If the financial markets are any indication, there’s been a remarkable shift for riskier assets as of late, with equities rising to fresh record highs. And the catalysts have been plenty, with lockdown restrictions easing globally, the much-needed US dollar in relative retreat in the FX market easing global liquidity strains, and most importantly both fiscal and monetary policies in full swing.
In Europe, last Thursday’s European Central Bank (ECB) decision resulted in an increase in its bond-buying stimulus package by €600bn to €1.35tn, and followed an earlier announcement of a fresh €130bn fiscal stimulus package out of Germany. One may argue about whether it’s a day late, but it’s hard to suggest it’s a dollar short when viewed in the context of the economy, budget, and overall monetary base.
It came as no surprise then, that equities would recover despite ongoing fundamental economic risks, and as pointed out in a previous article here, the gap between the financial markets and the real economy could easily widen further. Any positive news on the economic front such as surprise upside figures out of US Non-Farm Payrolls (NFP) last Friday have offered an even higher platform for financial markets to lift off of.
There have been plenty of explanations as to why NFP defied expectations of a big drop in employment change, but more importantly, the unemployment rate is still well above that of the Great Recession’s 10% peak, and the labor force participation rate has dropped from above 63% in February to below 61%. The employment to population ratio shows a harsher drop, from 61% at the start of the year to below 53% in the latest reading (that figure dropped from 63% to 58% from 2008-2009).
And that’s the US, where much-needed record fiscal and monetary stimulus packages were swiftly released, and significant portions already used up. Stimulus of similar size relative to the economy will be difficult to replicate for most countries, and more importantly, will be difficult to apply in the event of a second or third wave. This is based on the assumption that a comprehensive vaccine won’t be introduced anytime soon, and a priority on an individual level for avoidance.
It is here that governments on the surface are faced with two choices should another wave occur: (1) Reinstitute a lockdown, or (2) keep light restrictions in place. The first would require stimulus once more and test budgets already heavily in deficit and where monetary easing is seemingly at its highest. In other words, not an option that can be realistically applied repeatedly and most certainly not globally. Which leaves us with the second option that would still test the economy but not as heavily as the first, and will likely result in more Covid-19 cases and casualties.
Only so many industries are capable of shifting to a work from home approach, and certain sectors that employ a significant portion of the population need a physical presence and require physical activity for the product to be produced or the service to be carried. Furthermore, the decision for a full lockdown and the increased unemployment will carry its own risks and open the door for cases and casualties of another kind.
In all, rising real risks can’t be ignored moving forward, and factors that have resulted in rising financial assets that could easily continue to advance higher can’t be viewed as general economic success given that both markets and the economy have been reliant on necessary stimulus in the short term. In the waves that follow and with limited room for stimulus, decision-makers will be tasked with an unenviable decision.
* Any opinions expressed in this article are the author’s own
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