Financial Markets Monthly - August 2020
While reports on second quarter GDP are showing previously-unthinkable declines, timelier data generally point to a stronger than expected rebound amid easing containment measures and significant government support. But can those latter factors continue to support the recovery through the second half of the year? The US has unfortunately demonstrated the cost of easing restrictions too much, and is paying the price in both a stubbornly high infection rate and a loss of momentum in spending and job creation. Other jurisdictions have had more success controlling localized outbreaks and keeping their case curves flat, in some cases allowing for a further, gradual roll-back of containment measures. But social distancing will be the new normal for some time yet, ultimately capping the economy’s supply side recovery until a vaccine is widely available.
As for extending government support, progress has also been mixed. EU leaders were able to agree on a landmark Recovery Fund that will facilitate fiscal transfers to countries in need—a deal that helped push peripheral spreads lower, and the euro to fresh multi-year highs. But that money will flow over years, not months. In the US, Congress has thus far failed to pass a new fiscal package, leaving unemployed Americans in the lurch. In several countries, expensive support programs like wage subsidies and transfer payments will eventually be scaled back, resulting in a deferred income hit for some households and businesses.
Monetary policy support, at least, remains locked in place. Central banks are committed to keeping policy rates at ultra-low levels until the recovery is well underway, or even until the economy is back to full capacity. That guidance, along with ongoing QE, has pushed government bond yields to record lows in a number of advanced economies. Equity markets have been buoyed by those low rates and better-than-feared earnings season.
- A number of US states are finally getting their coronavirus outbreaks under control, but measures to curb the virus’s spread have dented the recovery’s momentum. High-frequency data suggest slower consumer spending and hiring in recent weeks.
- Canada has done a better job of keeping its case curve flat, and should see a sizeable rebound in Q3 GDP. But less supportive fiscal policy, ongoing social distancing measures, and weakness in the oil and gas sector, will likely result in a slower recovery later this year.
- The Bank of Canada has committed to keeping interest rates low until the economy is back at full capacity and inflation returns to 2%. While inflation jumped higher in June, we think it will remain below target at least through 2021, making rate hikes a distant prospect.
- GDP declines in the UK and Eurozone in Q2 reflected the relative severity of outbreaks and containment measures, with declines ranging from 10% in Germany to nearly 20% in the UK and Spain (non-annualized). Activity has picked up in recent months, though less fiscal support going forward will create challenges.
- Central banks have shied away from lowering policy rates into negative territory (at least those that hadn’t already done so before the pandemic) but the Bank of England was weighing the merits of such a move in August. We think the BoE could cut its bank rate below zero later this year.
Josh Nye is a senior economist at RBC. His focus is on macroeconomic outlook and monetary policy in Canada and the United States. His comments on economic data and policy developments provide valuable insights to clients and colleagues, and are often featured in the media.
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