Economic Update – Nov 2020 – “Economic and Investment Scramble”

Last month we noted that Fiscal policy had arrived. Not to be out done this month, the Reserve Bank of Australia (RBA) has lowered interest rates and commenced a quantative easing (QE) program.  Governments and central banks have been reacting to a year that has been a COVID-19 induced scramble causing economic and investment upheaval. The scramble has included: COVID-19, debt-funded fiscal and monetary economic aid packages and the seemingly messy US Presidential Election.

In the US Election it’s a two-horse race where one believes he is the best horse ever, the other seemingly forgets he is in a race. Front runners do get run down and Trump has closed the perceived gap highlighted by various polls, I would say that this election will not be over until Trump is removed from the White House, possibly forcibly at the official end of term, January 20th. The possibility of a contested result, if Trump is beaten, looks very real right now.

In Australia and the US, the technical recession is over, but to be clear we still in a recession as the RBA highlighted. Europe is likely to show positive GDP data however with further COVID-19 restrictions in the UK, France, Germany and Italy, Europe may see yet see a double dip recession.

The current global economic crisis exceeds the dislocation caused by the global financial crisis between 2008-2010. Then, the US economy contracted at an annualised rate of 6.4% in 1Q09 and by 0.7% in 2Q. In mid-November 2009, the then chair of the US Federal Reserve (the Fed) Ben Bernanke said interest rates are likely to remain “exceptionally low for an extended period.” The US 10-year bond yield was 3.34% and the 30-year 4.28%. Moving forward to the present day, the US economy contracted at an annualised rate of 5% in 1Q20 and fell off a cliff for a massive 31.4% annualised contraction in 2Q20. In mid-October, the current Fed chair Jerome Powell said interest rates are likely to remain “exceptionally low for an extended period.” The US 10-year bond yield was 0.73% and the 30-year 1.51%, and they are currently 0.77% and 1.56%, respectively.

While a vaccine, followed by widespread vaccination should contain the virus, the resulting debt is likely to trouble governments for decades to come. Given the magnitude of the debt load and the likelihood it will increase as deficits continue, it could take decades of economic boom for government revenues from taxes to cut the debt to acceptable levels.

The global economic outlook remains littered with potholes. These potholes mean there was a high risk of an uneven economic recovery and setbacks along the way. The World Health Organisation (WHO) recently said the Northern Hemisphere is facing a “dangerous moment”. New daily infections have reached record highs as the northern hemisphere heads into winter. However, death rates remain below the initial peak…..so far. Nevertheless, with death rates and hospitalisations lifting, governments are once again grappling with the health?economic dilemma. So far, governments have avoided reinstating nationwide lockdowns where possible. But they are running out of other options. We expect that negative Q4 20 GDP growth will follow a very sharp rebound in activity experienced over Q3 20. The volatility in economic activity highlights just how sensitive the economy is to the path of the virus.

At the European Central Bank’s (ECB) post?meeting press conference, ECB President Christine Lagarde signalled that more policy easing would likely be delivered in December. She noted that further easing would consist of a “recalibration” of existing tools, rather than introduce new tools. Economists also expect more policy easing from the Bank of England (BoE).

China, however, has moved rapidly onwards from the virus. GDP is on the improve. Interestingly at the 14^th 5-Year Plan (FYP), China did not specify a numerical economic growth target. Instead China plans to focus on domestic demand and to secure technology supply chains amid the growing tensions with the US. President Xi has pledged to achieve carbon neutrality by 2060 which will put green development firmly in the spotlight and stealing some global leadership from the US.

The coming five years will be critical both politically and economically. Politically, the 14th FYP will mark the first five?year period of the Chinese government’s ambition towards its second centenary goal to build a “modern socialist country” after reaching its first centenary goal of building a “moderately prosperous country”. Meanwhile, Australia is bearing some of the fallout from the US-China tensions.

In Australia on Tuesday the famous Melbourne Cup was run. Twilight Payment won and will surely make the already wealthy Lloyd Williams wealthier, but so will the RBA who lowered the cash rate to a historic low of 0.10% and announced a historic $100bn bond buying program (low interest rates benefit the wealthy the most and increase the gap between rich and poor). The quantity based asset purchase program that will involve buying $A100bn of Australian Commonwealth Government Bonds (ACGBs) and Semi?government bonds of maturities of around 5?10 years over the next six months. The RBA Governor noted that recent economic data has been a bit better than expected and the near?term outlook is better than it was three months ago.

The interest rate sensitive parts of the economy, particularly the housing market, have already been responding positively to incredibly low interest rates. Any further reduction in mortgage rates that follow from the RBA’s decision will put further upward pressure on dwelling prices. Indeed dwelling prices could accelerate quite quickly as the economic recovery continues to gain traction.

The domestic economic outlook has improved over recent months and the RBA has upwardly revised its profile for GDP in the November Statement on Monetary Policy (SMP) published today (Friday 6th Nov). By extension the RBA has downwardly revised its profile for the unemployment rate. These forecast revisions largely reflect a run of better than expected economic data (actual outcomes) and ongoing improvement in many of the forward looking indicators of the economy.

It is unusual for the RBA to ease policy when the economic outlook is improving. The RBA’s updated forecasts on indicate that they expect the economy to have elevated spare capacity over the forecast horizon (end 2022). And they will continue to forecast below target underlying inflation over their forecast horizon. RBA policy will likely now remain on hold at least until Q2 2021 when the asset purchase program ends. Further policy easing beyond that cannot be ruled out, but this will depend on the economic conditions and outlook at the time. Essentially, we anticipate ultra-low interest rates in Australia, and the rest of the developed world economies, for some time to come.

The ingredients of 2020 are: the yet uncontrolled coronavirus; the yet uncontrolled debt-funded fiscal and monetary economic aid packages; and the yet global economic recovery. In the US at the time of writing, Joe Biden (Democrat) looks set to narrowly defeat Donald Trump (Republican) for the Presidency. Trump, will remain President until January 20 when either he or Biden will be sworn-in. If Trump does loose, the next 70+ days could be very interesting.  Bravely, financial markets have already decided all will end happily.

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Sources:  Commbank Global Markets Research, RBA, Morningstar, Goldman Sachs.