Chief Economist’s Weekly Brief – Dichotomy

April has been a month of contrasts. Multi-year low prints on economic activity in both the US and the Euro area, with worse to come, on the one hand. While equity markets continued to push higher from their late-march lows, buoyed by unprecedented monetary and fiscal stimulus. Markets will always run ahead of the economy. The question is, with so much uncertainty on the pace of recovery, have they overdone it? 

More gloom. Wave 3 of the Business Impact of Coronavirus Survey (BICS), for the two weeks ending April 19th, shows that 1-in-4 of the participating businesses had either temporarily closed or paused trading. 25% of UK firms still operating saw their turnover getting wiped out by more than 50%. There has been a massive uptake of the support schemes – two thirds of businesses applied for the Job Retention Scheme. The need to stay at home is being heard. Over 80% of adults in Britain had either not left their home or only left for the permitted reasons in the 9 – 20 April period. 

Fourteen to one. A majority of Northern Ireland firms reported a ‘significant’ fall in income according to the latest NI Chamber & BDO snap survey for 22nd – 24th April. 3 in 5 businesses fell into that category with three-quarters reporting some drop in income during the last six weeks. Some firms are seeing revenue rise but they are outnumbered fourteen to one. Cash flow pressures are intensifying with two-thirds of businesses having less than three months of funds to call upon. 2 in 5 companies have reduced staff. Some 85% of local firms have furloughed some or all of their staff which compares to two-thirds for businesses in Great Britain.

Spare capacity. April is proving to be a bumper month for record lows and the latest European Commission sentiment survey on the UK didn’t disappoint. Confidence in the services sector plunged to an all-time low while morale amongst manufacturers fell but remained above 2009 levels. Worryingly, employment expectations within both manufacturing and services fell sharply in spite of the government’s Job Retention Scheme. The manufacturing figures were the lowest of any large European country. Meanwhile spare capacity at factories has never been higher. Manufacturing output dipped below 58% of capacity which marks the lowest reading in the survey’s 40 year history and compares with an EU average of 70%.

Shockwaves.  Lockdown is rippling through the economy, causing the amount of money held by individuals and firms to swell, even as it changes hands more slowly.  The UK money supply surged by a record £57bn in March (6x more than usual).  It was propelled by a 4.4% m/m jump in corporate deposits as businesses scrambled to improve liquidity by borrowing £34bn from banks, and then deposited almost every penny.  The dearth of opportunities to spend drove growth in household savings and an unprecedented £3.8bn drop in consumer credit balances.  And, as the housing market froze, mortgage approvals for house purchase fell by one quarter to 56,200.

Banking in the time of Covid-19.  Most big UK banks reported their Q1 financial results this week and gave another window on the impact of Covid-19 on the economy.  There were headline figures to cover future bad debts but most of those provisions were based on forecasts of an incredibly uncertain environment. More revealing was the scale of forbearance already offered.  Almost a fifth of all mortgagers have asked for a payment holiday.  If most of those payment holidays have been requested due to interruptions to income, then there will be millions more people on the Government’s furlough scheme and associated initiatives. We’ll get the ONS’s latest view of the labour market impact later this week.

Here comes the inevitable. Advance estimates for US GDP showed an annualized rate of decline of -4.8% for Q1, the worst since the global financial crisis. Residential fixed investment and government spending contributed positively to GDP but with economy just two weeks into lockdown, consumer spending clocked a -7.6% decline, the worst since 1980. And what was the market reaction? The news barely registered with the market opening 400 points higher! While it would be a folly to predict markets, the full impact of the lockdown in Q2 mean it’s safe to predict worse economic ahead.

Slump. The Eurozone economy posted a quarterly decline of 3.8% in the first quarter, comfortably eclipsing the previous record contraction of 3.2% q/q eleven years ago. That new record won’t last long. A double-digit, full lockdown induced, quarterly decline remains a work in progress in Q2. Of the big four economies, France and Spain were hit the hardest with decline of 5.8% and 5.2% respectively. Against this backdrop, it is not surprising that inflationary pressures continue to evaporate with CPI decelerating to 0.4% y/y in April. The ECB’s efforts to avoid a deflationary spiral will likely intensify.

The Upside Down. A gloomy economic prognosis was the main message from the latest Federal Reserve and ECB meetings. Fed Chair Jay Powell warned the effects of Covid-19 on the US economy are “severe”, ECB president Lagarde suggested that Eurozone growth could shrink between 5% to 12% in 2020 with Q2 GDP diving 15% in the worst-case scenario. While the Fed stood pat, the ECB announced further supportive liquidity measures, including a new series of non-targeted pandemic emergency longer-term refinancing operations (PELTROs) allowing banks to borrow at -0.25 per cent, in effect paying them to borrow money.

Cloud 9.  Global equity markets shrugged-off the slew of terrible economic data to notch-up their best monthly performance in a decade in April.  Despite what many believe could be the largest economic shock in more than a century, the FTSE100 briefly entered bull market territory last week and US stocks are now trading just 10% below pre-Coronavirus highs.  If this all seems detached from reality, just look to the huge package of monetary and fiscal stimulus unleased by governments around the world – investors certainly are.

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