Financial markets continue to be moderately positive on risk with the market pricing in some form of gradual and sustained recovery with the probability of another lockdown being low, and we think this can continue – albeit more choppy in weeks to come as some concerns about a resurgence of COVID-19 second wave are noted. The pace of the economic rebound is still not clear as economies gradually open up. Pockets of COVID-19 spread may lend uncertainty to the economic rebound.
Next week, we will get important data for the opening of the economies, where the PMIs in both the US and the euro area will be closely watched. In the US, we expect the indices to rise to around 50 (or perhaps slightly higher) and similarly in the euro area. High frequency data and some of the sentiment indicators we already have for June at least point to a strengthening of the recovery signal in the euro area (see our twitter, 17 June, with Zew from this week moving into the upswing quadrant). Last month the euro area PMIs told us that the trough is behind us and the bleeding has stopped, but to talk of a ‘real’ recovery taking shape in Europe, we need to see these PMIs move back into expansion territory. In the US, we also get real private consumption in May. We already know that retail sales improved more than expected, so it will be interesting to see if consumption followed.
Central bank support and fiscal measures continue to act as a backdrop in the uncertain environment. Most recently, the Fed announced it will activate one of its several emergency facilities and start purchasing corporate bonds. And since the Fed meeting last week, market speculation on further easing has been present in markets. In Fed Monitor – A primer on the Fed’s discussions on changing its forward guidance, 17 June, we take a closer look at the Fed’s ongoing discussions on how to strengthen its forward guidance, which we identify as the Fed’s main concern, from both a theoretical and practical point of view. Overall, we expect the Fed to implement a mix of yield curve control and an average inflation target at its September meeting. We believe the Fed recognises the drawbacks of a stand-alone yield curve control policy. We consider some sort of average inflation targeting as better for risk than yield curve control policy. In Europe, the ECB allotted EUR1.3trn in its TLTRO liquidity operation supporting the banks funding behaviour / need and risk sentiment, see more ECB Research Record-high TLTRO3.4 take-up, 18 June.
As regards Brexit, UK has now formally ruled out extending the transition period running until 31 December 2020, as expected. The UK and the EU have agreed to hold more negotiation rounds in July and August. The ambition is now to reach an agreement in August ahead of the EU summit in October. There are signs that both sides may be willing to soften their positions during these negotiations, but comments after the meeting suggest the individual negotiating positions are unchanged. Our base case (65%) remains a simple free trade agreement on goods (not services) in the autumn. We do not expect any breakthrough this summer. We still assign a 35% probability of a no deal Brexit by year-end. see more in Brexit Monitor – New “soft” deadline in August but the “hard” deadline is still 31 December 2020, 17 June.
