ECB announces further monetary relief as states begin gradual reopening
- The ECB exceeded market expectations of further monetary support as the Coronavirus pandemic continues to take its toll on businesses. At their meeting on Thursday, they agreed three key monetary policy changes:
- PEPP package increased by €600bn, from the current envelope size of €750bn, bringing the total package to €1.35bn. These asset purchases will continue alongside the standard QE program which continues unchanged. This exceeded market expectations of a €500bn increase
- The horizon of PEPP purchases has been extended to mid-2021 (from end 2020)
- Maturing PEPP purchases will be reinvested until at least the end of 2022
- In the press conference following the meeting President Lagarde said that the governing council shared the “unanimous view that action had to be taken” especially given their downwardly revised inflation forecast of 1.3% in 2022 - well below the ECB’s target of close to but below 2%. ECB Staff macroeconomic forecasts were revised down for both GDP growth and inflation. The eurozone economy is expected to contract by 8.7% in 2020, and expand by 5.2% in 2021. Inflation was revised down in the short term to 0.3% in 2020 on the back of energy prices, and medium-term inflation also shifted lower.
Employment and sentiment surveys rebound
- US nonfarm payrolls posted an unexpected 2.5m gain in May (consensus was for 7.5m jobs to be lost), taking the unemployment rate down from 14.7% to 13.3%. Encouragingly three quarters of those who had been classified as having lost their job since the start of the Covid crisis reported that they only been on temporary layoff in May, auguring well for a continued recovery in the labour market in the coming months.
- US initial jobless claims declined to 1.98m during the week ending 30th May, down from almost 7m per week at its peak in March (previous week: 2.1m). This takes the total jobless claims since mid-March to 42.6m, representing roughly 1 in 4 people that were previously employed now not in work. Economists are expecting that the current level of unemployment, likely c.20% in May, is now at its peak. However, as weekly claims persist concerns are mounting over the several years that it will take to retrace to employment conditions that we saw at the end of last year.
- The US ISM survey rose from 41.5 in April to 43.1 in May, with new orders, production and employment components up 4.7 points, 5.7 points and 4.6 points respectively. Respondents commented on the ongoing demand-side weakness although some noted early signs of business resuming. The non-manufacturing ISM rose from 41.8 to 45.4 (consensus: 44.4), with business activity driving the majority of the increase (+15 points). Both indicate expected contraction.
- The global all-industry PMI saw its largest monthly increase in May, +10.1 points to 36.3. The services sub-index increased to 32.6 and manufacturing to 41.1. Among the weaker sub-components was employment, +1.9 points over the month from record lows, with hiring expected to resume in Q2 but not to levels seen pre-crisis for some time. On a regional basis, developed markets recovered more than emerging markets – US composite rose c.10 points to 36.4, Europe composite increased c.18 points to 31.9, China composite reached the highest level since 2010 at 54.5 (one of few expecting expansion), whilst the Indian composite remained depressed at 14.8 after a fall of 43.4 points in April.
- Euro PMIs were revised down marginally from the flash estimates in May. The final Euro area Manufacturing PMI was 39.4 (flash: 39.5), German Manufacturing PMI 36.6 (flash: 36.8), France Manufacturing PMI 40.6 (flash: 40.3). Among the smaller manufacturing sectors, Italy and Spain beat consensus considerably with final readings of 45.4 and 38.3 in May (April: 31.1, Spain: 30.8). Whilst manufacturing sector respondents are more optimistic than March / April at the peak of the pandemic in Europe, the indicators point consistently to expected contraction in the coming months.
- The Caixin China General Services Business Activity Index reached 55.0 in May (previous: 44.4, consensus: 47.3), making this the most optimistic reading of the services industry in almost a decade. New export business is still expected to contract, although the index improved from 38.1 to 44.4 over the month and the overall new business in rose from 48.4 to an expansionary reading of 55.8.
- China’s PMI numbers also pointed to an improving domestic economy, slowed by external demand. The composite reading was 54.5 in May (April: 47.6), and services (52.3, previous: 52.1) rebounded stronger than manufacturing (50.6, previous: 50.4). The rise in service sector sentiment, which accounts for c.60% of the Chinese economy, was driven by an increase in domestic demand. The economy shrank 6.8% in Q1 YOY as much of the country was in lockdown, and employment remains a priority for the government to avoid further contraction.
Risk markets describe a huge surge
- The ongoing re-opening of European and North American economies, with the added headwind from the ECB policy action and the strong US jobs data, triggered remarkable gains in risky markets over the week. Global equities were up 5-6%, with some higher beta segments like European banks up as much as 20%.
- Sterling investment grade credit tightened around 20bp over the week. Core government bond yields rose from 5bp in the short-end (pinned by central bank policy rates remaining at the zero bound) to 25bp at the long-end as reflationary expectations took hold. Brent crude rose another $4 over the week to top $40/bbl.
- The USD was a principal casualty of the risk-on tone, losing 2-5% against other G10 currencies (apart from the haven Swiss franc and Japanese yen). Gold fared even worse, falling 3% vs USD. Emerging market currencies surged, with the countries with the biggest Covid exposure actually performing the best (Brazilian real +8% on the week).