Market stress likely to remain limited, even if cases rise
We continue to think that central bank backstops make a re-run of the March panic in financial markets unlikely, a key assumption underpinning our view that “risky” assets will recover further ground in the second half of 2020.
While equity markets have fallen back a bit over the past three weeks amid worries about the increase in new coronavirus cases in the US and elsewhere, there is little sign of the widespread market dislocations that accompanied the global spread of the pandemic in late February and March. If anything, strains in core money markets have eased further over the past month.
That is probably in large part thanks to central bank backstops put in place in March, which have reassured investors that even if the prices of risky assets fall, market functioning will be maintained. Although those backstops may be tested if the rise in new coronavirus cases continues and equities tumble further, we think that central bank support will continue to keep the global financial system on an even keel. So while a major “second wave” in the pandemic is a key downside risk to our generally optimistic forecasts for risky assets, we don’t anticipate that it would lead to a repeat of the money market freeze and distressed selling across financial markets that occurred in March.
Indeed one of the standout features of this crisis is the swiftness of central banks and government intervention to prop up the market and businesses , something that took months to do during the Great Recession of 2008, but lessons have been learned and action taken.
With monetary policy likely to remain loose for a very long time and the world’s largest economies gradually re-opening, we think that developed market “risky” assets will continue to recover from their pandemic-induced Q1 slump.
Although the rally in risky assets has lost some steam in recent weeks, there are two key reasons why we think that it will continue. First, in our view the worst point for the global economy is now past. The most timely economic data are already improving, and in some cases, notably in China, the recovery in economic growth has been faster than we had anticipated.
Second, we feel monetary policy will continue to support risky assets. For a start, we expect policymakers to keep interest rates at rock-bottom levels for a long time and continue quantitative easing. On top of that, some, most notably the Fed, have gone further than ever before in providing direct support to risky asset classes, like corporate bonds, in order to ensure that the pandemic doesn’t trigger another financial crisis.
Evidence from the US is that we are over the worst, unemployment is on the way down, the recession is over and we are on an improving trajectory. It is unlikely to be a swift recovery, more “U” than “V”, but a recovery still.
A key downside risk to this view is a widespread second wave of coronavirus. Our forecasts assume that renewed outbreaks in advanced economies remain localised and small relative to the original outbreak.
This article reflects the research and opinions of Capital Economics and Irongate and is not intended to be a forecast or recommendation.