MUFG: More US stimulus reinforces the role of the Fed

MUFG: More US stimulus reinforces the role of the Fed

Currency
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By Derek Halpenny, Head of Research, Global Markets EMEA and International Securities

USD: More US stimulus highlights central bank financing realities

Former Fed Chairman Ben Bernanke has stated that he did not believe in the Vshape recovery hypothesis, arguing that the reversal from current lockdowns would probably be slow with high risks of further disruption along the way. It will be all eyes on China going forward from today with Wuhan’s 76-day lockdown formally coming to an end. Will there be a further outbreak at the global epicentre of the COVID-19 virus? Certainly available data from China suggests activity elsewhere has recovered but is yet far from normal, backing up Bernanke’s view to a degree.

Bernanke’s view, if realised, would also imply this crisis turning out to be very very expensive. President Trump yesterday called for a further USD 250bn to help finance the Paycheck Protection Program that has already been allocated USD 350bn but is proving hugely popular given the loans are forgivable. A vote on this could come in the next 48hrs just as the House led by Nancy Pelosi is pushing for another USD 1trn of stimulus to top up the USD 2.2trn Phase 3 deal approved recently. If that’s Phase 4 then Phase 5 – an infrastructure spending program is also being discussed.

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All of this is taking us into eyeshot of a total sum potentially approaching USD 5trn! Yes, USD 5trn or around 25% of GDP. And that sum doesn’t even consider the added stimulus provided through the Federal Reserve’s lending programs.

How is this sustainable? I think one consequence is becoming abundantly clear. The COVID-19 crisis is taking us into the realms of central bank financing of government fiscal spending. Prior to this the Fed had been shrinking its balance sheet and there was some credibility to the idea of returning the QE-fuelled security purchases back into the markets. That idea following this crisis will just not be credible.

The Fed’s balance sheet jumped by USD 605bn to last Wednesday. We will find out tomorrow evening the increase in the week to today. The FOMC minutes from the emergency meeting on 15th March will be released today (19:00 BST) and while a little dated now we expect to highlight the determination of the Fed to respond as needed to the crisis. Huge fiscal stimulus that is in reality financed be reserve creation by the Fed will have consequences at a later date. The speed of balance sheet expansion is not impacting the dollar negatively now but later in the year when economic conditions improve, the dollar will come under more sustained downward pressure.

EUR: German COVID recoveries an important milestone

As we continue to see the growth in COVID-19 new cases and deaths decelerate across Europe, the focus will continue to shift to the timing of lockdowns being reversed. In that regard we see a number of factors that will prove important in shaping government policy on lockdown reversals. Two will be crucial – recoveries from COVID-19 and the capability of upping the scale of testing. Yesterday, the Johns Hopkins data revealed this took place in Germany where there were 7,381 recoveries from hospital – the largest one-day number since the outbreak. On the same day, there were 2,144 new cases, implying a decline in net new cases of 5,237. We will now be tracking this data more closely given it will play into shaping government policies on reversing lockdowns. The scale of recoveries is important for health services capacity and increased capacity would mean a country being in a much better position to consider reversing lockdowns.

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Germany is not alone in being in this position. Indeed, it may be premature to imply Germany will see this persist – the new recovery jump might not be sustainable. But Austria has now recorded a decline in net new cases for four consecutive days, by a total of 956. And it’s no coincidence that Austria is one of the countries to confirm some reversal of its lockdown starting next week with certain shops opening for the first time. A clear plan has been laid out with more shops opening on 1st May and then schools, restaurants and bars and most other services two weeks after that – implying more normal economic conditions by around 15th May. Large public gatherings will not take place until into June.

That’s a potential indicator of how long these reversals are likely to be. Austria responded quickly (its lockdown began on 16th March) has therefore had a relatively low number of cases (12,592); and a very low number of deaths (243) but with everything going to plan will not resume near normal economic conditions until the middle of May. The more extremely impacted countries will likely be returning more slowly and is still not yet approaching recoveries surpassing new cases (apart from Germany of course). This will be a long haul.

So we are cautious over the current risk-on trading conditions. The US equity market has now rallied 18.8% from the low point on 23rd March and is now only 22.5% below the record high on 19th February. A lot of good news appears in the price based on that performance and hence some renewed risk aversion may be on the horizon that will see some of yesterday’s dollar losses reverse.

EUR: Lack of EU direction to weigh on currency

The euro is under-performing today and for good reason. The speed of the COVID19 crisis on the real economy has been so brutally fast that it requires rapid policy response. On an EU-wide perspective that has not been forthcoming. As we’ve come to expect, the ECB has responded rapidly and individual countries have responded but there has been little on an EU-wide perspective. Yesterday was a chance to change that but apparently after 14 hours of discussion, nothing was agreed.

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The good news is that another call has been scheduled for Thursday. A disagreement on ESM conditionality between Italy and the Netherlands was to blame for the breakdown of the talks. That will not go down well and doesn’t read particularly well given the terrible situation Italy in particular finds itself. We expect progress to be made and hopefully by Thursday we will see a deal reached. But the contrast with the US is clear and while central bank financed fiscal spending will have longer-term consequences for the dollar, for now, the lack of cohesion in Europe is a EUR negative. It doesn’t help that the EU’s top scientist, who heads the European Research Council has resigned over the EU’s approach to COVID-19.

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