The good, the bad and the ugly

When it comes to this week’s global economic data there has been something for everyone. A massive rebound in retail sales in the US, a drop in global inflationary pressures, particularly for producer prices, and central banks have also been back in the frame. Financial market volatility has eased compared with last week, as traders try to figure out the themes that will dictate market performance for the rest of the summer.

The US economy’s biggest cheerleader: the consumer 

Retail sales rebounded sharply in the US last month, rising 12.4% excluding auto sales, which is a keen reminder that not even enforced lockdowns can keep the US consumer dormant for too long. This doesn’t quite make up for the 15.2% decline for April, but it is a decent recovery, nonetheless. Sales were, no doubt, boosted by the US Treasury’s decision to mail out cash to each American household, a direct form of QE that the US government hopes will keep Main Street in business and people in jobs. So far, the US consumer has held their part of the bargain and hit the shops once more, while US jobs numbers have improved. This does not mean that the US economy is out of the woods. We will need to see if retail sales continue to recover in the coming months when the US Treasury is not sending out cheques in the post. Added to this, if there is a second wave of Covid, there is a chance that the jobless figure could get a lot worse. 

Why a second outbreak of Covid-19 may not trigger a market panic 

While we are definitely not perma-bulls over here at Minerva Analysis, we do appreciate well-researched reports. In our view, fears about a second wave of Covid-19 striking the heart of the global economy are premature, for now. Firstly, the outbreak in Beijing is small and seems to be well contained. Secondly, governments around the world have had time to prepare for a second wave of this pandemic and implement test and trace systems. For example, in Beijing there has been 137 new cases of coronavirus in the past week, which has led to 27 neighbourhoods being put into lockdown. Flights have been cancelled to and from Beijing, however, roads remain open and companies and factories can still operate. If China can control this outbreak in a localised way, then it could give investors the confidence that a second wave of Covid-19 will not lead to another global economic shutdown. Track and trace systems will be crucial to containing a second wave of Covid, which makes the UK’s delay in setting one up appear like another failure on our government’s part during this crisis. However, if they can get the system working by the Autumn then the UK has a fighting chance of escaping the worst ravages of second wave of the coronavirus, which is set to hit the UK as we move into the winter months. Thus, for now, a second wave of coronavirus in Beijing need not cause a panic in financial markets. Added to this, news that a cheap steroid can dramatically improve the survival rate for those who end up in intensive care with coronavirus is also a positive medical development that is soothing financial markets right now. It is worth remembering that as coronavirus remains the dominant global theme, medical developments in relation to the virus will be key drivers of financial markets. 

Are falling inflation rates a threat? 

The recent spate of weak inflation data is a mixed bag. On the one hand the decline in prices in the UK, Eurozone and Canada (which fell into deflation last month) is a sign of economic distress caused by the lockdowns, however, on the other hand it gives central banks the ammunition to push more stimulus into the global economy. The Chair of the Federal Reserve told the US Congress this week that there remains considerable uncertainty about the speed of the economic recovery, and he said that the Fed would let the market decide the speed of its bond purchases. Essentially this is the ultimate Fed put – if the market performs poorly then the Fed will be there to buy up bonds. Of course, the opposite is also true – if the market outperforms then the Fed will stop purchases. If the latter scenario plays out, then the disconnect between the economy and financial markets had better heal itself, or Fed support could end before the global economy has healed. 

What to expect from the Bank of England 

On Thursday the Bank of England will announce its latest policy decision. Interest rates are expected to remain at 0.1%, however another £100bn of QE is expected to be announced as a result of the 20% decline in GDP for April. If the Bank increases QE by less than £100bn this is likely to underwhelm markets and trigger a decline in UK risk assets, however, a bigger sum, some analysts are expecting £150bn of extra QE, could boost UK stock prices as we move into the latter part of the week. The minutes of the meeting are also worth watching to see if the Bank is preparing for negative interest rates. Any sign that negative rates are coming could be met with another wave of pound selling. GBP/USD fell 150 pips on Wednesday, as the market priced in a dovish BOE. However, if there is no mention of negative interest rates during Thursday’s BOE meeting then we could see some GBP upside, back towards key short-term resistance at $1.2560 and then $1.2600. To conclude, if GBP/USD is to recover back towards the $1.28 highs from 10th June, then we will have to see a less dovish BOE this week and a sustained recovery in risk sentiment that could trigger another wave of dollar selling.