Potential air pocket in economic data ahead due to decline in US income support and second wave in Europe
We are watchful of the risk of an air pocket in the US economic recovery due to the waning support from US federal weekly unemployment stimulus checks under the CARES Act that expired in July.
President Trump’s executive action on 8 August to extend federal unemployment benefits will take a few weeks to be delivered, and provides a lower amount of USD300 per week versus USD600 previously. Moreover, it is constrained by USD44 billion of federal funding which can last for only around one month.
While the potential impact of the income drop is concerning, it has yet to show clearly in economic data such as credit card spending and purchasing managers’ indices (PMIs). Of note is the latest initial jobless claims figure, which climbed above 1 million again after two weeks of declines, although we are reluctant to read too much into one data point.
In our view, if we ultimately fail to see a new fiscal aid package from the US Congress, the effects of a sharp fiscal cliff would hurt markets.
Our base case expectation, however, is that new fiscal aid will eventually be delivered. Despite the two parties’ disagreements in many areas, both sides agree that unemployment benefits need to be extended and, in any case, Congress will need to start a general fiscal funding process in September when they return from recess. Ironically, if we did see a softening in economic data and market turbulence in the weeks ahead, this would further incentivize both parties to compromise and deliver a new stimulus bill.
Exacerbating this situation are the latest surprise declines in Eurozone flash PMI numbers due to a second wave of Covid-19 infections.
Similar to the second wave in the US sunbelt that we saw over June and July, we expect that the rising rate of infections in Europe will take time to peak and over the meantime comprise a headwind for market sentiment. Given Europe’s success in managing and controlling the pandemic versus the US thus far, however, there are grounds to expect that the length and depth of this drag would be more limited in Europe relative to the US.
US Presidential Election and rapid ratcheting of China tensions pose concerns
Adding to these certainties for investors will be the November US Presidential Election, which historically comes into focus and contributes to rising equity volatility in the few months before elections.
As President Trump remains behind in polls albeit gaining ground, we should not be surprised to see him further ratcheting up tensions against China given the popularity of the anti-China agenda amongst his base, and the desire of the China hawks in his administration to implement their agenda before the election. The quotient of unpredictability in this area of risk is high; one month ago, very few would have expected that WeChat would be banned in the US.
Short-term market turbulence could present opportunities for entry if long-term trajectory remains positive
Given the V-shaped market rally since March and some pockets of the cross-asset universe reflecting high levels of optimism, we are watchful of the risk of near-term market turbulence ahead, considering the factors discussed above.
That said, despite the scope for near-term turbulence, it is our view that the long-term trajectory for risk assets would likely remain constructive as it is underpinned by a long-term economic recovery and supportive policy stance, and these bouts of volatility could present opportunities to add exposure at more favorable pricing.
Anticipated Fed announcement of “average inflation targeting” framework will affirm long tide of ultra-low rates
Our base case is that the Fed will announce the conclusion of its monetary policy review at its meeting on 15-16 September, which will see the Fed officially establishing an “average inflation targeting (AIT)” framework.
Under the AIT framework, the Fed will tolerate overshooting of inflation above 2% without raising rates in order to make up for past periods where inflation has fallen short.
This represents a significant dovish pivot in US monetary policy and we believe that the Fed is likely to take an “outcome based” approach to providing forward guidance on interest rates – by explicitly stating that it would wait for inflation to return to 2% and above on a sustained basis before considering increasing interest rates.
The Fed’s move should not be entirely surprising to markets as it has been well flagged by various Fed members and we also expect Fed Chair Powell to set the stage for the Fed’s policy shift at Jackson Hole later this week. That said, given the broad implications of this monetary policy pivot, we do not believe that the effects are fully discounted by markets. The shift to AIT will affirm the long tide of supportive monetary policy over this initial phase of the new economic cycle and will anchor US rates at near-zero levels for up to the next five years.
What does the investing environment ahead look like?
We believe that the investment environment ahead will be characterized by:
Notwithstanding the scope for near-term market swings, we see this environment being generally supportive of credit, commodities, emerging markets, emerging market currencies, and equities - in particular cyclical and value equities related to energy, commodities, base metals and agriculture.
Maintain core positions in technology equities, but do some rebalancing into solid cyclical/value names
Long-term trends - including the 5G revolution, the rise of the cloud, IOT and e-commerce - will continue to underpin the long-term performance of the technology sector, which is why we believe it is important for investors to maintain core positions. But given the sharp rally and stark divergence in performance between tech and cyclicals/value, we believe it is an opportune time to rebalance portfolio exposure into solid names in cyclicals/value.
Gold has a role in portfolios; for investors who are underweight, recent weakness provides entry point to start averaging in
Finally, we like gold which will be an omnibus beneficiary of the trends of a weaker US dollar, rising inflation, pressure on real yields and a hedge against the tail-risks of global reserve currency debasement and inflation spikes. Our 12-month target for gold is USD2,150/oz and after the recent price correction, we believe investors who are underweight and seeking to add gold exposure can begin to average in as it would be impractical to attempt to time the bottom of the correction.
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Version: July 2020