Economic Outlook – 7 June 2020

US

• After a major deterioration in April, both of the ISM indices improved in May, with the weightier non-manufacturing index coming in better than expected. Despite the uptick, both indices are still in contractionary territory. US vehicles sales echoed a similar message, coming in a bit better than expected (up nearly 40.0% month-on-month), though at 12.2 million the level of sales re­mains well below pre-pandemic levels.

• Upside surprises in labor market data appeared to drive much of the week’s positive sentiment. Stocks rose sharply on Wednesday, following a much smaller-than-expected decline in ADP’s tally of monthly payrolls. The payroll processing firm reported that private sector jobs contracted by only 2.7 million in May, versus expectations for a drop of around 9 million. Official news on Friday that overall employment actually increased in May caught observers almost universally by surprise and sent the S&P 500 to its best daily gain in three weeks. Defying consensus expectations for a decline of around 9 million jobs, the Labor Department reported that employers added back 2.5 million positions during the month. Instead of rising to nearly 20.0% as forecast, the unemployment rate dropped to 13.3% from 14.7%. While the job gains paled in comparison to the 20.7 million jobs lost in April, they helped calm fears that the economy had entered a negative feedback loop in which jobs lost directly to the coronavirus and the shutdown, as in the case of retail and restaurant workers, for example, were cascading into other sectors.

• The positive economic news pushed the yield on the benchmark 10-year Treasury note to its highest level since mid-March. While resulting in a sell-off in Treasuries, the better economic data supported modest gains in the broad municipal market through much of the week.

• The US Federal Reserve expanded the eligibility for its municipal lending facility to include more localities. That brings the total number of issuers eligible to participate in the program to 380 from around 260 previously. Illinois is expected to be the first issuer to tap the facility on Friday with its issue of a one-year note. 

• Amid nonstop headlines highlighting ongoing friction between the US and China, US trade Representative Robert Lighthizer said that he feels “very good” about the progress of the phase one trade deal. The trade representative dismissed media reports that China is not honoring its commitments on soybean purchases and said that the country is doing “a pretty good job” on structural reforms. Lighthizer’s comments come in the midst of moves by China to impose a national security law on Hong Kong that critics say will impinge on the territory’s political freedoms, which has raised tensions with the US.

• Stocks recorded their best weekly gain in two months as investors celebrated signs of the beginning of an economic recovery. The small-cap indexes were particularly strong, with the Russell 2000 and S&P MidCap 400 indexes surging roughly 8.0%, while value stocks outpaced growth shares by a wide margin. The technology-heavy Nasdaq Composite Index established an intraday all-time high, and the S&P 500 Index moved within roughly 6.0% of its February 19 peak. Within the S&P 500, energy shares outperformed, helped by news that OPEC and other oil major exporters were considering scaling back production. Financials shares were helped by a rise in longer-term interest rates, which boosts banks’ lending margins. Industrials shares were also exceptionally strong, lifted by a sharp rebound in Boeing. The typically defensive consumer staples and health care sectors lagged.

• In terms of data release, the FED meets on Wednesday and the expectation is for the institution to keep the policy rate unchanged at 0.00% to 0.25%, as the appetite for going negative is very limited.  And on Thursday, US initial jobless claims are out.

EU

• The European Central Bank (ECB) announced it is increasing the Pandemic Emergency Purchase Programme (PEPP) envelope by EUR 600 billion, to a total of EUR 1,350 billion. The ECB expects this to ease the monetary policy stance further amid downward revisions to the inflation outlook, and it restated that these purchases will continue to be conducted in a flexible manner over time, across asset classes and jurisdictions. The horizon for the net purchases will also be extended to “at least the end of June 2021”. The statement also noted that, in any case, “the Governing Council will conduct net asset purchases under the PEPP until it judges that the coronavirus crisis phase is over.” The final addition to PEPP was that the maturing principal payments from securities purchased under the PEPP will be reinvested until at least the end of 2022, and that the future roll-off of the programme’s portfolio will be managed to avoid interference with the appropriate monetary stance. These reinvestments will arguably increase the ECB’s flexibility to converge towards capital keys over time. However, it does raise the impression that the temporary nature of PEPP may need to give way to a somewhat higher degree of permanence, which could prove politically controversial.

• Core eurozone bond yields climbed on the week as the ECB increased its support for eurozone economies. In Germany, the 10-year bund yield traded at around -0.3% on Friday, up some 11 basis points (0.11%) from the start of the week. Peripheral eurozone bond yields fell markedly on the news, with the Italian 10-year yield slipping to its lowest level since March.

• Germany’s ruling coalition agreed on a EUR 130 billion stimulus package for the country, exceeding the top end of expectations by 30.0%. The package includes a cut in the value-added tax for the rest of the year, funds for 5G mobile networks and railways, and higher rebates for electric cars. Germany’s stimulus measures, including liquidity aid and loan guarantees, total about a third of its annual economic output and substantially exceed the programs launched by other eurozone countries.

• France cut its 2020 economic growth outlook to -11.0% from an earlier -8.0% forecast. Finance minister Bruno Le Maire says the country won’t raise taxes to pay for economic support measures.

• In Germany, the May labour market report showed a further increase in the unemployment rate to 6.3% from 5.8% in April. Still, the employment losses remain relatively contained, as Kurzarbeit is cushioning the labour market crisis. PMI and IFO point to improving employment expectations in May, not least among service providers

• Shares in Europe surged as countries eased lockdown restrictions and the ECB injected fresh stimulus into the eurozone economy. The pan-European STOXX Europe 600 Index ended the week 6.91% higher. Germany’s Xetra DAX Index climbed 10.60%, the CAC 40 in France advanced 10.47%, and Italy’s FTSE MIB Index gained 10.71%.

• In terms of data release, on Monday the German industrial production is out.

UK

• The final round of talks between the UK and the European Union (EU) on a post-Brexit trade relationship ended with both sides still far apart on core topics. UK Prime Minister Boris Johnson is now expected to meet European Commission President Ursula von der Leyen and EU Council President Charles Michel around the time of the next EU summit on June 19. The UK’s post-Brexit transition period expires at the end of this year, and the deadline to request an extension is the end of this month.

• UK Services PMI figures came out at 29.0 in May; this is the headline seasonally adjusted IHS Markit/CIPS UK Services PMI Business Activity Index, and it remained well below the 50.0 mark that separates expansion from contraction. The figure was up slightly from the earlier ‘flash’ estimate of 27.8. More critically, the latest reading was also up from 13.4 in April, signalling a slower pace of decline than in the previous month. Given the importance of services to the UK economy, this recovery from disastrous to merely dire should be welcomed. That said, how business makes progress in the future with impediments such as the two-week quarantine upon entering the UK (effectively, a complete international travel ban) will become ever-more pertinent as firms look to win new orders, not just keep existing customers happy. Signs are also emerging that firms are looking well into the future and, furlough or no furlough, business leaders are making decisions about the necessary size and shape of their workforce; in other words, unemployment (always a lagging indicator) is set to rise. The figures for June are going to be particularly telling, as they will be a first indication of the scale and potential shape of a recovery as the economy emerges from lockdown.

• UK Construction PMIs rose to a still highly undesirable 28.9. For PMIs, it is useful to remember that a higher number does not necessarily mean better. The PMI survey asks how has business been in comparison with the previous month, not the long-run average. The UK Construction PMI in April posted an appalling 8.9, and May rose to a simply dreadful 28.9. However, given that May was still below 50, this implies that the situation in May was worse than during locked-down April, which seems strange to us because at least a few more sites were open. The conclusion is that a longer-term picture of overcapacity and lax demand is beginning to assert itself, at least in construction, and this is before the coronavirus-related impact of people shifting their working and consumption habits is factored in.

• British house prices fell for a third straight month in May as the coronavirus crisis hit the market, but the decline was smaller than April’s, mortgage lender Halifax said on Friday. Prices fell by 0.2% in March from April, compared with a 0.6% fall in April from March. Compared with May 2019, prices were up by 2.6%, a bit slower than April’s 2.7% annual rise, Halifax said. The relaxation of the coronavirus lockdown for the housing market in England in mid-May had led to some early signs of action from buyers and sellers, said Russell Galley, Halifax’s managing director. Looking ahead, market activity is expected to increase progressively as restrictions are eased further across the whole of the UK and we continue to have confidence in the underlying health of the housing market over the long term,” he said.

• British consumer confidence in late May fell to its lowest level since the global financial crisis over a decade ago as people worried about a rise in unemployment and falling house prices caused by the coronavirus crisis, a survey showed on Friday. GfK, a polling firm, said its consumer confidence index slipped to -36 in second half of the month from -34 in the first two weeks, its lowest since January 2009 and not far off a series low of -39 touched in July 2008. “With no sign of a rapid V-shaped bounce-back on the cards, consumers remain pessimistic about the state of their finances and the wider economic picture for the year to come,” GFK said.

• In terms of data release, on Friday the UK GDP April estimate is out.

China

• China’s sovereign 10-year bond yield increased for the week as a resurgence in business activity raised hopes for an economic turnaround following a sharp slowdown at the start of the year. Chinese government bonds have remained popular with overseas investors, with nonresident inflows totaling USD 7.7 billion for the second straight month. However, this may partly reflect the inclusion of Chinese bonds in the JP Morgan Emerging Market Government Bond Index since the end of February. 

• One week after promising more forceful monetary policies to support the economy, the People’s Bank of China (PBoC) sprang into action with the creation of two targeted monetary programs. The PBoC set up a RMB 400 billion quota for the central bank to buy 40.0% of domestic loans to SMEs (small and mid-size enterprises) from local banks. Additionally, the PBoC pledged to help banks meet the cost of extending loan and interest payment relief to SMEs. Both monetary tools came after Premier Li Keqiang recently announced that policymakers would allow smaller enterprises to defer their interest and principal payments until 2021 to shore up the recovery.

• China’s official purchasing managers’ index (PMI) edged down to 50.6 in May from 50.8, reported the country’s statistics bureau, marking the third straight month the reading stayed in expansionary territory. Beneath the headline number, however, the reading showed increases in new orders, a reduction in inventories, and stronger industrial prices, all of which suggested improving demand. Separately, the private Caixin/Markit manufacturing PMI rose to a four-month high of 50.7 in May, while the Caixin services PMI rose to a better-than-expected 55.0, the gauge’s first expansion since the coronavirus outbreak.

Sources: T. Rowe Price, Reuters, MFS Investment, TD Economics, Danske Bank, M. Cassar Derjavets.