End of summer round-up and back-to-school Q4 outlook
Hedging and Capital Markets
Real Estate | London
SummaryOver the past month, the impact of the global pandemic on the European economy is now evident in the reported GDP data. Reporting of severe contraction should be no surprise to anyone, but what matters now is how quickly we can recover.
We have seen some rebound in activity as governments lifted restrictions, but much of this was just the pent-up demand from the time of lockdown.
So far, almost V-shaped recovery then? Well, not quite. There is a long way to go until the recovery can be assured and plenty of data points suggest it could be a W-shaped recovery. Continued working from home and the loss of revenue from white collar workers in major cities threatens further job losses and business closures. Many economists highlight that once government job and economic support programmes fade, so too will the recovery. There is also the impact of localised lockdowns, ending up with a “stop-start” scenario and further weakening consumer and business confidence.
A quick look at where we are now compared to pre-COVID.
Retail sales have recovered.
But consumer confidence remains depressed.
The UK economy contracted at a record rate in Q2, due to collapses in private consumption and investment amid the prolonged domestic lockdown. The ONS reported gross domestic product fell in the second quarter by 20.4% compared with the previous three months – the biggest quarterly decline since comparable records began in 1955. That confirmed what was already known: the economy was in a severe recession in the first half of the year after GDP had contracted 2.2% in Q1.
The severity of the shock was very much expected following the monthly GDP data for April and May, though the rebound had already begun in June on the lifting of some restrictions, and this momentum has continued so far in Q3. Both the manufacturing and service sectors strengthened in July and August according to the monthly purchasing managers indexes amid stronger output and new orders. Less encouraging is the labour market, with 730,000 jobs lost between March and July, and millions of workers still on furlough. This is masking the true picture of the labour market, and so likely to hamper the recovery further.
In the Eurozone, the economy also contracted at a record-breaking pace in Q2 for the same reasons as the UK. GDP contracted by a record 12.1% compared against the first quarter, where early containment measures contributed to a 3.8% contraction. The good news is that economic sentiment surveys in Germany and the wider Eurozone have risen for four months in a row, pointing to a brighter outlook among business.
Looking ahead, available data signals caution for a robust recovery in Q3. Although economic sentiment continued to improve in July and August, consumer confidence sagged, likely weighed down by rising new infections rates and the tightening of restrictions in several countries. Retail sales fell unexpectedly in July for the first time in three months, suggesting consumer spending rebound is faltering. Furthermore, after jumping to a more than two-year high in July, the composite purchasing managers index dropped sharply in August as services activity virtually stalled. Worryingly, manufacturing and services jobs were cut for the sixth month running amid still-subdued demand.
Meanwhile, the euro’s value has risen sharply over the past few months, amid optimism for the bloc’s recovery following the agreement on a recovery fund, as well as a dramatic shift in USD sentiment. Investors have been piling into the euro during the summer, with speculators holding a record long position (bets for the currency to rise in value) against USD as of a week ago.
Annual consumer price inflation in the Eurozone has slowed sharply since the start of the year. The latest data showed it fell for the first time in four years. While it might be too soon for the European Central Bank to counteract, a stronger Euro is a factor that will contribute to low inflation and could mean CPI undershoots the ECB’s already low expectations. It is perhaps no surprise then that one of the executive board members of the ECB gave a subtle warning that while the ECB does not have an FX target, EUR-USD does matter. We expect to hear more on this subject when the ECB announces their monetary policy decisions on Thursday – no changes are expected.
Despite months of “intensified” rounds of talks, and four years since the original UK referendum vote, trade discussions between the UK and the EU have once again reached an impasse.
Both sides want to keep blaming each other – and while there are two major areas of focus (state aid rules and fishing rights), it is the case that nothing is agreed until everything is agreed. The history of trade negotiations tells us that the last three weeks are more important than the last three years, and there is still hope that a last minute deal will be thrashed out.
This week's talks will mark the start of the final phase of negotiations. Both sides need to be wrapped up by the end of October to enable a deal to be in place for when the UK’s post-Brexit transition period expires at the end of the year. With both sides bumping up against their red lines, the need to compromise couldn’t be greater to help break the stalemate. The pound’s recent gains and the respective implied volatility in the options market suggest there is an expectation that a last-minute deal remains much more likely than a no-deal outcome.
Reviewing the economic forecasts for the full year 2020 outturn feels like a fool’s exercise – this is no “normal” year, and the oscillations of economists means there is no firm number to hang your hat on. What matters more is not the quarter-on-quarter changes, but what the new, sustainable levels of growth, unemployment, and inflation look like for 2021 and beyond. Once the impact of the lockdown is no longer distorting the numbers, supply chains are recovered, and the government support on wages is removed, we will get a better sense for the future. This will also be influenced by the availability and timing of a vaccine. As infection rates continue to rise in Europe, and as we move toward colder temperatures and spending more time together inside, the urgency for a vaccine to help foster the economic recovery grows ever greater. One can only hope the many thousands of great scientific minds currently working to achieve this outcome will once again prove that humankind is capable of taming mother nature.
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Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.20-0351
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