Asset Management Europe: Monthly Letter – October 2020

Marc-Antoine Collard, Chief Economist, Head of Economic Research, Asset Management, Europe

Economic environment

Although third-quarter GDP releases are not yet available, growth is expected to rebound uniformly and strongly as lockdowns were relaxed and substantial pent-up demand was released everywhere. Yet, the economic outlook remains exceptionally uncertain, with the pandemic continuing to exert a substantial toll on economies while geopolitical risks remain a wild card.

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Recent signs from high-frequency indicators and business surveys suggest the pace of the global recovery has lost momentum. Indeed, the localised lockdowns and new restrictions being imposed to tackle a new wave of outbreaks are likely to have contributed to the recent moderation of the recovery. However, thanks to improved treatment and medication, hospitalisation and fatality rates have decreased, which has decreased the likelyhood of renewed economy-wide lockdowns.

The Covid-19 shock is being felt particularly hard in service industries – including travel and tourism, accommodation and hospitality, and entertainment – and they are likely to face persistent headwinds as the normalisation of activity and cross-border mobility gathers pace. As there is limited data to track developments in services – nothing analogous to the monthly industrial production data on the goods-side of the economy – the assessment of the differential performance across sectors is complex. Market participants have relied on the Markit services business confidence index to track economic activity in the sector, and the latest data showed a fall in confidence in September, from 52 to 51.6. While the slip could be a one-off and the index remains above the 50-threshold, it is a reminder that, despite an improving industrial sector, the continued headwinds on the much-larger services side of the global economy could limit the recovery in the coming quarters.

Meanwhile, recent developments have reinforced concerns that fiscal policies are not being managed effectively. In the US, failure to extend fiscal stimulus drove real disposable income down -3.5% m/m in August and households had to draw on earlier stimulus, which pushed down the savings rate. While consumer spending continues to recover, the trend has cooled noticeably after a period of strong growth in the early part of the recovery and as incomes are affected by declining unemployment insurance benefits.

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The Democratic-controlled US House of Representatives has approved a new fiscal stimulus package worth $2.2 trillion, but without the backing of Republicans in the Senate and the Trump administration. Yet, the Fed has repeatedly warned that the withdrawal of fiscal support could stunt the US recovery. In fact, it is highly unusual for the Fed to take part of the public debate on the fiscal front, especially since it is only a few weeks before an election, which somewhat foreshadows the fragility of the economy.

In the UK, the Chancellor, Rishi Sunak, announced a new jobs support programme to succeed the furlough policy that is ending on 31 October, in which the government paid those unable to return to their workplaces because of Covid restrictions as much as 80% of their wages. In the new programme, workers will be guaranteed at least 77% of their normal wages, although employers could end up paying 55% of wages for an employee working just a third of their normal time. Hence employers might shun this new wage-subsidy scheme rather than paying up for employees on reduced hours, which could result in higher unemployment rate.

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Overall, growth prospects depend on many factors, including the duration of new Covid-19 outbreaks and the degree to which containment measures are maintained or reinforced, as well as the extent to which significant fiscal and monetary policy actions support demand. Furthermore, two geopolitical risks will evolve quickly in the next few weeks: Brexit and the US elections.

The UK Prime Minster, Boris Johnson, and the European Commission President, von der Leyen, are now personally engaged in trying to unblock talks, notably on state aid, fisheries and dispute resolution mechanisms. On the latter, Brussels is determined to ensure a robust mechanism and the issue has gained urgency since Mr Johnson has introduced the Internal Market Bill which could break the UK’s Withdrawal Agreement signed earlier this year. The European Commission has formally launched a procedure on the grounds that the legislation undermines the duty of cooperation in good faith contained in the agreement. The question now is whether both sides can resolve differences that lie at the heart of the sovereignty arguments that fuelled Brexit. EU leaders will take stock of the Brexit talks’ progress at a summit on 15-16 October and a realistic deadline for reaching agreement is the end of October, giving the European Parliament, national parliaments and the House of Commons sufficient time to ratify any agreement. 

The second geopolitical risk lies in the US elections. While polls suggest Democratic candidate Joe Biden is the favourite to win, President Donald Trump indicated he might not concede if he were defeated on 3 November . Yet again Trump cast doubts on postal voting, arguing – without tangible evidence, it must be said – that the process is ripe for fraud. Were Mr Trump to refuse to accept the result of the election, it would take the country into uncharted territory. In previous elections, losing presidential candidates have conceded even when the electoral results were very close, including in 1960 when John F. Kennedy narrowly beat Richard Nixon and in 2000 when George W. Bush beat Al Gore in Florida. That said, following an appalling presidential debate between the two candidates, Biden’s lead has started to edge higher, not only decreasing the likelihood of a contested election, but also increasing the chance of a Democratic clean sweep which would make Q1 2021 fiscal stimulus more likely. The rapid and extensive fiscal support provided since the pandemic began has proved effective, helping to prevent an even larger economic contraction. With confidence still fragile, continued fiscal support remains necessary to support incomes and ensure a durable recovery. It is clear that the health of the public finances will have to be restored eventually, although undertaking fiscal consolidation measures now would be far too premature.

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