17.06.2020 11:40

Market Outlook: Fed corporate bond-buying plans may offset virus-related worries

Stock markets fell last week, due to investor worries about a second wave of coronavirus outbreaks, a US Federal Reserve policy meeting that caused disappointment and downward revisions in economic forecasts. We view this as a correction during an upward trend rather than as the beginning of a lengthy decline.

Worries about a second wave of COVID-19

Parts of Beijing were locked down after new coronavirus outbreaks were traced to Xinfadi, a major wholesale market for seafood, vegetables and fruit. American statistics showed rising infection rates in some western and southern states − with increased hospitalisations in Texas, for example. These developments helped trigger worries among investors about a second wave of the virus.

Meanwhile more and more European countries are reopening their borders to travellers from elsewhere on the continent. This week they included France, Switzerland and Germany, with Spain reopening this coming Sunday.

Global GDP forecasts are downgraded

Another factor contributing to recent stock market gloom was the latest set of gross domestic product (GDP) forecasts from the Organisation for Economic Cooperation and Development. The OECD’s more optimistic scenario is that global GDP will fall by 6% this year, bouncing back to 4.1% growth in 2021. The OECD’s more pessimistic scenario assumes that a second wave of COVID-19 will occur. If so, the organisation foresees a global GDP decline of 7.6%, with unemployment in the 37 mainly affluent OECD member countries rising to 10% this year.

Read the June 2020 OECD Economic Outlook

Federal Reserve actions driving both stock market ups and downs

In the United States, last week’s Federal Reserve meeting pointed to a continued zero key interest rate policy until 2022. The Fed’s new economic forecasts showed continued high unemployment and a 6.5% decline in American GDP in 2020. The meeting generally disappointed stock markets; in the US, the broad S&P 500 index lost nearly 6% the following day.

But this week’s announcement that the Fed is now finally activating its planned corporate bond purchases reversed the stock market mood again. When the programme was first unveiled in March, it was a decisive factor in restoring investors’ risk appetite.

The Fed is also making it possible for small and medium-sized businesses to apply for loans on favourable terms under its Main Street Lending Program, which will provide a total of USD 600 billion via banks.

SEB's new Currency Strategy report: Stronger Swedish krona

Many traditional exchange rate drivers – such as interest rate and economic growth rate gaps between countries – have diminished in importance and have instead been replaced by the global growth outlook, risk appetite and political uncertainty. In SEB’s latest Currency Strategy report, our main scenario is that risk appetite will remain good. This should benefit small currencies like the Swedish krona, which we expect to appreciate this year and in 2021. The US dollar previously had the advantage of higher interest rates than other countries. Meanwhile risk appetite is improving. Looking ahead, this implies that the USD may depreciate further. But if risk appetite worsens, we expect the opposite trend.

Read more in the June 2020 issue of Currency Strategy

 

Our market view

Worries about new virus outbreaks in the US, lowered growth forecasts and downbeat messages from the Federal Reserve (Fed) helped trigger a clear correction in stock markets last week. However, some bright spots in macroeconomic statistics, discussions on how virus outbreaks need not lead to major new lockdowns and an announcement that the Fed is now actually starting to buy corporate bonds were enough to make the mood among investors bounce back, in any case as of this writing.

Investors are apparently expecting a V-shaped recovery after the economic downturn and are assuming that current positive signals will turn into a more lasting trend. Together with continued extremely low interest rates and bond yields, this may justify today's historically rather high share price valuations and thus the recent upturns. But the scale of the rebound is a source of concern.

Because of the economic slowdown, corporate earnings forecasts for 2020 are being revised sharply lower. From expectations of earnings increases of at least 10% globally a couple of months ago, forecasts are now pointing to declines of around 25%. Most observers, including us, expect earnings to regain lost ground during 2021, probably also setting the stage for earnings to continue increasing after next year. If the reopening trend and stimulus measures continue to dominate the growth picture, earnings are likely to increase substantially in the future – which is probably necessary in order to justify further stock market upturns based on fundamental arguments.

The prospect of continued stimulus – both Fed bond purchases and the ongoing discussions in the US Congress on new fiscal packages – will help to sustain risk appetite. Assuming that virus-related setbacks are manageable, macro statistics also suggest that the economic downturn may prove shallower than feared and the recovery may be faster than many people expect. In a climate of continued focus on positive news, today’s historically high share price valuations should not be an obstacle to new upturns, but they will probably limit upside potential. We have a cautiously optimistic view of risk assets such as equities and high yield corporate bonds, and we are maintaining our hypothesis that stock market downturns can be regarded as buying opportunities.  

Please contact your private banker if you have any questions or concerns.