Recovery in markets likely to keep favouring those hit hardest - Capital Economics
Capital Daily

Recovery in markets likely to keep favouring those hit hardest

Capital Daily
Written by Hubert De Barochez

Across developed and emerging economies, those stock markets and currencies that had fallen the most after fears emerged about the coronavirus outbreak have generally bounced back more strongly since such concerns have eased. Provided that the virus is brought under control, we think that this pattern will continue between now and the end of this year, although we doubt that risky assets in general will make up all of the ground that they have lost.

  • We think that US retail sales and industrial production fell sharply in March
  • Korea’s Democratic Party expected to win most seats in Wednesday’s parliamentary election
  • The Bank of Canada may add corporate bonds to its asset purchases (15.00 BST)

Key Market Themes

Across developed and emerging economies, those stock markets and currencies that had fallen the most after fears emerged about the coronavirus outbreak have generally bounced back more strongly since such concerns have eased. Provided that the virus is brought under control, we think that this pattern will continue between now and the end of this year, although we doubt that risky assets in general will make up all of the ground that they have lost.

Over the past three weeks or so, most risky assets have started to recover, following the announcement of big monetary and fiscal support packages. This has been helped by signs that the epidemic is being brought under control in various countries – the number of new cases globally has trended down in recent days (see here). In turn, this has allowed some governments to start discussing lifting some restrictions and easing lockdowns.

A general pattern has emerged, whereby those assets that had been hit the hardest have generally bounced back the most. This is certainly the case for equities. (See Chart 1.)

Chart 1: Changes In MSCI Local Currency Indices (%)

Sources: Refinitiv, Capital Economics

Chart 1 shows the changes in the prices of local-currency MSCI indices during two periods: between 17th January and 23rd March on the horizontal axis, and since 23rd March on the vertical axis. During the first period, MSCI indices dropped across the world by between 20% and 50%. Then, the stock markets that performed the worst during this first period generally outperformed during the second – which started the day the Fed announced a big stimulus package (see here).

Although we don’t expect risky assets in general to make up all the ground that they have lost since the outbreak of the coronavirus by the end of this year, our view is that the trend that we have seen since they have started to recover will gain more momentum – provided the epidemic is successfully brought under control. This is the main reason why we think that equities in Emerging Europe, the Middle East, Africa and Latin America will outperform their peers in Emerging Asia during the rest of this year. (See here.)

As far as currencies are concerned, we have seen the same pattern in developed markets – the hardest hit have recovered the most against the US dollar. (See the blue diamonds in Chart 2.) But there have been some exceptions in emerging markets, where the currencies of some countries with weak external balance sheets – such as Brazil, South Africa, Turkey and Argentina – have failed to bounce back. (See the grey diamonds in Chart 2.) We wouldn’t be surprised if these patterns in the currency markets also continued during the remainder of this year. (Hubert de Barochez)

Chart 2: Changes In Currencies Against US Dollar (%)

Sources: Refinitiv, Capital Economics

Selected Data & Events

BST

Previous*

Median*

CE Forecasts*

Wed 15th

US

Industrial Production (Mar)

14.15

+0.6%

-4.1%

-7.0%

*m/m(y/y) unless otherwise stated; p = provisional

Key Data & Events

US

Signs of progress in the fight to contain the coronavirus epidemic –the number of daily new cases in the US has fallen for the past four days – have prompted a renewed push from the Trump administration to ‘re-open’ the economy. However, a significant lifting of restrictions is probably still several weeks away at least. And in any case, the lifting of restrictions will be determined by state governors rather than the White House.

Wednesday will bring the first hard activity data to capture the economic hit from the epidemic, with retail sales and industrial production figures due for March. We expect significant declines in both. But with containment measures only really stepping up from the middle of the month, the full scale of the damage probably will not be evident until the April data. (Andrew Hunter)

Europe

Over the weekend, France’s government announced that the lockdown there will be extended until 11th May. Although Spain and Italy’s governments have allowed a minor relaxation of restrictions in recent days, substantial parts of both economies will remain effectively shut until May at the very earliest. Meanwhile, we think that Sweden’s registered unemployment rate will have jumped in March, and inflation is likely to have fallen even further below the Riksbank’s target.

In its first set of post-coronavirus forecasts, the UK’s Office for Budget Responsibility (OBR) estimated that a three-month lockdown would result in a 35% hit to GDP in Q2, larger than the 25% slump that we expect. Even if the OBR is proved correct, its assumption that there will be no longer lasting economic impact from the virus may prove too optimistic. Once restrictions are lifted, weak consumer and business confidence, high unemployment and corporate bankruptcies are likely to mean that it takes some time for the economy to return to normal. (Melanie Debono & Ruth Gregory)

Other Developed Markets

The Bank of Canada could announce that it will add corporate bonds to its asset purchase programme when it meets on Wednesday. If not, attention will mostly be on the Bank’s new forecasts, and who will replace Governor Stephen Poloz when his term expires in early June. Meanwhile, the government looks set to announce some fiscal support this week for struggling oil and gas firms. (Stephen Brown)

China

While the year-on-year contraction in exports and imports eased last month, Chinese trade remained at its weakest in over a year in seasonally-adjusted level terms. That is despite the reopening of factories and recovery in domestic demand. With COVID-19 now weighing more heavily on economic activity in the rest of the world, the worst is probably still to come for China’s export sector.

Meanwhile, although China’s consumer price inflation fell from 5.2% in February to 4.3% in March this was entirely due to falling food and energy prices. Core inflation ticked up slightly. And finally, broad credit growth rose from 10.7% y/y in February to 11.5% in March. The pick-up was driven by corporate borrowing and demonstrates that the authorities have kept credit flowing to firms despite the shock to activity. The lack of a noticeable pickup in shadow credit and mortgages suggests that restrictions on shadow banking or the property sector have not been relaxed significantly. (Martin Rasmussen)

Other Emerging Markets

In Emerging Asia, Bank Indonesia left interest rates unchanged at 4.50% on Tuesday, but the decision to cut the reserve requirement ratio by 200bp, and dovish comments in the accompanying press conference, suggests that further rate cuts are likely. Elsewhere, Korea’s parliamentary elections will go ahead as planned on Wednesday. The government’s effective response to the coronavirus outbreak seems to have boosted support for President Moon’s Democratic Party. But it still looks unlikely to gain a majority in parliament, let alone the three-fifths supermajority needed to pass bills without support from smaller parties. That is likely to stifle structural reform efforts.

In Sub-Saharan Africa, following the extension of South Africa’s lockdown over the weekend, the central bank cut its policy rate by another 100bp, to 4.25%, in an unscheduled meeting on Tuesday. We think that more easing lies in store, particularly since the government’s shaky public finances will limit its fiscal response to the coronavirus crisis. Meanwhile, we think that Nigeria’s inflation picked up from 12.2% in February to 12.5% in March. However, that is unlikely to prevent the country’s central bank from cutting interest rates further. (Gareth Leather & Virág Fórizs)

Published at 16.29 BST 14th April 2020.

Editor: John Higgins

john.higgins@capitaleconomics.com

Enquiries: William Ellis

william.ellis@capitaleconomics.com