Starting with the U.S.: A recession is on the cards…
It is amazing how quickly the outlook has changed – the global economy is struggling and central banks are doing all they can to soften the landing. In times when the whole world is impacted, economies with a strong (pre-event) macro and available firepower will do better relative to the rest of the world. The U.S. comes in this category.
To protect the economy from the slowdown impact of coronavirus, the Fed announced a $700bn+ quantitative easing (QE) program on March 15 – this was in addition to the USD1.5tn funding for the overnight bank repo market and bond purchases. A week later it increased this QE to “unlimited” i.e. an open-ended commitment to keep buying assets. Basically, the Fed guaranteed unlimited liquidity thereby giving the markets comfort that there will always be a buyer for U.S. securities. Another worrying characteristic of March was that Treasury yields were rising and the stock market was falling – basically sell everything and sit on cash. The Fed slashed key interest rates twice in March and they now stand between 0% and 0.25%. The rate cuts along with the QE resulted in stabilising Treasury bond yields by March 20 (it was a very volatile 2 weeks before this). The 10-year Treasury Yield is now at c. 0.75% and the 30-year at c. 1%.
The impact on the economy is showing with jobless claims rising to 6.6mn in March 2020 and consumer sentiment at a 4 year low. The first-quarter GDP is expected to contract c. 5% and with March retail sales dropping by 10%, expect the macro numbers to be bad for the next quarter. On the flip side, the S&P 500 dividend yield is now 5x the 10-year Treasury yield – this is a good indicator for long term flows returning to equities. Market volatility remains, but volumes are going down – so hopefully heavy volume selling pressure is drying up. The 2tn economic relief plan will show impact in April, now just need to track what analysts will say about forecasting earnings and dividends.
Moving on to Europe: The ECB also throws in its firepower…but will not avoid a long recession
The event that was on the top of our minds in 2019 happened – Brexit…but that all seems to far away from where things are now. With the flight of liquidity to the U.S. Dollar, both the Euro and the British Pound witnessed tremendous pressure. The fall of both currencies relative to the U.S. Dollar was halted only closer to the last week of March when the U.S. Fed further cut rates and announced its unlimited QE strategy.
The ECB launched its own QE programme of Euro 750bn on 19 March in addition to the Euro 120bn purchase programme of 12 March. Further Euro 3tn of liquidity was made available through refinancing operations. The 10-year yield now stands at c. -0.4% and 30-year at c. 0%. The UK government announced a GBP 350bn aid package for the economy on 17 March.
Marco indicators from Europe are going to be poor. Euro Area PMI for the services sector is at an all-time low of 28.4 and the manufacturing composite index is at 31.4 (below the 36.2 in 2009). The services sector was the backbone, but with the shutdown of the region, there is a great risk of this backbone also being lost. The German auto sector is seeing huge disruptions with a fall in sales in the 2 large markets of EU and China. The pre-coronavirus macro was tough, now the outlook for the region is very fragile.
China: Out of the woods?
Going by statistics China is going to be the first major global economy to recover from the economic impact of the coronavirus. As per official figures, the resumption of work rate is at 70% for nearly 6900 key foreign-invested enterprises. Daily power coal consumption by the six major power generation groups is now only at 17% below the same post-Lunar New Year holiday period and of those who left tier-1 and tier-2 cities for the holiday, 81% have returned. But while there may be domestic resilience, the global trade partners of China are in a shut-down. Chinese imports and exports are not going to recover any-time soon and Nomura securities have cut growth rate estimates for 2020 to 1.3% from previously 4.8%.
Closer home in India: Lower growth, but at least no recession
This quarter has seen Nifty slide from a 52-week high to making a fresh 52-week low. The leading indices have lost almost a third in value in such a short span that this may be the fastest fall we have ever seen. Three things have spooked the markets:
- COVID 19 pandemic: As we write the total number of persons affected have exceeded 1.2mn. India has relatively better placed with a few thousand cases. The decision of the Indian government for a complete lockdown in the entire country for 21 days starting March 25, 2020, may help ‘flatten the curve’ for India and prevent its medical system from being overwhelmed by a large outbreak of COVID-19 cases. The lockdown will have a serious economic impact on India.
- Yes Bank – Moratorium & Bail Out: Yes Bank was the 5th largest private sector bank in India with a loan book and deposit base of Rs 2+ Lac Crore each. A moratorium on its deposits caused a systemic issue with public losing confidence in the financial system, causing a run on even otherwise healthy banks. As a last resort, government & RBI have roped in SBI which will manage the turnaround and ensure depositors’ money is safe.
- “Oil War” of Saudis: Saudi plans to flood the market by increasing supply of Crude despite lower demand, probably in retaliation to Russia not agreeing to cut production and/or to make US shale gas unviable. This has resulted in WTI Crude Oil to crash from USD 61.5 a barrel in Dec 2019 to less than USD 30 now. Whilst this is good news for an oil-importing country like India having a large current account deficit, this will lead to “risk-off” mode across the globe and a flight of foreign capital out of India.
These are indeed extraordinary times and Reserve Bank of India (RBI) stepped up with the much-needed medicine. In line with global central banks, the RBI responded with emergency measures including 75 basis points (0.75%) rate cut besides several other measures to reinforce financial stability in the market. In a surprise move, the RBI offered relief to the corporate bond market by allowing banks to buy investment-grade corporate bonds through the Targeted Term Lending Operation (TLTRO) besides other liquidity enhancing measures to the tune of Rs.3.7 lakh crore (trillion). The RBI also said that it would maintain its accommodative stance “as long as necessary” to revive growth.
Whilst the RBI’s move was a step in the right direction, the Indian government too would need to provide the necessary fiscal and monetary support to the economy and the financial system. While the government is currently focused to control the pandemic and restore essential services, a stimulus package for the corporates and especially SMEs / MSMEs would be essential to soften the economic impact of the sharp contraction in economic activity. Many of the larger economies globally have announced large fiscal and monetary packages over the past few weeks and progressively increased the scope of the measures.