Dispersion in a LUV-shaped recovery

global perspectives

Dispersion in a LUV-shaped recovery

Salman Ahmed, PhD - Chief Investment Strategist

Salman Ahmed, PhD

Chief Investment Strategist

Market sentiment has begun to stabilise since our last note as signs emerge of infection curves flattening in Europe and New York City, and massive fiscal and monetary policy interventions in key developed markets improve the likely magnitude, speed and duration of the recovery.

 

Systemic risk eases, but we remain bearish on a near-term growth

Decisive central bank action, particularly by the US Federal Reserve (Fed) and European Central Bank (ECB), has eased systemic-level risks. Liquidity conditions have improved markedly, and a variety of indicators point to healing in key debt markets as demand for US dollars abated. Global credit markets are also functioning better as the Fed joined other central banks in direct purchases of corporate bonds, providing a critical backstop. Meanwhile, decisive action from the ECB has also driven an improvement in the periphery space.

In our view, actions taken by key central banks over the last two weeks have saved the system from a complete systemic collapse triggered by the COVID-19 shock.

We remain more bearish than consensus on Q2 growth forecasts

That said, April’s data will be critical in understanding the extent of the nosedive resulting from broad and sweeping shutdowns. We remain more bearish than consensus on Q2 growth forecasts for most countries and expect to see contractions of at least 25% across the board based on a number of high frequency data we monitor.

 

Exit strategies

As infection rates show signs of flattening in key developed markets (especially in Europe), attention is turning towards exit strategies. Asia’s experience remains key, and the second round of infections in Japan, Hong Kong and Singapore demonstrate that a binary lifting of lockdowns could be problematic.

We expect to see a sequential lifting of lockdowns, which will create different recovery trajectories across sectors with a combination of L-, U-, and V-shaped recoveries occurring depending on business activities. Any social or economic activity that requires close physical proximity are less likely to fully come back online in the near future.

Sequential lifting of lockdowns may create different recovery trajectories

In the short-term, this could mean a very fragmented recovery. Policy support has put a short-term floor under risk pricing and subdued volatility from the very intense levels we saw in mid-March. However, we expect dispersion to continue based on relative exposure to the COVID-19 shutdowns and corresponding policy response. We believe this will create relative value opportunities both within and amongst the various risky asset classes, and assets that benefit from the backstops put in place by the FED and ECB are likely to outperform.

The pandemic has highlighted the financial materiality of sustainability dynamics at a systemic level

In the longer-term, COVID-19 has laid bare weaknesses in the global political and economic order, which are likely to have long-lasting implications on the how governments, households, companies and investors behave going forward. The pandemic has highlighted the financial materiality of sustainability dynamics at a systemic level and we expect the fiscal policy response will continue to support the climate transition. Digitalisation has been a clear beneficiary of the COVID-19 pandemic, in our view, and we expect this shift to continue, which is likely to prove supportive for Fintech, for example.

Ultimately, a vaccine remains the only solution to the current healthcare crisis.

 

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We believe indiscriminate selling has created attractive relative value opportunities, but this is not the time for indiscriminate buying.

 

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