Risk assets (equities, High-yield corporate bonds) surged due to positive vaccine news and lower US political uncertainty
Global equity markets rose, as the outcome of the US elections (Biden and GOP in the Senate) bodes well for the average investor via less trade uncertainty and the continuation of pro-business policies. Positive vaccine news boosted investors’ risk appetite further on Monday (see Markets Section) with the S&P500 recording new all-time highs.
With the Democratic candidate Mr. Biden emerging as President-elect in the US (inauguration date: January 20th), attention turns to the race for the Senate. Out of a total of 100 seats, Republicans are estimated to have likely secured 50. The Democrats hold 48 seats (including 2 Independents who tend to vote in conjunction with them). The remaining two seats (in the State of Georgia) will probably be decided in run-off elections which will take place on January 5th. Notably, if the Democrats win them both (a low-likelihood scenario), equaling the Republicans at 50 seats, they would effectively control the Senate (on top of House of Representatives), as the vice President acts as a tie-breaker in such cases. Having said that, Republicans maintaining an outright majority in the Senate appears the most likely scenario. In that case, pushing forward the president-elect’s and more broadly the Democrats’ political agenda (including massive fiscal stimulus both imminently as a response to the pandemic and further ahead, higher corporate taxes and stricter regulation), will be more challenging.
At the same time, the deterioration of epidemiological data continues unabated, particularly in the northern hemisphere which moves towards winter. That development has prompted many European countries to re-impose tighter restrictions and clouds the economic outlook. In the event, although the GDP rebound in Q3 overshot expectations by a wide margin (+12.7% qoq, versus consensus estimates for +9.4% qoq), PMI forward-looking indicators point to contracting activity in the services sector. That trend is expected to strengthen (and probably broaden), in view of the renewed social distancing measures. In all, we expect a return to negative GDP growth in the current quarter, of -3% qoq (-7% yoy), leaving the full year 2020 GDP growth at -7.4% yoy, followed by a partial recovery in 2021 (+4.3% yoy).
That scenario takes into account the pandemic-related restrictions as recently announced (e.g. late in October in Germany, France and Italy). Only a modest easing follows, with parts of the economy that involve wide interaction of people (e.g. bars, cafes, restaurants, gyms) remaining under tight restrictions up to March 2021 – apart of a possible partial and temporary easing in the Christmas period. A more meaningful easing is presumed to start during April 2021. An effective vaccine is assumed to start being deployed as of January (optimism for such an event increased recently, following respective, promising announcements for the Pfizer/BioNTech vaccine candidate) and sufficient vaccinations take place by the end of summer to avoid a 3rd wave of the pandemic in Autumn 2021, without having to resort to renewed social distancing measures.
Regarding inflation, CPI is weighed by depressed consumer demand, with the headline growth in negative territory (-0.3% yoy) and the core at +0.2% yoy (as of October). Overall, the European Central Bank’s (ECB) target (“close, but below 2%”) remains out of sight. In that context, the ECB has pointed to new action at its December meeting. Although ECB officials have not provided hints regarding the mixture of tools to be employed, consensus expects that at least an expansion of the Pandemic Emergency Purchase Programme by €500bn to a total envelope of €1850bn will be decided.
Key negative risks to our baseline scenario: i) worse than assumed pandemic developments; ii) policy uncertainty mainly linked to a disorderly Brexit. On the positive side, effects from the European Commission’s “Next Generation EU” scheme (total size: c. 5% of euro area GDP) are incorporated only to a limited extent in our scenario. We view the balance of risks as skewed to the downside.