Markets traded with a relaxed tone this morning, characterised by a modest but continued recovery in risk appetite and easing financial conditions, accompanied by a weaker US dollar.
This improvement is not without justification, as three significant developments have occurred since Thursday afternoon in the form of the Eurogroup spending package, OPEC production cut, and significant new Fed measures announced last Thursday. Given that the likely trajectory of death rates in the US and UK is likely to follow that seen in Europe, there seems to be little impetus for a reversal in risk appetite this week. Markets are instead likely to focus on when lockdown measures will ease in key economies, and how severe the macroeconomic costs will be.
The International Monetary Fund released its World Economic Outlook today, which estimates that global gross domestic product will shrink 3% this year, compared to the 3.3% expansion predicted as recently as January.
This pessimistic forecast could worsen further, if the COVID-19 pandemic lasts longer than expected this year, or there is an extension in 2021. Prior to the IMF, the UK Office for Budgetary Responsibility released a similarly pessimistic “scenario” for the UK economy, which assumed a 3-month lockdown period. Under this scenario, GDP is envisaged to fall by an astonishing 35% this quarter, while the UK Government budget deficit would expand to its largest share of GDP since the second world war.
With the IMF and OBR setting extremely low baseline expectations for growth this year, one of this week’s key focuses for G10 economies will be how different governments approach ending the lockdown period. UK media are reporting UK restrictions will be extended into May, while Eurozone countries are already beginning to evaluate the lifting of certain restrictions. In the US, the issue is showing signs of becoming a political battleground, with Donald Trump last night claiming “absolute authority” over the end of restrictions, and New York Governor Cuomo publically defying this statement in an interview today.
G10 in green vs USD as risk appetite continues to improve
Some good news for the euro…
- Confinement easing in sight. The euro is trading on a better footing against USD this week, on hopes that the peak of the virus has already passed and plans to reopen economies are taking shape. At the moment, lockdown measures are being extended in the main affected countries but leaders are planning the gradual removal of restrictions on economic activity. The European Commission is also drafting a plan to coordinate the moves, which will be presented on Wednesday 15th. While the Commission warns that lockdowns could be re-imposed if the number of infections starts to spike again, markets are trading with better sentiment on the possibility of an upcoming resumption of economic activity.
- EU members finally agreed on a joint economic response to coronavirus after previous failed attempts. Although the package rules out the issuance of joint debt securities or “coronabonds”, the conclusion of the arrangement itself comes as a relief after ample criticism of the delayed EU response. The deal eliminates the conditionality requirements for the issuance of credit lines from the EU bailout fund, which is, to an extent, a second-best outcome for the countries in need compared to mutualised debt. Specifically, the agreement includes:
- Credit lines from the European Stabilization Mechanism of up to 2% of GDP for member states, without conditions, for direct or indirect expenses related to the crisis of the pandemic.
- A boost in the lending capacity of the European Investment Bank through the creation of a €25- €200 billion fund to finance loans to SMEs.
- Raising of the SURE fund of €100 billion by the European Commission, to finance temporary loans to unemployment insurance schemes of member states.
- Additionally, the creation of a recovery fund for the post-virus stage was agreed, although details were not outlined yet. France pushed for the option of issuing short-term joint debt for this fund, as well as the possibility of integrating it to the next seven-year fiscal budget. However divisive these extra plans might turn out, the fact that leaders acknowledge the need of additional recovery plans to reverse the impending economic risks are a positive sign for the eurozone.
- Germany’s stimulus filters faster through the economy. Economic aid in Germany has quickly reached the intended sectors of the economy, as opposed to other countries where support has faced several constraints. Germany has previously maintained famously tight fiscal policy, so the immediate fiscal support in light of the crisis has had a favourable effect. The government has made available €1 trillion on state guarantees, loans and direct capital transfers to companies, while making access to workers’ wage protection more flexible. Berlin has already delivered €1.3 billion to freelancers and small businesses, processing 140,000 applications in just a few days. In contrast, financial support in other countries has been less expeditious. In the UK, a survey revealed that only 1% of companies have successfully applied for emergency credit.
Euro joins G10 in recovery against USD after extraordinary volatility in March
Ranko Berich, Head of Market Analysis
Olivia Alvarez Mendez, FX Market Analyst