Gravity wins in the end

Key points

• Traditional macro indicators are pointing to a relapse in Europe – but the situation in the US is also fragile.
• Market resilience depends on the capacity of monetary policy to be constantly re-calibrated. On this we take a special interest in ECB board member Panetta’s speech last week, but we note that in EM some central banks are forced to give up on “all-out accommodation”.
• Some positive “mood music” on the chances of a Free Trade Agreement between the UK and the EU.

The sense of disappointment on the state of the recovery is particularly acute in Europe, where the traditional macro indicators, such as the PMIs or the forward-looking components of the national surveys, are already pointing to a relapse in September, before most of the new restrictive measures taken to contain the second wave of the pandemic kicked in. But the situation in the US is also problematic. There, Initial jobless claims remain significantly higher than at any point during the Great Recession of 2008-2009. Beyond the economic data, markets need to consider the US election uncertainty, especially since Donald Trump’s public refusal to commit to a swift transition if he loses.

September provided another natural experiment on the market’s dependence on easy monetary policy. Equities - which are not touched by central banks -  have lost 8% in the US. High-yield credit, only indirectly supported, suffered a bit, but investment grade credit, fully covered by the quantitative easing schemes of the Fed and the ECB, has barely moved. Still, this broad resilience of large segments of financial markets is dependent on the capacity of the monetary stimulus to be constantly re-calibrated to deal with new headwinds. From this point of view, we have been reassured by an important speech by ECB board member Fabio Panetta, who laid out what we think is the doves’ proposal to the central bank’s strategy review.

Not all central banks are equal. Credibility issues and compromised fundamentals pre-Covid act as “gravitational forces” which ultimately constrain monetary policy in some emerging markets to give up on their all-out accommodative stance. The central  banks of Turkey and – to a lesser extent – Hungary have had to “break ranks” and hike last week. This may be positive for financial stability but of course won’t help growth.

In this difficult environment, we take comfort in the positive developments in terms of political stability in Italy after the regional elections, as well as in the “positive mood music” in the British press on the chances of a Free Trade Agreement between London and Brussels.