Today’s newsletter is going to be more of a potpourri from the international economic and market news flow than a theme-specific post. Before I proceed, let me say a few words about the dire sentiment associated with this pandemic.
Yesterday’s post was relatively upbeat. I was talking about a European lockdown relaxation that allowed the economies in some countries to return to a somewhat normal post-lockdown environment by mid-June. This would be faster than anticipated by economists. But, it doesn’t mean a V-shaped recovery per se. It still means a U- or an L-shaped recovery. Even Bill Gates told Le Figaro that he doesn’t see a return to normal for two years (link in French)
I stand by yesterday’s analysis, of course. But, a strange thing happened last night when I presented it on-air at Real Vision. It got more downvotes than usual and negative commentary, including one person saying “I live in Germany and could not confirm the optimism of retailer picking-up in Germany, and I am more into deeper insights into the markets, not superficial news collection.” Now, maybe I didn’t get my point across in video format. Here’s the link. You can watch and see if I did.
But, I don’t think that’s the issue. I think it goes to negative sentiment and confirmation bias. I remember a similar sentiment bias in May 2009 after I signalled the recession was over. That caused me to write a whole Ingmar Bergman-themed post about it called “Through a glass darkly: the economy and confirmation bias in the econoblogosphere“.
I am not going to go that far here, mostly because we are deep into an almost Depression with an uncertain outlook. But I did want to flag it as an issue because I was taken aback at how fervently viewers at Real Vision believe in a very dark vision of the immediate future. Is this just an outgrowth of self-selection – doom and gloomers looking for their daily dollop of negativity to confirm their own views? Or is it representative of sentiment right now? And if so, what does that say about near-term economic and market outcomes?
I don’t have the answers to any of those questions. But, again, I want to flag this because I think it may be important regarding the economy and asset markets.
Opening up New Zealand
If we get this coherent relaxation scheme in any economy, it can serve as a model for others. And then, the economy can trend toward best case scenarios. It’s not a V-shaped recovery. But, because of the limited length of the economy’s drawdown, it might not count as a Depression either.
That’s still my view now that we are actually seeing the lockdowns relaxed. New Zealand is one country to watch here. They have now moved from a level 4 alert down to level 3, with restaurants now opening for take out. And there is a lot of pent-up demand on that front. Mobile ordering systems crashed under the heavy traffic today.
But this isn’t going to pay the bills for restaurants. And, once that relief gives way to the post-lockdown normalcy, we will still be short of pre-lockdown economic levels. That means more policy easing. And I see that some people are speculating about the Reserve Bank of New Zealand instituting negative interest rate policy. Westpac’s chief economist predicts NIRP. I don’t see it in Anglo-Saxon economies because it hasn’t worked in western Europe or Japan. But I thought I’d flag it since this sentiment may be driving some bond market activity in New Zealand and elsewhere, like the US.
Sweden and its NIRP signal
Another central bank to watch on the negative interest rate policy front is the Riksbank in Sweden. They had gone negative, but ended the policy experiment at the end of last year, the first to ditch NIRP. And I believe we were well on our way to normalizing policy toward zero elsewhere in Europe before the pandemic turned things on their head.
The Riksbank issued their latest policy statement today amid speculation that they would go negative (link in Swedish on pressure for negative rates). And they didn’t. Global FX and Rates Strategist for Nordea, Andreas Steno Larsen, thought their post-policy statement was almost hawkish – at least relative to expectations.
And while Sweden is not a major central bank in some regards, I think their policy hold is significant because it puts a marker down for the Anglo Saxon central banks to follow. To the degree they want to add policy stimulus, they will err on the side of bond purchases and fiscal policy, but won’t take rates negative.
The Fed is up next. It will be interesting to see what they have to say about policy.
Denmark’s Faroe Islands example
Across the way from Sweden, in Denmark, the European re-opening experiment began. And Denmark’s Faroe Islands is taking this re-opening one step further now.
On 9 May, they will start First Division football matches again. And that’s significant because it’s the events sector of business that has been hit hardest by coronavirus due to the risk of contagion. I have no indication that fans will be permitted in games as yet. But Svenska Dagbladet is reporting that at least the games will begin (link here).
The Faroe Islands have a population of 51,000 – so roughly similar to Iceland. They closed the borders in mid-March. And to date, they have had only 187 cases of coronavirus, of which 180 have recovered. There have been no deaths. So, they recently began to re-open, with the football matches as the biggest experiment in the re-opening.
Why does it matter? In the same way Iceland is an outlier because of it’s remoteness, the Faroe Islands are. But, this move will set a precedent that others can follow. It lends credence to my view that we will see re-opening proceed faster than expected, with the stickiness of fearful consumer lockdown behaviour the biggest downside risk in terms of resumed consumption patterns.
Oil rout continuing
Taking a break from this move to a sort of upside-outcome-analysis, I want to remind you of the downside risks. The price action in oil markets shows us. The front month June 2020 WTI crude contract is trading with a high $10 or $11 handle now.
A lot of this is driven by the outsized impact that retail investors are having via the USO contract rolls into the July contract, producing a super contango at the front end of the futures curve. For example, July 2020 WTI contracts are trading at $18.22 and August is at $21.75. The much-traded June 2021 contract is at $31.49.
Moreover, if we compare Brent, the front month is at just over $20, with July 2020 Brent trading at $23.00 a barrel. So, a lot of this is specific to the lack of storage at Cushing, OK and the fact that WTI contracts are for physical delivery, while Brent is a cash-delivery contract.
Nevertheless, the FT is reporting that “Oil groups fear loss of 30,000 jobs at UK North Sea fields“. There is clearly a glut of supply. And it points to the massive global drawdown in demand. Storage-wise, there’s talk of tanker rates going up to $2 million per day. That’s crazy levels. Last week, I quoted a $180,000 figure. In February, the rates were $30-40,000.
Is this just speculative though? The $2 million level certainly is. But, it reflects the anxiety now permeating the energy sector due to the loss of demand. And it mirrors the negative sentiment I talked about at the outset of this post.
On the whole, I tend to believe a buoyant equity market will meet the real economy on the downside over the medium-term, meaning the downside risk outweighs upside potential in the next 6-12 months.
At the same time, the re-opening of economies presents another range of outcomes. If you get premature lifting of lockdown, as we may be seeing in the US, it could mean a large second wave of viral infections and a loss of consumer confidence. Even so, just the mere fact that some businesses are open and workers are getting paid may help prevent worst case outcomes. It’s all very uncertain right now.
On the upside, this re-opening we are seeing, if followed by a relatively muted second wave of Covid-19 infections, could keep shares elevated. And since (northern) Europe is more likely to benefit from early re-opening and a muted second wave, we could see economic outperformance there. European stocks are on the cusp of a bull market as a result, catching up to the US.
For now, I remain of the view that Europe’s economic re-acceleration is proceeding faster than anticipated and that presents some room for upside. But, over the longer term, Bill Gates’ view is probably the correct one; we won’t normalize for a very long time. That speaks to U- and more likely an L-shaped outcome. Is that priced in? I would say no – certainly not in the US and probably not in Europe either.