There are increasing signs that the resurgence of COVID-19 cases in Europe will require new restrictions. US stocks hit a record high this week after a 50% rebound from their lows in March. In part this rally in stocks may well be due to real interest rates at record lows in the US. After a correction in early August gold prices are rising again, potentially underpined by low real rates and reflecting continued concerns about risks of fiat currency devaluation.
Over the last week, the pandemic has topped 22 million COVID-19 cases globally and 785,000 deaths. Some of the bigger regional and country drivers in terms of the case count such as the United States, Latin America, and India are now generally showing a slowdown in the spread of the virus. Western Europe however and parts of Asia are facing resurgence in cases, albeit from low levels.
In the US, daily new cases have come down to 51,000, from 53,000 cases a week ago and 63,000 cases 2 weeks ago. At the same time, encouragingly, testing appears to be increasing again after recent disruptions. As a reminder, based on the testing experience in other parts of the world, the share of positive tests needs to decrease to below 5% and remain there for several weeks in order to indicate a true suppression of the virus. In terms of the death toll, with 1,000 COVID-19 deaths daily, the US is sadly tracking the ensemble forecast from the Centers for Disease Control and Prevention, surpassing 175,000 deaths since the start of the pandemic. Further positive news is that fact that the number of people states report to be hospitalised in the US with COVID-19 continues to drop. Currently, more than half of COVID-19 hospitalizations are in the South, while hospitalisations in the Northeast have fallen to 5%.
In Europe, a continued rise in new cases remains in focus. To put things into perspective, on an aggregated basis the bigger Western European countries still report around 10,000 cases daily, five times less compared to the United States. Spain remains the biggest driver of the resurgence in cases in the region, with over new 5,000 daily cases but France, followed by Germany and the UK are also seeing a rise in reported infections.
Once adjusted for the increase in testing, Spain looks like a real worry with the surging share of tests at 7.4% coming back positive. Positivity rates are still relatively low in the rest of the Western Europe but they are edging higher in France (2.2%) and Italy (2.1%).
Looking ahead, given the persistent rise in the new cases, it’s not surprising that there is talk of a slowdown in the pace of lifting of the official mobility restrictions. Downside risks to a recovery in economic activity could will arise if such restrictions are deemed to be necessary. Indeed, a number of countries stepped up distancing measures in recent weeks: facemasks are now compulsory outdoors in Spain, Italy, Belgium and in a rising number of cities in France. Italy is to shut discos and clubs and make it compulsory to wear masks outdoors in some areas.
US core inflation has been extremely erratic since March. This trend continued in the latest data for July which at + 0.6% (on a sequential month-over-month basis) was the strongest reading for core consumer price inflation (CPI) since the January 1991 and one of the biggest ever surprises relative to consensus expectations going into the number.
Headline inflation data is always noisy, bounced around by fluctuations in the prices of food and oil, which is why developed market central bankers spend vastly more time looking at core, rather than headline inflation as a measure of the underlying trend in prices.
However, right now the traditional measure of core inflation, which only excludes food and energy price components, is not proving a good guide to underlying price pressures as it has been heavily distorted by the short-run effects of the pandemic. Better, but still far from perfect metrics are statistical measures of trend such as the median and trimmed mean measures of inflation. Whichever measure one looks at, you see a major shock in the spring, followed by a partial bounce back through summer.
When the virus hit in March, certain types of firms saw demand evaporate overnight, leading to huge falls in the prices they were able to charge. Hotels and airlines were obvious examples of the type of firm most severely affected, but there were many others including clothing stores and car rental firms. Once the economy began to open up again in May/June and firms were able to bring their short-run output closer into line with demand, these intense short-run deflationary faded and firms that cut prices sharply in the spring have begun to return toward normal levels. Those sectors which saw the greatest fall in prices in the spring are now seeing the largest increases: this echo effect is likely to continue for a few more months. This phenomenon is not restricted to the US, similar patterns are probably going to be seen in the inflation data across the other developed economies, the precise magnitude in any given country will depend upon the severity of the pandemic and the policy responses to it.
Federal Reserve (Fed) Chair Powell has repeatedly said that he is ‘not even thinking about, thinking about, raising rates’. This data is not going to change his mind. The Fed was probably surprised by this CPI data, but it’s worth remembering that this still leaves core CPI inflation having averaged 0.5% on an annual basis since March, well below the Fed’s target.
More importantly, the Fed will focus on the medium-term outlook for inflation and how that relates to the labour market and not on the distortions caused by these (extremely large) relative price effects.
The US unemployment rate is currently in double digits, and on the Fed’s forecast declines to 6.5% by late-2021. Persistently elevated unemployment in the mid-single digits should push down on core (PCE) inflation by about 0.25% relative to its pre-COVID trend of around 1.75%, taking it to something in the region of 1.5%, well below the Fed’s inflation target. The objective of avoiding the US getting stuck in the low-inflation trap where the eurozone and Japan have been in for a long time remains very much on the minds of members of the Federal Reserve.
The S&P 500 index struck an all-tiume high yesterday, having now rallied more than 50% from the lows in late March (see Exhibit 1 below). The earnings season has confirmed that US profits have resisted much better than elsewhere, helped by technology companies, whereas in Europe index performances were penalised by the greater weight in more traditional sectors.
In bond markets, the 10-year real US Treasury yield rose last week but remains close to historical lows at almost exactly minus 1% , a level never recorded before this year. If inflation can rise in the future without triggering a policy reaction from the Federal Reserve, then real yields (nominal bond yield minus the breakeven inflation rate) will be lower.
Real yields also have a relationship with gold prices in that negative real yields reduce the opportunity cost of investing in gold, (which pays no yield), making it much more attractive. A brief correction in real yields may explain the brief correction in gold prices that took place in early August .
Gold performed strongly over the past week (3.5%). After falling from the historical highs registered at the start of August, the price of gold has rallied back 3.5% over the past week with international tensions rising and the renewed weakening of the US dollar.
Gold continues to attract interest on account of fears about the potential for monetisation, low real yields, a weak US dollar and ongoing international tensions among the supporting factors.
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