June 02, 2020

June 02, 2020 | Adviser News

Economic Update: COVID-19

Weekly Macro & Markets View

Highlights and View

  • Several Asian PMIs bounce back in May, but remain weak
    China’s PMIs should continue to hover above 50, but the new exports and employment subcomponents need to be monitored carefully.

  • The European Commission proposes a EUR 750bn recovery fund financed by EU issued debt
    The proposed mutualisation of COVID-19 related costs is important for the integrity of the Union, and will help safeguard a recovery.

  • The ISM Manufacturing Index ticks up in May but remains in contractionary territory
    New orders and employment show that the contraction is easing while consumer confidence is improving slightly.

US credit supply crosses USD 1tn as inflows hit record


Source: Bloomberg

Credit markets have seen a record pace of supply this year as companies shore up liquidity given the substantial negative impact of COVID-19 on cash flows. Indeed, US investment grade issuance has crossed the USD 1tn mark already. This increase in liquidity, together with the drawn down in credit lines and the USD 500bn Fed primary market facility, implies that investment grade issuers should have a comfortable liquidity position to weather the crisis amid deep Q2 earning declines. Looking ahead, a more normal supply pattern is likely to emerge, which is leading to stronger supply/demand technicals in the credit market. Indeed, new issue concessions have disappeared, while Marriot’s 10yr bond saw a 10 times orderbook at one point during the placement process. Stronger technicals are also seen in cash credit spreads continuing to tighten, outperforming credit derivative index spreads. On the demand side, the liquidity glut created by central banks is leading to inflows, with last week seeing a record inflow of USD 3.8bn into US corporate credit across investment grade, high yield and leveraged loans. What remains to be seen is how this higher debt load will be worked down, but we think that companies are more likely to reduce debt levels in the medium term, rather than engaging in M&A or share buybacks.

US: The ISM Manufacturing Index ticks up in May

The S&P 500 ended May with a positive return of 4.5% after a plus of 12.7% the month before. The index now stands just slightly more than 5% below its 2019 year-end level despite the worst recession since the Great Depression still raging. Investors are looking through the very weak economic data and focusing on the green shots signalling that the worst economic impact may lie behind us. Initial jobless claims, though still very high, have now fallen for eight weeks in a row. Importantly, while initial jobless claims have risen by a cumulative total of more than 40mn, continuing claims fell by almost 4mn to 21mn, indicating that many jobless workers are being rehired. The Conference Board’s consumer confidence index ticked up in May, lifted by improving expectations, while the perception of the current situation has further deteriorated. Finally, though still in contractionary territory, the ISM Manufacturing Index rose to 43.1 in May from 41.5 in April, helped by improvements in both new orders and employment conditions.

Eurozone: The European Commission unveils a plan to mutualise COVID-19 costs

The European Commission’s proposal for a recovery fund matched the initial French-German proposal in critical aspects but boosted the size of the fund by adding EUR 250bn in loans on top of the EUR 500bn grant component. The distribution of funds will be largely unconditional, as long as it is directed towards health and health-related spending. The EC will finance the fund by issuing debt on behalf of the EU, which means that some of the costs of the COVID-19 crisis are being mutualised. While the proposal still needs to be signed off on by the European Parliament and the 27 EU member states, this is an important step forward for Europe. Elsewhere, depressionary macro data underline that such a fund is badly needed. While the Eurozone Manufacturing PMI shows an easing in the pace of decline in May, consumer confidence and business sentiment were weaker than expected, particularly in the badly hit services sector. With lockdown restrictions now easing, economic activity should improve, but risk is to the downside.

Switzerland: A fragile economy despite successful virus containment

While the Manufacturing PMI edged higher in  May, helped by stronger output and a pickup in hiring plans, the broader KOF leading indicator fell further, consistent with a decline in activity compared to April. We suspect this mainly reflects weak activity during the first half of the month, when only a few lockdown restrictions had been eased, and expect better data over coming weeks. By contrast, GDP data, released later this week, will show that growth turned negative in Q1, before tumbling in Q2. Indeed, exports slumped by over 10% in April, following on from a 3.5% decline in Q1, with watch exports down a massive 80%, while retail sales ex food/fuel were down by almost 30%, after a slump of 17% in March. While a recovery is now due, businesses have been hit hard and conditions are fragile. Despite successful virus containment in Switzerland, it will be critical that policy support is not removed prematurely as both domestic and global conditions will be vulnerable for a long time to come.

Japan: Second supplementary budget supports the ailing economy

Amid fewer new coronavirus infections, Japan’s government has ended the state of emergency in the remaining prefectures and announced another major fiscal stimulus package, financed by a second supplementary budget. The total programme size, at JPY 117.1tn or 21.5% of GDP, equals exactly the size of the April package, while fiscal expenses, at JPY 31.9tn, are higher than those of the first package and will be fully financed by JGB issuance. Drilling down further, the so called ‘fresh water’ impact amounts to only JPY 6.7tn, boosting GDP growth by less than 0.4%. Avoiding mass unemployment and supporting SMEs are at the core of the new measures. As expected, Japan’s economic downturn accelerated in April, with industrial production down 14.4% YoY and retail sales 13.7%. The economic slump is also starting to have an impact on Japan’s labour market, with unemployment beginning to rise and summer bonuses projected to decrease more than 4%. However, consumer sentiment is starting to improve, while equity market investors enjoyed a 7.7% rise of the Topix over the last seven trading days.

APAC: PMIs signal recovery, but overall conditions remain vulnerable

In volatile and highly unusual times, it’s important not to over interpret the PMI data. We therefore prefer to focus on broader trends when looking at the data currently. Manufacturing PMIs for May were roughly unchanged in Korea and Taiwan, while they rebounded markedly in the ASEAN countries, with the exception of Indonesia. Most Asian as well as Australia’s Manufacturing PMIs are now hovering in the lower 40s, which suggests that the whole region is still struggling in the aftermath of the COVID-19 shock, despite the rebound following various policy initiatives and a relaxation of lockdown restrictions. China’s recovery is further along, with the NBS Non-Manufacturing PMI back to pre-crisis levels at 53.6, supported by the strong construction component. The output component of the Caixin Manufacturing PMI even surged to the highest level in nine years, as backlog orders have been filled and inventories accumulated. We remain cautious as export orders continue to contract and the weak employment component signals difficult labour market conditions.


What to Watch

  • In the US, the ISM Non-Manufacturing Index is expected to have ticked up in May while labour market data are likely to have further deteriorated compared to April.

  • The ECB may deliver an expansion in the PEPP purchase programme at Thursday’s policy meeting while the Services PMIs will be watched for signs of stabilisation.

  • Most of the interesting Asian data releases for this week have already been published yesterday and today. We expect China’s May exports and Malaysian April exports to confirm a deterioration versus the prior month.


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For previous updates, click below:

❯  16 March 2020
❯  23 March 2020
❯  31 March 2020
❯    6 April 2020
❯  14 April 2020
❯  20 April 2020
❯  29 April 2020
❯    4 May 2020
❯  11 May 2020
❯  19 May 2020
❯  26 May 2020

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