The walking dead

Markets continue to focus on the good news.

It sounds good for all the wrong reasons.

The good vibes continue to reverberate amongst market participants, latching onto anything with some semblance of a rapid recovery. As economies continue to reopen gradually, the hope is that everything will continue to go on without a hitch. The promise that central banks will continue to support market functioning for the foreseeable future has dramatically reduced tail risk and has stabilized financial conditions. In Europe, a Franco-German fiscal alliance appears to have dusted off the shackles of government spending and created renewed optimism of a marriage between fiscal and monetary policy. Although this all sounds good, the possibility of a second wave of infections remains high, especially without widespread testing. The flattening of the COVID-19 curve is what has allowed optimism to build, and any threat to that sends us right back to where we were in early March. The other potential macro bazooka is the rapidly deteriorating US/China relations, which appear to be at their worst under the new administration. It will be just a matter of time before China retaliates, and depending on that retaliation, we could see an unwind of all of this calm we've enjoyed in markets over the last few weeks.

Data may be favouring further reopening.

All US states have commenced some form of reopening, what happens from here is largely unknown. Globally, the daily number of cases broke a new record and there are concerns that a second wave will hit soon. Of course, it's unclear if this increase is a result of the virus spreading or due to expanding testing capacity. Although logically, one would think easing lockdown measures would result in higher case counts, one big name on Wall Street, Marko Kolanovic from JP Morgan, suggested the opposite this week. Although there are plenty of armchair epidemiologists out there, myself included, Kolanovic is someone who I think is worth mentioning. Notably, he has this striking chart, which shows that many states had decreasing case counts after lockdowns were lifted (see below). There are plenty of factors that can explain the decline, but one that Kolanovic highlights is the "removal of the most effective spreaders," which incorporates anything from hand washing to large social gatherings. Although I think lockdowns were crucial to stopping the spread, I tend to agree with Kolanovic that they have served their purpose and have become less effective at stopping the spread. The broader theme here is that as long as reopening is done responsibly, any new outbreaks should be manageable. Unfortunately, part of the process of reopening responsibly is increasing testing capacity.

Apple mobile activity data suggests Americans are driving more.

I recently learned about this mobility data that Apple has provided. The data shows how many requests have been made for directions through the Apple Maps app. Below I've created a heat map of the data for the US for 2 points in time. The chart the left is for early April, while the chart on the right shows data from this Saturday. The data is indexed to 100 on January 13th. Any number above 100 indicates that there are more Apple Maps requests for direction than on that date. The bottom line is that it shows that states are gradually beginning to reopen.

Source: Apple Mobility Trends

It's alright; I'll start a cold war in an election year.

Logic would suggest that the greater the impact the virus has on the economy, the lower the likelihood the incumbent administration will remain in power. As such, we saw the administration initially downplay the threat of the virus and, more recently, shift the blame to the World Health Organization (threatening to cancel funding) and China. Although the WHO's heat remains, over the last few weeks, hostilities towards China have increased dramatically. China's move to enforce mainland security protocols into Hong Kong law is the latest and probably most deadly blow to the US/China relationship. Please make no mistake that this development is a real game-changer with the potential to strip Hong Kong of its coveted role as a global financial hub. This type of aggression from President Xi pulls the US into the ring and essentially forces them to take a stand against the US. Things are made increasingly tenser with China officially abandoning its growth target for 2020, making it an inevitability that China will not meet the import quotas outlined in the phase one trade deal from last year. The broader concern here is that many of the themes that were present in the 2016 election (xenophobia, big vs. small government and capitalism vs. socialism) continue to be front and center. There's no question in my mind that China will surpass the US as the largest economy until there is some coherent national plan for tackling these issues. Irrespective of who wins the US election in November, the US is as near as makes no difference in a thorny cold war against its far east counterpart.

Monetary policy will remain accommodative for the foreseeable future.

Global central banks and negative interest rates.

By late February, it had become increasingly clear that many central banks would need to dust off their Great Financial crisis toolkits to alleviate stress in funding markets. These policies range from yield curve control (targeting long-term interest rates as well as short term) to asset purchases and even negative interest rates. In North America, the idea of negative interest rates has, for the most part, been dismissed. However, in Europe, the ECB has adopted a Negative Interest Rate Policy (NIRP) for more than 5-years. This week, the Bank of England's chief economist, Andrew Bailey, suggested that negative interest rates were still a possibility in the UK. With markets experiencing a whole new level of uncertainty, central banks have stepped up to provide certainty that they will do whatever in their power to support market functioning.

The walking dead.

The unprecedented response from central banks around the world has raised plenty of questions surrounding moral hazard. The argument goes that, by having central banks support markets, companies have no incentive to behave responsibly since they will never have to face the consequences for their actions. To be fair, this type of critique always finds its way into market commentary when central banks start interfering in markets. There is no question that central bank policies have compressed risk premiums across asset classes and has resulted in large sums of capital misallocation. The desire to search for yield in the world that's void of it is a dicey prospect. The result is that companies that shouldn't receive funding end up accepting cash to continue operating at a loss. The sheer existence of these companies is based on the expectation that interest rates remain low forever. These companies are referred to as zombie companies, and there are many of them out there, making any attempt to normalize policy (raise interest rates) a painful process that is met with escalating defaults. I recommend people read my explainer series on searching for yield for more information.

As undesirable as these dynamics are, what is the alternative?

Central bank asset purchases seem to offend a lot of people. I understand the criticism, having more zombie companies is not ideal. In some sectors, these types of companies will be inherently deflationary and will likely hamper productivity/wage growth. However, when faced with a crisis that forces company revenues to zero in many cases, what should policymakers do? Yes, by purchasing corporate debt, unproductive companies are left in the economy that arguably shouldn't exist, but at the same time, we are preserving these linkages in the economy. When this crisis is over, at least people will have a job to go back to, making it more likely the recovery will be quicker. Is there a way to fix this zombie apocalypse in the corporate credit market? Unfortunately, I'm not convinced there is. A part of me thinks this is just part of the new normal.

Tiago Figueiredo