As economies are slowly moving from ‘hibernation’ to the opening-up phase, risk sentiment remained volatile this week. Lacklustre Q1 earnings news and fears about second waves of infections alternated with hopes about positive news of drug trials and policy initiatives to support the economic rebound after the crisis (such as the EU’s recovery fund). The fragile mood was amply illustrated by severe stress in oil markets this week: despite the recent OPEC+ deal, the first contract of WTI crude turned negative, as investors shied away from physical deliveries and global storage capacities are vanishing fast while fears about subdued oil demand linger. We expect downward pressure on the oil price to prevail until economies start to open up again on a larger scale.
The spread between Italy and Germany’s government bond yields is yet again nearing levels at which the ECB actively begun to intervene in the market, just a few weeks ago. On top of the distressed health situation in Italy, there are concerns that it could turn into a debt crisis, as Italy soon could see one or more rating downgrades due to its skyrocketing debt-to-GDP ratio. The risk of Italy being downgraded to junk later this year together with a rising number of ‘fallen-angel’ Eurozone corporate bonds that lost their investment grade rating, were probably the main reasons why the ECB eased its collateral rules this week, now accepting junk-rated bonds as collateral as long as they had at least the lowest investment grade rating on 7 April.
While the worst in terms of COVID-19 infections is likely behind us for now, evidence of the severity of the economic fallout is just starting to emerge. Flash PMI readings for April pointed to the steepest fall in business activity for the euro area, UK, US and Japan ever recorded. While the service sector bore the initial brunt of the coronavirus crisis, the collapse in demand and supply constraints have now caught up with manufacturers. Employment losses also gathered speed, although anecdotal evidence suggests short-term work schemes in Europe are helping to limit job losses. The picture is bleaker in the US, where 26 million Americans have by now lost their jobs over the past five weeks on the back of the coronavirus crisis. In light of these gloomy surveys, Q1 GDP figures released next week in the US (Wednesday) and euro area (Thursday) will give some insights about the magnitude of the economic damage in the early stages of the outbreak and we look for a contraction of around -4% q/q AR and -2% q/q for the US and euro area, respectively. Official Chinese PMIs for April are also out on Thursday and especially the services index will be of interest as it better reflects the demand side. After Chinese PMIs already showed a strong rebound in March, we look for a slight dip in the April readings to around 51.0.
Next week also brings central bankers back to the stage. We do not expect new policy initiatives to be announced by either the Fed (Wednesday) or the ECB (Thursday), but look for any possible changes to the Fed’s existing credit facilities and ECB concerns about Italian yields and hints about its next policy steps. The Riksbank is meeting on Tuesday and we argue for a 25bp rate cut to complement the toolbox (see What to expect from the Riksbank , 21 April). At its policy meeting on Tuesday, Bank of Japan is set to do what it can to stimulate the Japanese economy, which is likely already in the third quarter of recession. A scrapping of the cap on JGB purchases has been mentioned and there is likely to be an increase in the purchases of commercial paper and corporate bonds.
