The Glass Is Still Half Full (For Now)
The global economy continues to improve, with economic data still exceeding expectations amid massive fiscal and monetary stimulus measures, but the risks may be rising that momentum will slow. Retail sales have rebounded strongly across the globe, and industrial production has turned higher. Flooded with liquidity, risk assets march higher, with Q2 marking the trough in earnings. While supportive policies have been key to the solid rebound, uncertainty about additional fiscal support is mounting as economies try to find the balance between stimulus and growth. The viral path also adds to this uncertainty, with a resurgence of new cases in Europe and Asia. While it is still too soon to tell the extent of permanent scarring, we are watching the labor market as the duration of layoffs lengthens, business balance sheets even though bankruptcies remain relatively low, and consumer confidence, particularly where it affects the return to many in-person activities.
In the U.S., economic data continue to surprise to the upside. Manufacturing, housing, and autos continue to drive impressive growth. A relatively weaker USD is a boon to the manufacturing rebound, while industrial production is being aided by continued reopening, lean inventories and strengthening global demand. Low mortgage rates have also supported the continued strength in the housing market. Meanwhile, uncertainty over additional fiscal support and lingering COVID-19 cases means the road ahead for the services sector will likely be longer. While the economy is not yet in the clear, additional policy support should aid the recovery until uncertainty eases. Overall, markets continue to anticipate a substantial earnings recovery in 2021 and the implicit “Fed put” also keeps a lid on credit risks. Investor positioning still biased towards cash could provide further upside in risk assets.
In Europe, the bounce-back is underway: industrial production and economic activity surveys such as the PMIs all signal a solid pickup in activity. Most sectors of the European economy look set to show a rebound in Q3. Clearly, the authorities’ response to the pandemic has been effective in avoiding a meltdown and the reopening of shops and plants was meant to create growth. While the return towards normality has been faster and stronger than expected, not all is well in Europe. Uncertainty about the health of labor markets and SME balance sheets abound, as unprecedented policy support clouds the signals normally provided by unemployment rates and bankruptcy numbers. Nevertheless, governments around continental Europe have signaled intent to extend most of income-support measures, boosting sentiment that a steep income cliff by the fall may be avoided. In total, for consumption and investment to rebound sustainably and the recovery to have legs, such uncertainty must dissipate... second waves permitting.
In Asia, while parts of the region successfully conquered the first wave of the virus, signs are mixed about how long the rebound can endure. After a strong initial bounce in China, growth in activity data underwhelmed in July. Supply has snapped back, but the return of demand is weaker amid elevated domestic and global uncertainty. In Japan, 2Q GDP collapsed, though to a lesser extent than in the U.S. and Europe. The decline was led by consumption and weak global demand, while capex and residential investment held up better. High-frequency data points to a solid bounce back in Q3, though concerns of a second wave weigh on the outlook. Finally, liquidity and credit growth have aided the rebound in the region, but while they remain broadly robust in North Asia, there are signs they may be weakening in India, Indonesia and the Philippines.