There is a mounting anxiety among investor communities regarding the rising number of Covid-19 cases in different spots across the globe.
China recently announced taking new measures to contain the virus contagion such as closing schools and some businesses, cases in US point at record rebounds in some states though for the US, we can say that it is more an acceleration of the first wave rather than a second wave contagion.
There is no such news across the European countries so far, where economies and borders reopen at an accelerated pace despite rising worries elsewhere in the world. But the data elsewhere points that the second-wave contamination is a risk that should be taken seriously.
What will happen if the global economy faces another round of business shutdown? How would the central banks and governments react, and what would be the implications for the cross-asset markets?
Since the beginning of the Covid-19 pandemic, the second-wave contagion has been a much-feared scenario among investors, but the lingering risks didn’t prevent the global risk assets from recording a V-shape correction. The rapid recovery in risk assets was mostly boosted by massive monetary and fiscal support, and somewhat backed by the hope that the recovery would be faster and smoother than expected. The rising new cases dashed the latter hopes, triggering a beginning of what looked like a correction sell-off. But the Federal Reserve’s (Fed) latest intervention aiming to expand its asset purchases program to individual corporate bonds rapidly wiped away the worries of a renewed slump in equities, reminding investors that there is room for more intervention if things were to get ugly.
In parallel, the US government said to prepare a 1-trillion-dollar infrastructure proposal to boost growth.
Regarding the pandemic itself, we believe that a second-wave contamination will likely be managed differently than the first. While we have seen a complete economic shutdown during the first wave, we may see partial, selective shutdowns during a presumed second wave, hence less impact on the overall economic activity.
In its latest forecast, the World Bank predicted a 6% decline in the global GDP, which would reach -7.6% in case of a renewed shock.
Hence, the world is not out of the woods just yet, but investors and policymakers are better prepared than the first wave. This means that the second wave of contamination won’t be a second wave of shocker.
With solid support from the central banks and governments, another wave of risk sell-off across developed markets should remain limited. The dips should find buyers before the headwinds get too strong.
For emerging markets however, the downside potential could be more threatening, given that any additional stimulus has a negative impact on the emerging market currencies, aggravate their foreign debt levels, their financial solvability, their capacity to raise more funding and their recovery prospects.
Why developed markets do not suffer the same outcome is a distortion in market perception. In this respect, despite record rise in the US government debt, investors continue rushing to US sovereign markets for protection. While a renewed run to safety could pull the US yields to record lows seen in March, we believe that the negative rates are not on the cards for the moment. The Fed’s reticence to pull the interest rates to negative territory should cap the downside potential. On the upside, the US 10-year yield is seen below the 1.0% mark for an extended period.
Activity in other safe-haven assets hint that despite the rally across risky assets, investors held on to their gold, yen and Swiss franc holdings to stomach the risks of another market rout.
Gold finds buyers near $1680 per oz since April, and the demand in the precious metal will likely remain strong if the risk of another market rout persists. The upside potential remained limited at $1765 per oz so far. Only severe headwinds across global equities could unlock the potential toward the $1800 mark.
In a recent report, Goldman Sachs wrote that the price of an ounce could aim the $2000 handle if inflation should accelerate faster than expected – provided that gold is a traditional portfolio hedge for faster inflation. The latest data suggest that overheating consumer prices are not cause for immediate concern, but the solid rebound in retail sales and robust recovery in energy prices hint that the inflation levels won’t stay near zero beyond the second quarter. Still, there is little evidence that the massive monetary intervention would boost the inflation levels in developed economies above the central banks' 2% target in the foreseeable future. Though, the rising inflation may be a headache for the emerging world sooner rather than later.
Demand in US corporate bonds will be boosted by the Fed’s new corporate bond purchases program. The latter is also positive for equity prices, as improved demand in corporate bonds will reduce the corporate default risk and give a further support to share prices. This is another reason why another dip in equities should not be as severe as the one we have seen in March.
US equities should continue setting the tone for the global risk appetite.
Among equities, the utilities and technology stocks should outperform cyclical sectors such as financials, energy and commodity stocks. Therefore, we may see the British FTSE 100 lagging its peers if investors start jumpshipping the most sensitive sectors to the Covid-19 pandemic. Nasdaq, on the other hand, would surf on a steady high demand in online services and should find a solid support near the 8600 level, its 200-day moving average.