While supply is coming back, the demand recovery remains unclear. The damage in Europe is showing up larger than expected a month ago, but high frequency data showed some signs of improvement in May. China’s economy is on the road to recovery, though the path differs by sector.
Supply is rapidly coming back, although with large differentiation across industries. What remains unclear is the strength of demand recovery. There will be a recovery, but it will also include a significant reshaping of key sectors, with far brighter prospects for technology and health care and far deeper damage in travel and leisure. Equity markets are pricing in the current recovery and the early signs show that data is picking up quickly in some areas. In Asia, this reflects mainly real rebounds in China, while in the U.S. and Europe it may still depend more on the strength of the government fiscal and monetary support. Risk assets may have farther to run this year, especially against the prospect that bond yields will remain low, but they may face challenges as the uncertainties of next year come into view.
Flash PMIs and high frequency data showed some signs of improvement in May but remain at very depressed levels with broad-based weakness. While there is hope for a strong recovery as restrictions ease, weak consumer confidence and a slow recovery in the labor market will keep the return of demand and spending—particularly in consumer-facing and leisure industries—measured, and therefore the road to recovery longer. The housing market is a bright spot on the near-term outlook, having entered the crisis on good footing; pent-up demand, limited inventories, and low mortgage rates position it well for a modest rebound as restrictions ease. As risk markets continue their march higher amid extraordinary Fed liquidity and look towards 2021 with much optimism, risks remain whether short-term liquidity risks evolve into longer-term solvency issues, especially amid elevated corporate leverage and a default cycle that is just beginning.
As everywhere, the damage inflicted by the pandemic on Europe is showing up to be even bigger than expected a month ago, and the final bill is still very much up in the air. Lockdowns are being relaxed (sporadically and slowly) and economic activity is coming back to life in a very slow and uncertain manner. However, just as unprecedented as the shock, so too was authorities’ response: fiscal and monetary policies are ensuring liquidity is maintained. Markets understand there is a lender of last resort in the EU (the ECB) and budget rules are being lifted, so the house is keeping up. But what lies ahead? For that we need to understand the scars left by this shock into the social and economic fabric of the continent. It seems still too early to see that.
China’s economy is on the road to recovery, though the path differs by sector. The manufacturing sector and return to office is recovering first, followed by the service sector, with leisure and travel lagging behind. Until a vaccine for COVID-19 is widely available, this differentiation by industry will likely hold true for other countries around the globe. While China leads, Japan lags. A state of emergency in Japan wasn’t implemented until mid-April and continued through late-May. This means China’s economic data is showing recovery, and the worst is yet to come for Japan’s hard economic data. Weak global demand will weigh on Japan’s recovery as restrictions ease due to the export-reliant nature of the economy. While liquidity risks have abated thanks to the influx of central bank liquidity, a strong U.S. dollar remains a headwind for growth prospects overall, especially as global debt continues to rise and much of it is denominated in dollars.