• Yesterday’s NYT showed trends in Covid-19 cases for each U.S. states and district. There is an even split: the number of states with rising cases equals the number of states with stable and the number of states with declining cases.
• Germany will lift its travel ban on 29 European countries, including Britain and Iceland, on June 15 and replace it with travel advisories

• As Iran Lifts Its Lockdown, Coronavirus Cases Return to Peak Level

• Africa appears to have been able to avoid severe COVID-19 outbreaks so far. The continent has 16.7% of the world’s population, yet the WHO says that it accounts for just 1.5% of its cases and 0.1% of its deaths. Admittedly, fewer resources probably means fewer tests, suggesting these numbers are understated. But there are good reasons to think countries there could be more resilient, including demographic factors, with a much younger population and lower rates of obesity than elsewhere. Meanwhile, reduced intra-continental travel may also be helping to slow the spread. Nonetheless, African economies are not immune to global conditions. Recent IMF forecasts suggest sub-Saharan Africa GDP will contract by 1.5% this year, marking its first annual contraction since 1992. (Fathom Research)

COVID-19 cases seem to be falling for reasons other than lockdown

There is a growing sense that the number of new coronavirus cases is falling for reasons other than lockdowns. After all, several countries that have eased lockdown in recent weeks have seen the number of new infections continue to decline. Germany and Italy, and to a lesser extent the UK and US, are cases in point.

The reasons for this decline are uncertain, although highly relevant for the economic outlook. We have identified three possibilities, each with different implications for the outlook: 1) that we may be on the way to achieving herd immunity (good for economic outlook); 2) due to behavioural changes (not good for economic outlook if due to changes that reduce economic activity — like not going to bars, restaurants, etc); 3) infection rates are seasonal (bad for the economic outlook since it raises possibility of second wave in winter).

In the early stages of the pandemic, it was estimated that around 60% of the population would need to develop antibodies against the virus for the population to develop herd immunity; these studies assumed that the basic reproduction rate (or R0) of the virus was about 2.5, and that this figure applied to more or less everyone (i.e. someone who had coronavirus would infect between two and three others when everybody in the community is susceptible to the disease).

A series of studies have shown that a far smaller share of the population has developed antibodies to the disease, even in hotspots such as the UK and Spain (studies earlier this month suggested that about 5% of the population in each country had developed antibodies, although it was higher in some areas such as London, at 17%). Despite this, the effective reproduction rate is falling in some of these places, and significantly, it seems to be staying below one even as lockdowns ease.

It is possible that the initial estimates of herd immunity thresholds and R0 were wrong. It is also possible that since different cohorts of the community have different propensities to catch the virus and spread it (due to physiological, lifestyle, behaviour or other reasons), those who were more likely to catch the disease and spread it have already done so, and that the effective transmission rate of the rest of the population is therefore now a lot lower. If herd immunity has been reached, people could go about their business (including economic activities such as travelling, visiting bars, restaurants, etc) and infection rates would continue to decline. This outcome would be good for the economy.

Another possibility is that infection rates have fallen due to behavioural changes. If true, a key question is what type of behavioural changes have been effective at reducing infection rates and whether there is an economic cost in maintaining them. It would be a good outcome if relatively small changes like washing hands had a big impact. It would not be so good if it is due to changes in behaviour that reduce economic activity, such as not attending sporting events, travelling or going to restaurants.

That an easing in lockdown measures has not been accompanied by a new spike in cases has raised hopes that restricting economic activity may not be necessary to reduce infection rates, and indeed this seems to have underpinned the rally in cyclical equities this week. It also should be noted that while this development is positive, economic activity has not returned to normal in many places that have eased lockdown so it seems premature to conclude with any great certainty that economic activity can go back to normal without case numbers rising again. For example, Citymapper’s mobility index suggests that life, and economic activity, has not returned to normal, even in places like Stockholm which never went into lockdown. (And as demonstrated in previous Recovery Watch notes, data on the movement of people is better at explaining the variation in economic output than official government stringency measures.)

A final factor to throw into the mix is the extent to which weather and changing seasons affect transmission. Some studies have suggested that exposure to warmer weather (in particular sunlight and vitamin D) might have a small effect in reducing infection rates, while others found no evidence of this. An initial estimate by Fathom did not find a significant difference between the northern and southern hemisphere when trying to model the decline in infections.

Nevertheless, the widely commented on recent decline in new cases has, by and large, occurred in countries in the northern hemisphere. Meanwhile, cases are on the rise in many countries in the southern hemisphere, where it is now winter, even though some of these are countries that have implemented some of the strictest lockdown measures globally (South Africa and Argentina) or where lockdown measures are have become stricter over the last month (Brazil and Indonesia).

Admittedly, the situation is under control in both Australia and New Zealand, but it is possible that this was due to swift and effective measures taken which eliminated the problem before the change in weather. It is also true that the number of new cases is still increasing in some large economies in the northern hemisphere (such as India and Mexico), but new cases have been trending down in most large northern economies, including hotspots such as Russia and Turkey. (…)

The bottom line is that weather could be playing a part in transmission rates, both in the north and south. If warmer weather has been driving the decline in transmission in the north, the economic implications are potentially large, and negative, since this raises the prospect of further lockdowns the autumn. Many businesses and sectors are struggling to get through the current lockdown, never mind having to deal with a second wave and further lockdowns. This is a risk to the global economic outlook.

Finally, asset markets seem to have priced in a relatively low weight of such a scenario unfolding. Of course, countries in the north will have time to prepare for a second outbreak before the autumn, but there is no guarantee that track-and-trace measures will be effective at curbing the spread of the virus or allowing the population to avoid economically costly social distancing measures. It is true that well prepared countries such as South Korea, Japan and Taiwan avoided large outbreaks of the disease during in initial stages of the outbreak, but they all recorded contraction in their economies in Q1. The chances of a V-shaped recovery have now risen (we now estimate them to be 55%), but a range of other letter-shaped scenarios (notably U, L or W) remains high. Investors would do well not to ignore the risks.

THE PMIs

USA: Business activity slumps further amid COVID-19 pandemic, but speed of downturn eases

The seasonally adjusted final IHS Markit US Services Business Activity Index registered 37.5 in May, up from April’s record low of 26.7 and slightly higher than the ‘flash’ figure of 36.9. The rate of reduction in activity softened notably amid some reports of businesses returning to work, but was nonetheless the second-sharpest since data collection began in October 2009. The decrease in service sector output was widely linked to emergency public health measures introduced to stem the spread. Stay-at-home measures and social distancing presented challenges to business reopening, especially those who focus on customer-facing services.

The overall decline in output was also reportedly linked to weak client demand. A number of firms stated that new order inflows remained sluggish as some clients were yet to reopen following temporary shutdowns. With the exception of April’s recent low, the latest data indicated the steepest reduction in new orders since the series began. Some firms suggested domestic demand was slowly picking up following a loosening of restrictions, however, new business from abroad also decreased at a historically substantial pace. Alongside ongoing global lockdown conditions, firms suggested that travel restrictions had limited foreign demand.

Expectations towards the outlook for output over the coming year remained negative in May, as uncertainty regarding the length of any recovery and when this would begin reportedly weighed on sentiment. That said, the degree of pessimism moderated as states loosened lockdown measures.

As firms sought to bolster new orders amid challenging demand conditions, they lowered their selling prices for the third month running in May. Downward pressure on prices charged was aided by another monthly decline in cost burdens. The reduction in input prices was reportedly linked to weaker demand for materials. Lower wage costs and oil prices were also highlighted.

Reflecting weak demand conditions, service sector firms reduced their staffing numbers at a significant rate in May. The rate of job shedding was faster than any other seen before April, as lower new business inflows led to greater excess capacity.

Another monthly slump in total sales also drove a further depletion in outstanding business. The fall was steep as firms worked through previously held orders.

The IHS Markit Composite PMI Output Index* posted 37.0 in May, up from April’s record-breaking low of 27.0. Although the pace of decline eased, it remained significant and the second-fastest since data collection began in October 2009. (…)

Chris Williamson, Chief Business Economist at IHS Markit:

The PMI numbers indicate that the US economy remained in a steep downturn in May. Encouragingly, the rate of contraction has eased considerably since the height of the lockdown in April as some firms get back to work and economic activity starts to resume. (…) A substantial part of the service sector nevertheless continued to be devastated by social distancing measures, and looks set to remain so for some months to come, limiting scope for a v-shaped recovery. The ongoing steep fall in employment remains a particular concern, pointing to a weakened consumer sector but also underscoring heightened risk aversion as companies seek to cut costs in the face of collapsing sales and an uncertain outlook.

Eurozone PMI rises in May but still signals severe contraction

Posting 31.9, higher than the flash reading of 30.5 and up on April’s 13.6, the PMI posted its best level in three months. Nonetheless, by remaining well below the 50.0 no-change mark, the index was again consistent with sharply falling activity across the region as restrictions related to the coronavirus disease 2019 (COVID-19) pandemic continued to have a severe impact on economic performance.

Both manufacturers and service providers endured further noticeable contractions in output although, in line with the headline composite figure, at much slower rates than April’s survey records. (…)

Albeit falling at a slower rate, levels of incoming new business continued to fall markedly during the latest survey period as lockdown restrictions designed to prevent the spread of COVID-19, whilst generally looser than in April, continued to severely hamper demand.

There remained evidence of excess capacity across the region during May, with backlogs of work falling sharply and for the fifteenth successive month.

A lack of new work meant companies were able to comfortably deal with current workloads and led in several cases to firms reducing their employment levels. Whilst there remained evidence of companies continuing to take advantage of furlough schemes, the net fall in employment remained severe and amongst the greatest in the survey history. Spanish survey providers continued to signal by far the sharpest fall in employment during May. (…)

Finally, latest prices data showed ongoing reductions in both operating costs and charges. Reduced employment expenses alongside lower prices for oil-related items led to a third successive monthly drop in input costs. The challenging business environment meant that service providers again reduced their own output charges markedly during May.

The IHS Markit Eurozone PMI® Services Business Activity Index rose markedly from April’s record low of 12.0 to record a three-month high of 30.5. Despite the improvement, however, the index remained well below the 50.0 no-change mark and indicative of another considerable reduction in service sector activity.

A similar trend in volumes of incoming new business was also indicated, with the rate of decline easing markedly but nonetheless remaining severe as ongoing restrictions related to the COVID-19 pandemic continued to restrict economic activity.

As the level of incoming new work fell again, outstanding business contracted for the third successive month and at a considerable pace. Firms reacted by making another severe cut to their staffing levels, led by companies in Spain.

Cuts to employment, and the ongoing use of furlough schemes, ensured that companies recorded a third successive monthly reduction in operating expenses. Lower fuel and energy prices were also reported. Faced with a challenging business environment, companies continued to cut their own charges at a marked pace.

Finally, confidence about the future remained inside negative territory during the latest survey period, although the degree of pessimism moderated further since March’s survey record. Notably, Italian service providers returned to optimism. Companies in Germany were the most pessimistic. (…)

Our forecasters expect GDP to slump by almost 9% in 2020 and for a recovery to pre-pandemic levels of output to take several years.

China: Services companies see steep increase in activity amid easing of COVID-19 measures

Latest PMI data signalled the first increase in Chinese services activity for four months in May amid an easing of measures related to the coronavirus disease 2019 (COVID-19) outbreak. Notably, both business activity and new orders expanded at the quickest rates since late 2010. However, the pandemic continued to have a detrimental impact on new export work, which fell sharply.

Backlogs of work fell for the third month in a row, in part driven by the resumption of normal business operations at many firms. Efforts to improve efficiency led to a further fall in staff numbers. Confidence regarding the year ahead remained strong overall, despite weakening since April.

At 55.0 in May, the seasonally adjusted headline Business Activity Index rose from 44.4 in April to signal the first increase in services activity since January. Furthermore, the rate of expansion was the steepest recorded since October 2010. Companies mentioned that an easing of restrictions related to the COVID-19 outbreak had driven the renewed expansion of activity.

The resumption of business operations and an improvement in client demand reportedly led to the first upturn in total new orders since January. The rate of expansion was the sharpest since September 2010 and faster than the historical average. Data indicated that the increase was largely supported by firmer domestic demand, as new export business continued to fall markedly in May. Firms frequently mentioned that external demand was weak amid the ongoing pandemic and subsequent public health measures that were maintained across many key markets.

Despite the improved sales trend, firms reported a further fall in outstanding business in May, albeit marginal. Signs of spare capacity and efforts to raise efficiency led companies to reduce their staffing levels again, though the rate of job shedding was the slowest for four months.

Average input prices were broadly unchanged for the second month running in May. While some firms reported that the resumption of more normal business operations had raised costs, others mentioned increased efforts to reduce expenses. Meanwhile, prices charged by services companies continued to fall amid efforts to stimulate sales.

Business confidence across China’s service sector remained strong in May, despite softening since the previous month. A number of monitored companies anticipate global economic conditions to strengthen once the pandemic situation improves.

At 54.5 in May, the Composite Output Index rose from 47.6 in April to signal the first expansion in total Chinese business activity since January. Furthermore, the rate of growth was the quickest since January 2011 and solid. The upturn was driven by steep increases in both manufacturing and services activity amid the relaxation of COVID-19 measures.

Overall new work also rose for the first time in four months. The solid rise was due to a sharp increase in sales at services companies, as new orders declined slightly across the manufacturing sector. Employment trends remained subdued, however, as both sectors reported slight falls in staffing levels amid signs of spare capacity. Notably, backlogs of work fell for the first time in a year.

Average input costs fell slightly for the second month running, while efforts to attract new orders led to a further drop in output charges. (…)

Remember, PMIs are diffusion indices measuring the number of positives vs negatives. They do not provide a measure of the actual activity level. Hence:

In general, the improvement in supply and demand was still not able to fully offset the fallout from the pandemic, and more time is needed for the economy to get back to normal. The composite employment gauge stayed in negative territory as companies were cautious about increasing headcounts. (…)

“Weak demand is indeed the biggest problem.”

• China Nudges Banks to Help Small Businesses Central bank is allocating $56.1 billion to buy slices of unsecured loans made by regional lenders to small and micro enterprises.

(…) Beneficiaries must promise not to lay off workers, much as the Fed encourages borrowers to retain employees.

The People’s Bank of China will buy 40% stakes in loans with maturities of at least six months, made between March and year-end. Qualifying banks must lower lending rates for small businesses and buy back the loans after a year. The central bank won’t bear the losses if loans turn sour. (…)

Japan: Services activity declines at substantial rate once again in May

The seasonally adjusted Japan Services Business Activity
Index recorded 26.5 in May, still substantially below the 50.0
mark which separates contraction and growth, and therefore
indicated a further decline in service sector output.

According to anecdotal evidence, store closures, cancelled
events and weak sales contributed to the latest drop in activity.
Over half of the survey panel registered lower output when
compared to April, while just 6% of firms recorded growth.

New export orders also fell drastically, although the rate of reduction was the weakest in three months.

Latest survey data pointed to the fastest decline in staffing levels since February 2010. (… ) Some companies also anticipate that demand levels will be substantially weaker for the foreseeable future. However, the degree of pessimism was the weakest since February as some firms predict a resumption of business activity. (…)

The au Jibun Bank Japan Composite Output Index recorded
27.8 in May, substantially below the neutral 50.0 mark and thus
indicative of a severe decline in combined output across both
the manufacturing and service sector. (…)

Looking at May’s survey data in isolation, the reading of the Composite PMI is indicative of GDP falling by around 10% on an annual basis. Taking into consideration the April reading, which was even worse, it is clear that the impact on second quarter GDP is going to be enormous.

IMF chief warns full global economic recovery unlikely in 2021

The global economy will take much longer to recover fully from the shock caused by the new coronavirus than initially expected, the head of the International Monetary Fund said, and she stressed the danger of protectionism.

Managing Director Kristalina Georgieva said the Fund was likely to revise downward its forecast for a 3% contraction in GDP in 2020, but gave no details. That would likely also trigger changes in the Fund’s forecast of a partial recovery of 5.8% in 2021. (…)

U.S. Light Vehicle Sales Recover in May

The Autodata Corporation reported that sales of light vehicles strengthened 41.5% last month (-30.3% y/y) to 12.17 million units (SAAR) from 8.60 million in April.

So far in Q2’20, sales have averaged 10.4 million, down 31.6% from an average 15.2 million in Q1. The 10.2% sales decline from 16.88 million in Q4’19 subtracted 0.82 percentage points from growth in real GDP.

Imports’ share of the U.S. vehicle market rose last month to 25.8%. Imports’ share of the passenger car market jumped to 32.1%. Imports share of the light truck market improved to 24.1% and remained up from the 12.0% low in January 2015.

• The Atlanta Fed’s GDPNow tracker estimates that real GDP growth in the second quarter will decline by -52.8%.

Fed Promised to Buy Bonds but Is Finding Few Takers The central bank thawed credit markets in March by promising a whatever-it-takes program to buy corporate bonds. Ten weeks later, the Fed has yet to buy a single bond.

Just the announcement of the backstop ended panic selling, boosted prices and fueled a record surge of new corporate-bond sales. Companies are now reluctant to sign up for Fed purchases because such a move could be seen as a sign of weakness during a market rebound, some bond fund managers and bank executives said. (…)

The Fed has yet to officially launch the initiative, which enables it to buy limited amounts of new and pre-existing bonds of companies, in part because it is hashing out the technical details. Only companies that certify they are U.S.-based and haven’t received other aid under the Cares Act—a $2 trillion financial-relief package that includes loans and grants to businesses—can participate in the program, which would disclose their names, the amount of their bonds that the Fed would purchase and the prices paid. (…)

Stung by Past Mistakes, Eurozone Takes a Page From U.S. to Fight Crisis Worried about the depth of its economic downturn, Europe is lining up two new packages potentially worth hundreds of billions of euros that boost prospects for a global recovery.

(…) On Thursday, the ECB is expected to unveil some €500 billion in additional bond purchases, taking its new firepower to almost €1.5 trillion, or $1.68 trillion, putting it on a par with the U.S.’s spending plan. That increase means that the ECB could soak up most of the additional debt the region’s governments are expected to issue this year.

In turn, the EU last week unveiled proposals for a €750 billion spending package whose size and political import could represent a turning point in both the bloc’s economic response to recession and its future ability to act together to fight crises. This week, Germany’s government will unveil a roughly €100 billion fiscal stimulus program; other governments may follow suit.

In total, Eurozone governments have unveiled fresh spending and loan guarantees that provide stimulus of around €1.5 trillion, or 13% of the region’s GDP, says Erik Nielsen, chief economist at UniCredit Bank in London. (…)

Both the ECB and Fed are expected to amass assets worth around 60% of their respective GDPs by the end of next year, compared with around 40% and 20% respectively before the crisis. (…)

The ECB and Fed have both learned that they can purchase significant amounts of government debt without pushing up expectations of future inflation, said Michael Metcalfe, head of macro strategy at State Street Global Markets. Fear of inflation was an important brake on the ECB during the last crisis. (…)

The Fed has signaled that it won’t cut interest rates below zero, a step that the ECB took five years ago and hasn’t reversed. Europe’s experiment with negative rates is putting pressure on the region’s weak banks, which are crucial for funneling its stimulus to businesses.

The question remains, however, of whether the extraordinary efforts will be enough.

Mr. Nielsen estimates that the eurozone economy will be 4% smaller at the end of next year than it was before the pandemic. To catch up on lost growth, the region’s economy will need to expand by 3% annually for at least five years, double its precrisis trend rate.

That will be an uphill battle, requiring at least another 5-10 years of aggressive government spending and very easy money policies from the ECB, Mr. Nielsen said.

• Oil Erases Gains With OPEC+ Meeting in Doubt Over Quota-Cheating
• Saudi Arabia poised to reverse extra production cuts as Opec+ meets Kingdom could supply extra 1m barrels per day from July, sources say
• Saudi Arabia and Russia reach deal on oil cuts, increasing pressure on other producers

OPEC leader Saudi Arabia and non-OPEC Russia have preliminary agreed to extend existing record oil production cuts by one month, while raising pressure on countries with poor compliance to deepen cuts to their output, sources told Reuters.

“Any agreement on extending the cuts is conditional on countries who have not fully complied in May deepening their cuts in upcoming months to offset their overproduction,” one OPEC source said.

Japan Warns Its Banks About Risky U.S. Debt Japanese regulators have warned the nation’s banks for the first time about the risk of investing in overseas securitized corporate loans, which have run into trouble from a wave of U.S. bankruptcies.

The Nearly Nihilistic Market Rally It may seem like the market cares about none of the tumultuous events in the world. Right now, it cares about one thing, to the exclusion of almost everything else, namely, the fact that government rescue measures seem to be working, at least to the extent of avoiding worst case scenarios.

(…) Analysts note that a year’s earnings doesn’t matter much to a company’s valuation under a discounted cash flow model. As long as earnings bounce back next year—or even the year after—a likely lower-for-longer interest rate is enough to justify gravity-defying stock markets. (…)

How much the next round of spending will pare back generous jobless benefits which end in July, and how spending will be used to encourage a return to something more closely resembling normalcy, has yet to be seen.

What happens with stimulus policies and incomes isn’t the only thing that matters, of course. But as long as the spread of the coronavirus is seen as under control in advanced economies, and a vaccine is expected to arrive eventually, it will be quite close to the only thing that matters for markets.

• As past crises have taught us, an initial stock market rally is no guarantee that we are out of the woods. The effectiveness of monetary and fiscal stimulus will only become clearer in the coming months. New stock market shocks, stemming from the pandemic or geopolitical tensions, could cause a return to volatility and new declines. (Conference Board)

Mike Larson, senior analyst at Weiss Ratings in MarketWatch:

“It’s the biggest disconnect I can remember in the almost-quarter century I’ve been active in the markets,” he said. “I can’t recall a time when we’ve seen a large disconnect between, not just what’s going on in Main Street versus what’s going on in Wall Street, but what’s going on in the underlying fundamentals that would normally impact Wall Street.” (…)

“The instant the Fed began discussing buying and backstopping high-yield bonds, fallen angels and so on, through a couple of different means, we’ve seen enormous inflows into ETFs. We’ve seen enormous interest in buying the riskiest possible credits out there,” he said. (…)

“I understand completely when you’re discounting future cash flows back to the present, lower rates help, and that contributes to the there-is-no-alternative trade, so I get the other side of the trade, and it’s hard to lean too hard against it in the short term,” he said.

“But when you look at whether, ultimately, the credit quality and the underlying fundamentals are going to support the asset values, you have to use some extraordinarily generous economic assumptions, and assumptions about the vigor of this rebound, to get from point A to point B. I think that’s the real danger here — I think that there’s a lot of complacency on what liquidity can accomplish when it comes to fixing solvency-related and asset valuation-related excesses.” (…)

CBO Says Economy Could Take Nearly 10 Years to Catch Up After Coronavirus

In an analysis that highlights both the depth and duration of the pandemic’s economic impact, the CBO said it has marked down its 2020-30 forecast for U.S. economic output by a cumulative $15.7 trillion, or 5.3%, relative to its January projections. Adjusted for inflation, the shortfall is estimated at $7.9 trillion, or 3% of cumulative gross domestic product.

Most of the gap results from the sharp contraction in economic activity this year, which was unforeseen when the CBO last published its 10-year outlook in January. The nonpartisan agency said last month it expects U.S. GDP to finish the year 5.6% lower than in the fourth quarter of 2019.

• China hits back at UK criticism of Hong Kong security law Foreign ministry warns Britain to ‘step back from the brink’ and stop interfering
• BCE, Telus pick European suppliers for 5G network gear, leaving Huawei role unclear

Canada, which has been conducting a lengthy review of 5G cybersecurity, has yet to announce whether the Shenzhen company will be barred from supplying equipment for the coming generation of wireless technology, which promises much faster download speeds.

BCE Inc.’s Bell Canada announced Tuesday it has struck a deal to purchase gear from Swedish supplier Ericsson and said it won’t be using Huawei equipment unless Ottawa permits it. Telus Corp., which said in February that it would launch its 5G service with Huawei gear, announced partnerships with Ericsson and Finland-based Nokia Corp. on Tuesday but did not back away from the Chinese company.

Canada’s review of whether the Chinese telecommunications equipment giant should be excluded from 5G is entering its 21st month. (…)