Good and bad came in almost equal measures yesterday. Rising infection rates are expected to be countered by additional stimulus measures. Stock markets stayed firm and resilient with the S&P 500 index gaining 0.74% on the day. Stable equities provided oil with some support and additional help came from the weaker dollar. Its index against a basket of major currencies has fallen to its lowest level since September 2018. Both WTI and Brent recovered from the day’s lows and managed to post marginal gains on the day.
The latest plan to support the US economy has been unveiled overnight. Republicans are proposing to spend an extra $1 trillion to mitigate the impact of the virus – $100 billion is set to go to schools and to issue stimulus payments of up to $1,200 to individuals. The proposed measures would reduce the weekly unemployment benefit of $600 to $200 as Republicans are encouraging those who lost their jobs to get back to the labour market. The proposal sets the stage for a fierce debate with Democrats who advocate their own $3 trillion economic agenda. Negotiations could take weeks creating more uncertainties.
Whether the current optimism will prevail is questionable. There are just simply too many developments being currently ignored, which imply that the upside, both in equites and oil, is limited. One practical consequence of the relentless spread of COVID-19 is new restrictions imposed worldwide, especially in Asia. Hong Kong banned the gathering of three people or more, Vietnam locked down one of its cities, Papua New Guinea closed it borders, China reported the most new locally transmitted cases since March and in Europe Britain ordered holiday makers arriving back from Spain to quarantine for two weeks. It is not just the new coronavirus cases that spike but also the tension between the US and China. The former took over the US consulate in the city of Chengdu after it ordered the building to be vacated as a counter measure to the closure of the Chinese consulate in Houston last week. Diplomatic relationship between the two nations must be very close to its historic low and this does not bode well for the global economy.
No surprise that gold is at its highest level ever as investors are hedging their bets in risky assets. In the oil market the weakening of the Brent structure is noticeable. The September/October spread has dropped 36 cents/bbl in less than two weeks whilst the October contract is now 44 cents/bbl cheaper than November compared to a discount of 15 cents/bbl on July 15. The backwardation on the Brent CFD curve is also narrowing whilst Urals is weakening against the European benchmark. Russia is set to increase seaborn Urals crude oil exports by more than 40% next month, according to Bloomberg. The writing is on the wall for equity and oil bulls.
Second wave of virus is underway
The coronavirus has not been contained or halted. After worldwide lockdowns have been lifted or eased there have been flare ups in new cases. Globally more than 16 million people have been infected, according to the coronavirus resource centre of the John Hopkins University, and the death toll approaches 700,000. The most infected countries, due to the size of their population coupled with the mismanagement of the pandemic, are the US, Brazil, India, and Russia. When human lives are at risk the economy inevitably suffers. In last month’s World Economic Outlook Update the IMF cut this year’s global contraction to -4.9% from -3% in April. A semi-decent recovery is anticipated in 2021 with a worldwide expansion of 5.4%, down from 5.8% predicted in April.
Investors, both oil and equities, probably use the above scenario as their base case hence the relatively stable equity and oil markets. The possibility of a longer-term recession lasting beyond 2020 is not entertained for the time being although it cannot be excluded. Whilst hopefully the war against the pandemic will be won in the foreseeable future it is imperative to keep in mind the worst-case economic scenario should this fight take much longer than currently anticipated.
To be blunt, avoiding the disastrous economic impact of a prolonged second-wave of the virus outbreak, (which is already taking shape indifferent parts of the world) is a must, otherwise next year’s global expansion will be revised further down and the recession can actually last longer than two years pushing some regions into depression. The international lender, in its update, introduced two additional alternative scenarios. The first one is a fast recovery in the second half of this year – this is now bordering with wishful thinking as the number of cases are continuously rising at an alarming rate. The pessimistic one assumes a second outbreak that will last well into 2021. These alternative scenarios are presented in percentage terms as a deviation from the baseline.
The global economy would grow 3.2% faster in case of a quick recovery in 2H of 2020 or 4.6% lower if a second outbreak intensifies or spills over into 2021. The latter case would lead to further downward revisions in global economic growth all the way down to 2024. Oil prices will also be affected. In the optimistic scenario they could be 9% higher than the 2019 average whilst under the second outbreak the deviation from the baseline would be -14%.
Drawing experience from the first wave of the virus governments are reacting differently this time around. It is certain that restrictions will be looser than in March and April, there will be targeted but not nationwide lockdowns. Studies show that one month of complete economic standstill leads to a GDP contraction of 3%, consequently no government will choose to go down that path again. It is plausible that economic considerations will take over health concerns as the second spike is spreading. Nevertheless, job markets will remain stagnant at best and unemployment rates are unlikely to improve hindering economic growth.
The longer-term implications of the re-emergence of the pandemic is equally disheartening. Central banks are running out of monetary tools to provide protracted support as interest rates have been cut close to or even below 0%. This means that fiscal tools (tax cuts, increasing spending) might have to be employed. Public debt will increase, and budget deficit will balloon. Logically, deteriorating fiscal conditions will be countered by raising taxes and cutting spending after the health crisis passes putting a break on economic prosperity.
We presented a case for a tight supply-demand oil balance for next year, especially in the second half of it, based on available data. These forecasts, in turn, are the result of predicted global economic growth in 2021. We still believe that the oil market will be supported next year but it is vital to follow the spread of coronavirus infections. The negative economic impacts of a potential second wave is likely to be felt sometime this year bringing a downside correction of risky assets with it. On the other hand, a global failure to tame the virus next year will lead to downward revisions of economic and oil demand growth and this would severely dent the presently healthy optimism for 2021.