spending is difficult to forecast, but it is likely that the retail spend tapers in tandem with stimulus measures.
These factors are not only relevant domestically, but globally, and will weigh on the trajectory of the local recovery. This means the forecasts are subject to an abnormal amount of uncertainty in being based off assumptions that could change very quickly and likely some “guess-timates”. More than in any other time, there is a wide range of economic probabilities (ruled to a large extent by the virus) that may come to fruition. And if the underlying assumptions change, the estimates will change.
Economy: The economy is estimated to have contracted 0.25% in 2019/20 and is expected to contract 2.5% this year (2020/21), with the sharpest fall in the June quarter. The unemployment rateis forecast to peak around 9.25% in the December quarter 2020, but could remain above 10%, with “true” unemployment closer to 15% in April, falling to 11% in June.
Although COVID-19 has blown a hole in Australia’s budget, the spend is necessary to bridge the gap between recession and the post-pandemic normal, whilst averting the worst-case depression. There was no alternative, and without the fiscal support, the economy would be in a far worse position. Although on a relative basis most of Australia has fared better than many other countries in suppressing the virus, we are far from the conclusion of the COVID-19 induced shock. A vaccine is likely a long way off, and the Australian economy faces significant hurdles with ongoing dislocations in the labour market, the virus resurgence in Melbourne that has already had a dampening effect on confidence and the blowback from the global slowdown weighing on the recovery curve. The tensions with China, Australia’s biggest trading partner, also remain on the backburner, ever-present, serving another blow for the hard hit education and tourism industries, which have been service export growth areas as the world inches away from reliance on fossil fuels and bulk commodities. A clear incentive to reshape Australia’s climate change policies and invest in renewables, where the country already has a significant comparative advantage – we can address both climate crisis and economic crisis through a focus on renewables and sustainable rebuild of the economy that serves future generations, as well as the current.
To maintain the trajectory of the recovery and avoid the “double dip recession”, confidence amongst businesses and consumers is critical in upholding investment and spending and re-asserting a self-sustaining trajectory for inclusive economic growth. The economy did not enter this crisis from a position of strength and in order to reinvigorate investment and productivity, reform is much needed. The government must maintain this stance in their future assessment of the “war time” fiscal deficits, rather than fixating on surpluses.
With the transmission of monetary policy now somewhat limited when it comes to reinvigorating economic growth, the baton must be passed to fiscal support. Utilising Australia’s balance sheet capacity and low borrowing costs in reviving investment, productivity and confidence, alongside returning the labour market to potential. The cost of borrowing at the effective lower bound is not a hindrance to businesses or consumers, the uncertainties surrounding the economy and the virus are the primary issues. To which the answer is fiscal, with monetary policy playing second fiddle.