By: BlackRock Investment Institute
Europe’s policy response to the virus shock was slow to get going – but an impressive array of fiscal and monetary measures is getting into place to bridge the economy through the shock. The euro area has also had relative success in tamping virus growth, positioning it well for reopening its economy. We see the two factors as supporting the region’s economy and markets in coming months.
Chart of the week
Google mobility data for U.S and key euro area economies, 2020
Sources: BlackRock Investment Institute, with data from Google, June 2020. Notes: The chart shows the percentage change in mobility (seven-day moving average) relative to the median level between Jan. 3 and Feb. 6, 2020. The yellow line is a simple average of Germany, France and Italy. The lines start on Feb. 24.
Lockdowns in Europe started relatively early and caused mobility to plummet. Google data – which use mobile phone location data to measure the change in visits to stores and workplaces as well as use of public transit – show average mobility levels across Germany, France and Italy plunging more than 70% below pre-virus levels. See the yellow line in the chart. The sharp drop was a huge drag for activity in the short term, but helped curb the virus spread more effectively. Mobility has rebounded quickly and is now on par with the level in the U.S. This bodes well for a pickup in activity, especially as it comes with a lower risk of infection resurgence, in our view. As a result, we could see the pace of recovery in the second half outpacing other regions, including the U.S.
After an initially slow start, the euro area’s policy response to the virus shock is picking up pace, with additional spending measures announced recently by Germany and France. Combined with additional monetary support, the size of stimulus is broadly sufficient to match the income shortfall on a euro area level, our analysis shows. The European Central Bank (ECB) has launched new and more flexible quantitative easing: the pandemic emergency purchase program (PEPP). Its targeted longer-term refinancing operations (TLTRO) scheme holds the promise to provide support to the private sector via cheap loans to banks. The ECB has also made clear that it stands ready to do more in monetary policy stimulus if the inflation outlook is still not showing sufficient progress toward price stability in September.
In addition, we see the new 750-billion-euro European recovery plan as a crucial turning point for Europe’s economy and financial markets. The bulk of the proceeds will be distributed as grants – over and above offering cheap financing to ensure the flow of credit to virus-hit economies through new European Stability Mechanism (ESM) credit lines. It will also for the first time create a jointly issued European “safe” asset of a meaningful size. Such pan-European debt would start to rival the total volume of German federal government debt outstanding, after including the almost 300 billion euros of ESM debt outstanding. To be sure, this is not a “Hamiltonian moment” for Europe – harkening back to the U.S. federal government assuming the debts that states incurred in the War of Independence. It’s about newly issued debt, and more work is needed to move the euro area toward a fully-fledged fiscal union.
Policy implementation risks remain. And the risk of a no-deal Brexit looms. Yet our BlackRock geopolitical risk indicator already shows elevated market attention to the European fragmentation risk, suggesting markets may have priced in at least part of that risk.
Bottom line: We are seeing many reasons to be optimistic about the euro area in the second half of 2020, including the ramped-up policy response and effective public health measures. The sum total of the euro area’s policy actions looks impressive – and they come on top of relatively large automatic stabilizers such as generous welfare benefits. As a result we maintain our overweight in European peripheral government bonds and are considering an upgrade to European equities.
Assets in review
Selected asset performance, 2020 year-to-date and range
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, June 2020. Notes: The two ends of the bars show the lowest and highest returns versus the end of 2019, and the dots represent year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, MSCI USA Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index, Bank of America Merrill Lynch Global Broad Corporate Index, Bank of America Merrill Lynch Global High Yield Index, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI Emerging Markets Index, spot gold and J.P. Morgan EMBI index.
Measures to contain the virus are gradually being eased in many developed economies. May’s data suggested the worst of the contraction may be behind us, but we see a bumpy restart in coming months. We are tracking the interplay of containment measures and mobility changes on activity as economies have started to reopen. The unprecedented policy response has boosted markets, leaving a potential resurgence of infections and policy implementation as key risks. U.S. Congress is headed for a fiscal cliff as jobless benefits, state support and payroll protection measures are expiring soon.
June 22 – Euro area consumer confidence flash
June 23 – U.S., UK and euro area flash PMIs
June 24 – German IFO business survey
A spate of business and consumer sentiment data across the U.S. and Europe could help markets assess signs of a rebound in activity. The pace of the activity restart depends on how successful countries are in suppressing the virus. We see a greater danger of renewed outbreaks in the U.S., UK and Canada than in Germany and Japan, based on our research on the relationship between mobility and virus infection rates.
2020 Investment themes
- The coronavirus shock is unprecedented and sharper than what we saw in 2008 – but its cumulative hit to growth is likely to be lower as long as authorities deliver an overwhelming fiscal and monetary policy response to bridge businesses and households through the shock. The main risk to our view: The decisive policy response is not delivered in a successful and timely fashion, causing lasting damage to the economy.
- The rate of growth in virus cases looks to be slowing in many regions, and stringent shutdown measures are gradually being lifted.
- The nature of the activity rebound will depend on the path of the outbreak, delivery of policy response and potential changes to consumer and corporate behaviors. Success will not just be about restarting the economy and containing the virus – but balancing both objectives.
- Market implication: We are sticking to benchmark holdings in most asset classes and prefer credit over equities.
Bold policy action:
- A decisive, pre-emptive and coordinated policy response needed to stabilize financial markets has taken shape, particularly in the U.S. The U.S. unemployment rate remains elevated, underscoring the need for effective policy implementation. The risk now is policy exhaustion, especially as U.S. fiscal measures are set to expire soon.
- The Federal Reserve built on its “whatever it takes“ approach to helping the economy through the shock and ensuring markets function properly. We could see its balance sheet more than double to just over $10 trillion by year end to support the fiscal response. The U.S. Treasury smashed records by setting out a $3 trillion borrowing plan in its quarterly refunding to fund the response – showing the blurring of lines between monetary and fiscal policy.
- The Fed has so far steered clear of committing to explicit yield curve control.
- We are gaining confidence in Europe’s policy response. The European Central Bank’s latest targeted long-term refinancing operation (TLTRO-III) was met with a record €1.3 trillion of demand. The Bank of England boosted its monetary easing by £100 billion, although weekly asset purchases may slow.
- A German constitutional court ruling threatens the ECB’s independence and could lead to euro area fragmentation in the long run. It’s crucial to have proper guard rails around policy coordination, as we discuss in Policy Revolution.
- China moved away from setting a GDP growth target for 2020, emphasizing quality of growth over quantity, and announced fiscal stimulus of at least 4% of GDP.
- Central banks have moved from alleviating dysfunctional market pricing and tightening financial conditions to ensuring credit flows to businesses and local governments.
- We see risks of implementation and policy exhaustion. Next rounds of U.S. fiscal stimulus look harder to achieve because of a return of political polarization after a short window of bipartisanship.
- Market implication: Coupon income is crucial in an even more yield-starved world, including corporate credit.
- Portfolio resilience has to go beyond nominal government bonds and consider alternative return sources that can provide diversification, such as private markets.
- A focus on sustainability can help make portfolios more resilient. We believe the adoption of sustainable investing is a tectonic shift that will carry a return advantage for years to come – and the coronavirus shock seems to be accelerating this shift.
- Market implication: We prefer U.S. Treasuries to lower-yielding peers as portfolio ballast and see a strong case for sustainable investing and private markets.
Asset class views
Six to 12-month tactical views on major global assets from a U.S. dollar perspective, June 2020
Note: This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.
Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, June 2020
Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.