Mike Pyle, Global Chief Investment Strategist at the BlackRock Investment Institute, together with Elsa Bartsch, Head of Macro Research, and Scott Thiel, Chief Fixed Income Strategist also both part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
Europe’s policy response to the virus shock was slow to get going – but an impressive array of fiscal and monetary measures is getting into place to bridge the economy through the shock. The euro area has also had relative success in tamping virus growth, positioning it well for reopening its economy. We see the two factors as supporting the region’s economy and markets in coming months.
Lockdowns in Europe started relatively early and caused mobility to plummet. Google data – which use mobile phone location data to measure the change in visits to stores and workplaces as well as use of public transit – show average mobility levels across Germany, France and Italy plunging more than 70% below pre-virus levels. See the yellow line in the chart. The sharp drop was a huge drag for activity in the short term, but helped curb the virus spread more effectively. Mobility has rebounded quickly and is now on par with the level in the U.S. This bodes well for a pickup in activity, especially as it comes with a lower risk of infection resurgence, in our view. As a result, we could see the pace of recovery in the second half outpacing other regions, including the U.S.
After an initially slow start, the euro area’s policy response to the virus shock is picking up pace, with additional spending measures announced recently by Germany and France. Combined with additional monetary support, the size of stimulus is broadly sufficient to match the income shortfall on a euro area level, our analysis shows. The European Central Bank (ECB) has launched new and more flexible quantitative easing: the pandemic emergency purchase program (PEPP). Its targeted longer-term refinancing operations (TLTRO) scheme holds the promise to provide support to the private sector via cheap loans to banks. The ECB has also made clear that it stands ready to do more in monetary policy stimulus if the inflation outlook is still not showing sufficient progress toward price stability in September.
In addition, we see the new 750-billion-euro European recovery plan as a crucial turning point for Europe’s economy and financial markets. The bulk of the proceeds will be distributed as grants – over and above offering cheap financing to ensure the flow of credit to virus-hit economies through new European Stability Mechanism (ESM) credit lines. It will also for the first time create a jointly issued European “safe” asset of a meaningful size. Such pan-European debt would start to rival the total volume of German federal government debt outstanding, after including the almost 300 billion euros of ESM debt outstanding. To be sure, this is not a “Hamiltonian moment” for Europe - harkening back to the U.S. federal government assuming the debts that states incurred in the War of Independence. It’s about newly issued debt, and more work is needed to move the euro area toward a fully-fledged fiscal union.
Policy implementation risks remain. And the risk of a no-deal Brexit looms. Yet the BlackRock geopolitical risk indicator already shows elevated market attention to the European fragmentation risk, suggesting markets may have priced in at least part of that risk.
Bottom line: We are seeing many reasons to be optimistic about the euro area in the second half of 2020, including the ramped-up policy response and effective public health measures. The sum total of the euro area’s policy actions looks impressive – and they come on top of relatively large automatic stabilizers such as generous welfare benefits. As a result we maintain our overweight in European peripheral government bonds and are considering an upgrade to European equities.
Measures to contain the virus are gradually being eased in many developed economies. May’s data suggested the worst of the contraction may be behind us, but we see a bumpy restart in coming months. We are tracking the interplay of containment measures and mobility changes on activity as economies have started to reopen. The unprecedented policy response has boosted markets, leaving a potential resurgence of infections and policy implementation as key risks. U.S. Congress is headed for a fiscal cliff as jobless benefits, state support and payroll protection measures are expiring soon.
A spate of business and consumer sentiment data across the U.S. and Europe could help markets assess signs of a rebound in activity. The pace of the activity restart depends on how successful countries are in suppressing the virus. We see a greater danger of renewed outbreaks in the U.S., UK and Canada than in Germany and Japan, based on our research on the relationship between mobility and virus infection rates.
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