Risk assets rose sharply in April, recovering some of the big losses incurred in February and March. While the deeply negative economic impact of COVID-19 restrictions started to show in data releases issued in most major economies, there were also promising signs that the peak had passed in the first wave of new COVID-19 infection numbers and mortality rates.
The curve was flattening even in the worst affected Asian and European countries and the United States. In Australia and New Zealand, there were signs of possible containment at a very low infection rate. There were also promising signs of progress in several countries, including Australia, working to develop COVID-19 cures and vaccines.
At the same time, most OECD countries were implementing substantial fiscal stimulus – mostly household income support or supplement programs – co-ordinated with central bank support. Between regular policy meetings the US Federal Reserve announced almost unlimited quantitative easing, extending its purchases to corporate debt and reducing concerns in financial markets that the COVID-19 led economic downturn could worsen and become a financial crisis centred on the highly leveraged and increasingly sales deprived US corporate sector.
Even in face of impending deep recession, the positive factors saw major share markets rally in April, with gains ranging from 8.2% for Britain’s FTSE 100 to 13.8% for the German Dax index. The US S&P 500 rose by 12.7% in April and Australia’s ASX 200 lifted by 8.8%. In the closing days of April and at the beginning of May, gains have been reduced, largely because of concern about the risks that lie ahead - economies and the companies they support may prove slow to revive as COVID-19 restrictions are patchily lifted; lifting of restrictions may lead to a second wave of infections and renewed restrictions; the most promising of the cures and vaccines being developed are still many months away from widespread distribution and use, among many others.
The strength in share markets during April was also reflected in rallying credit markets. The US Fed’s commitment during the month to provide buying support for corporate debt supported the share and credit markets alike.
Government bond markets suffered some dislocation in March but steadied in April, assisted by central bank buying support. RBA buying support to promote yield curve management and cap the 3-year bond yield at 25 basis points (bps) reduced as the bond market settled. The 3 –year Australian bond yield traded below 25bps through April while the 10-year bond yield rose by 13bps in April to 0.88%. In the US, the 10-year bond yield fell by 3bps to 0.64% while the 30-year Treasury yield fell by 4bps to 1.28%.
Most central banks are effectively suspending policy independence and are working closely with Governments to cushion their economies and financial systems during the COVID-19 crisis. Large-scale coordinated fiscal and monetary expansion will in time promote a possibly large lift in demand extending eventually to excess demand and higher inflation. Bond yields tend to rise well ahead of an expected rise in inflation but in current circumstances the rise is likely to be delayed by central bank bond buying activity keeping rates low as well as near-term deflation caused by very weak economic demand during the COVID-19 recession. Very weak demand has caused oil prices to fall to historically low prices in April, reducing energy costs and consumer prices more generally in the near term.
In Australia, the RBA in various statements during April has indicated clearly that it expects the official cash rate and the three-year bond yield to be no higher than the current target 0.25% for a protracted period. The RBA will see no cause to start lifting the official cash rate until the Australian economy is showing signs of growing at a pace likely to generate annual inflation rising consistently through the 2-3% target band. The latest annual inflation rate for Q1 2020 was higher at 2.2% y-o-y although average underlying annual inflation was still below 2% at 1.75%. More importantly, the Q2 CPI is likely to fall, weighed by lower petrol prices and lower prices for key services such as child- care and health care generated by the Government’s package of measures to support households through the COVID-19 crisis. Annual CPI inflation is likely to fall well below 2% in Q2 and stay below the remainder of 2020.
While interest rates are likely to stay low over coming months risk assets look set for a bumpier ride. The April rally factored in the possibility of an early end to the COVID-19 crisis and a V-shaped economic lift after brief albeit deep recession. There is still a possibility this could occur, but the developing uncoordinated and piecemeal lifting of restrictions around the world points to increasing risk of a second wave of infection and restriction.
Even in Australia, where the dampening of COVID-19 infection has been best practice by international comparison, the pick-up in economic activity beyond the crisis is likely to be restrained by high existing household debt, rising precautionary household saving, cautious bank lending practices during and beyond the current loan moratorium, very weak immigration and a persistently soft housing market. Downside risks persist for risk assets over the next few months in our view.