As countries and regions have restarted commercial activity over the past four weeks, there has been increasing optimism that a V-shaped economic recovery is now in train. Indeed, this has been the major narrative that has been driving the ongoing rally in financial markets.
Last week’s US employment report was the most important signal that the US economic recovery is both quicker and more aggressive than expected. With consensus expected job losses of 7.5 million in May, markets rallied on the back of news that employment jumped by 2.5 million. This included 1.5 million jobs added in the leisure and hospitality industry, regaining some of the 8 million job losses this year. The unemployment rate fell to 13.3% in May from 14.7% in April. PMI indices have also bounced from their April lows, while high-frequency indicators such as traffic flows have also picked up significantly in recent weeks. Truck traffic is now down just 5% from the same time last year, compared to 13% down at the end of April. Meanwhile, flights picked up more than 50% from the low in mid-April, while car sales were up 24% on average from the second week in May to the third.
Beyond the US we are also seeing signs of recovery, but with important regional differences depending on the speed at which governments have allowed various sectors of their economies to open up. In Europe, for example, Germany is leading the charge, with signs of recovery in discretionary spending and traffic. Ireland and the UK are laggards, reflecting both a more cautious stance to reopening and, as in the case of the UK, the current trajectory of the spread of the virus.
Is this the start of a V-shaped recovery in the global economy? It is important to note that given the scale of collapse in activity in April, any improvement was going to look like a sharp rebound. Markets often operate on momentum and there is probably more of that to run.
The employment gains in the U.S must be seen in the context of the 22 million job losses over the previous two months. This leaves employment down 12% since its February peak. As a comparison, employment fell by 6% throughout the global financial crisis post-2008.
The consumer, representing 80% of the US economy, will play a pivotal role in the US economic recovery. Consumers have undoubtedly retreated during the pandemic, with the savings ratio rising to an all-time high of 33% in April. However, much of this can be explained by consumers that couldn’t spend, rather than wouldn’t spend. As leisure facilities reopen, we will get a true sign of whether there has been more lasting damage done to the US consumer. The jury is still out, and we may not know for some time, but for now the markets are likely to continue with the narrative that the economic recovery is in train.
Filling the punch bowl
It is often said that it is the job of central bankers to remove the punchbowl just as the party gets going. If markets are partying again, it appears that central bankers are keen to add to the concoction of stimulus measures that have been introduced since the start of the pandemic. The Federal Reserve last night pledged that it would keep interest rates at zero “until it is confident that the economy has weathered recent events and is on track to achieve its goals of maximum employment and businesses”. While the Fed did not state how long this might be, the expectations of the FOMC members (contained in the so-called dot-plot) suggest that most believe that zero rates will be a feature at least until the end of 2022. The current pace of asset purchases ($120 billion per month) will also continue for at least the next few months. The reasons for the ongoing stimulus can be explained by the rather dire economic projections, with GDP not expected to return to its pre-crisis levels until well into 2022, unemployment falling to just 5.5% in 2022 and inflation remaining below its target at that stage too.
In Europe, the ECB had similar reasons for increasing its asset purchase programme by a further €600 billion in the meeting this month. This takes the total envelope for the pandemic emergency purchase programme (PEPP) to €1.35 trillion. The period for deploying the funds was extended to June 2021 or until it judges that the coronavirus phase is over. The aggressive action was justified by the fact that inflation is now expected to remain well below its target all the way to 2022. Given that the ECB has failed to hit its 2% target for most of the period since the Great Financial Crisis (GFC) and inflation expectations remain substantially below its target, there is clear scope for the ECB to keep filling the punch bowl.
Separately, governments in the euro area are also stepping up to support their economies in a way that was largely absent in the immediate aftermath of the GFC. The most radical moves have been made by Germany, which has recently become the first euro area country to announce a significant stimulus plan that goes beyond the immediate health and welfare response to the pandemic, with large amounts being pledged to certain sectors and for households. France has followed this week with a similar package worth €51 billion or 2% of GDP. Meanwhile, both countries are in support of an EU response that will include large-scale grants instead of just loans for countries that have suffered the most from the crisis.
Europe has often been accused of acting too slowly and too meekly in response to economic weakness in the region. Although EU leaders must thrash out the details of the response, there are positive signs this time around that they are willing to step up to the plate. This has important implications for the economic recovery and the external views about cohesiveness and prospects for the bloc.