Economic and Market Update August 2020
KEY POINTS
The progression of COVID-19 and the prospects for a vaccine remain the key drivers of economic activity globally.
The initial stages of economic recovery in the United States, Europe and the Asia-Pacific are proceeding slightly faster than we anticipated. However, localized lockdowns associated with a second wave of infections have the potential to slow the recovery in the second half of the year at the same time that pent-up demand fades.
China is ahead of most of the world in the timetable of its recovery, having been affected by the virus and containment efforts first. Chinese GDP grew by a greater-than-expected 11.5% in the second quarter compared with the first quarter, having contracted by −10% in the first quarter.
Global trade recorded one of the steepest drops ever recorded in the May-June period. Vanguard believes this represents an inflection point and the numbers have since bounced off lows, with our index of leading indicators increasing for a third consecutive month.
ECONOMIC GROWTH
Second-quarter GDP numbers came in largely as expected, with the global economy having experienced its sharpest contraction since the Great Depression. Now the world turns its attention to the third quarter and the pace of recovery. Recent data releases suggest that the initial stages of recovery in the United States, Europe and the Asia-Pacific are proceeding at a slightly faster pace than we had anticipated. However, as signs emerge of second waves of COVID-19 infection, we expect the pace of recovery to slow later in the year as localized lockdowns dampen activity and pent-up demand fades.
AUSTRALIA
Vanguard forecasts a −4% contraction in full-year GDP factoring in a renewed COVID-19 case surge and lockdown in Victoria—which accounts for about a quarter of GDP in Australia. Vanguard's baseline scenario also incorporates the possibility of regional lockdowns. As such, we continue to see modest growth in the third and fourth quarter. Meanwhile, an extension of the JobKeeper worker-retention program through March 2021 is a positive development.
CHINA
China is ahead of most of the world in the timetable of its recovery, having been affected by the virus and containment efforts first. Its GDP grew by a greater-than expected 11.5% in the second quarter compared with the first quarter, having contracted by −10% in the first quarter. Compared with a year earlier, China's GDP grew by 3.2%, having contracted by −6.8% in the first quarter. Preliminary reports suggest that the recovery moderated somewhat in July, as Yangtze River floods interrupted infrastructure construction and regional virus containment efforts weighed on consumption. The moderating trend in July is consistent with our view that sequential momentum will slow in the second half as catch-up production fades, medical and work-from-home exports peak, and domestic financial conditions tighten as the People's Bank of China prioritizes financial stability amid rising asset prices. Vanguard continues to foresee full-year growth for China in a 1% to 3% range.
UNITED STATES
GDP in the United States declined at a pace of −32.9% on an annualized basis in the second quarter, near the more optimistic end of our −30% to −40% estimate. Vanguard expects a more gradual recovery than consensus estimates amid continued virus transmission and consumer reluctance to engage in face-to-face activity. We continue to foresee 2020 U.S. economic contraction in a range of −7% to −9%, an outlook that assumes that regional virus outbreaks and associated restrictions on economic activity will occur, but that nationwide lockdown won't be required. We believe the strength of recovery depends upon the implementation of additional fiscal support and advocate that it be targeted at struggling businesses and households to minimize permanent effects to the economy, or "scarring."
JAPAN
GDP contracted by −7.8% in Japan on a seasonally adjusted basis in the second quarter compared with the first quarter, its third consecutive quarterly decline since the economy first felt the effects of the consumption tax hike in the fourth quarter of 2019. Vanguard foresees a moderate economic rebound in the third and fourth quarters of 2020 as demand abroad for Japanese manufactured goods improves. But sentiment remains sluggish as COVID cases have spiked to their highest levels since the start of the pandemic, which could adversely affect spending on services. We continue to foresee Japan's full-year GDP contracting in a range around −3% to −5%.
UNITED KINGDOM
The economy in the United Kingdom contracted by −20.4% in the second quarter compared with the first quarter. The effects have been most pronounced in those industries that are most exposed to public health restrictions and the effects of social distancing." Vanguard expects a slower recovery for the United Kingdom than we do for the euro area given the greater weight of face-to-face activities in the UK economy and a forecast reluctance for consumers to engage in highly social activities amid a recent uptick in new virus cases.
EMERGING MARKETS
The International Monetary Fund lowered its forecast for growth in emerging markets for both 2020 and 2021 on June 24, owing to a rapid intensification of COVID-19 in many emerging and developing nations. The IMF foresees emerging markets contracting by −3.0% before rebounding to growth of 5.9% in 2021.
MONETARY POLICY
Given our expectation for a slow recovery in demand amid pandemic containment efforts, Vanguard continues to expect monetary policy to remain loose throughout 2020 and well into 2021, with risks skewed toward further easing.
The U.S. Federal Reserve left the target range for its federal funds rate at 0%–0.25% on July 29 and said it would keep it there until it was "confident that the economy has weathered recent events." The Fed emphasized that the course of the economy depends on the progression of COVID-19, a view that Vanguard has held since the pandemic began.
The European Central Bank left its monetary policy unchanged at its July 16 meeting, keeping the interest rate on its deposit facility at –0.50%, continuing monthly asset purchases of €20 billion as long as needed to reinforce its accommodative stance, and maintaining the size of the Pandemic Emergency Purchase Program at €1.35 trillion through June 2021.
The Bank of England maintained its bank rate at 0.1% at its August Monetary Policy Committee (MPC) meeting and reiterated that the £300 billion of extra asset purchases announced since March would continue until the "turn of the year."
The Bank of Japan left its key short-term rate target at –0.1% at its meeting July 15. Vanguard believes that the BOJ will not cut rates in 2020 but instead continue with measures aimed at improving corporate financing and yen liquidity.
The Reserve Bank of Australia (RBA) maintained its cash rate and three-year government bond target at 0.25% on August 4, saying it would purchase Australian Government Securities in the secondary market as necessary to ensure three-year yields remained consistent with the target.
BREXIT
The European Union has marked its calendar. October 15 is the day it considers it will need to have approved a trade agreement with the United Kingdom in order for the European Parliament to have sufficient time to ratify the deal and for it to take effect by January 1, 2021. For the current negotiation and ratification time frame to be feasible, a trade deal would realistically need to be reached by the end of September to allow a formal treaty to be prepared.
TRADE
Data from national sources confirms one of the steepest drops in global trade ever recorded occurred in the May-June period, amid COVID-19 lockdowns. China, buoyed by exports of virus-related products such as pharmaceuticals, personal protective equipment, and home-office supplies, was a notable exception. Vanguard believes that trade reached an inflection point at midyear and has bounced off lows, with our index of leading indicators increasing for a third consecutive month.
INFLATION
Consumer prices in Australia fell 1.9% in the June 2020 quarter compared with the March 2020 quarter, and by 0.3% compared with a year earlier—the first such contraction since 1997. The data reflects reduced demand during the pandemic, with automotive fuel, child care, and preschool and primary education leading the decline. Vanguard expects the slow pace of demand recovery and rising rental vacancy rates to continue to exert downward pressure on prices.
EMPLOYMENT
The United States continued to add jobs in July, albeit at a slower pace than in the two preceding months, and the unemployment rate fell to 10.2%. Overall, we expect a gradual recovery in the number of employed people and a reduction in the unemployment rate by year's end to a range of 8% to 10%.
Unemployment in the euro area rose to 7.8% in June from a revised 7.7% in May. Vanguard believes that furlough and other job support schemes have successfully contained unemployment so far, but we're concerned about the roll-off of these programs, especially in Italy and Spain.
The furlough program in the United Kingdom has similarly limited the unemployment rate, but we expect the rate to rise above 7% in the fourth quarter as the scheme unwinds. We foresee a peak U.K. unemployment rate of over 8% in the first half of 2021.
The unemployment rate in Japan decreased to 2.8% in June from 2.9% in May, while the unemployment rate in Australia rose to 7.5% in July from 7.4% in June as labour force participation rates rose. We expect Australia's unemployment rate to rise further in the coming months, reflecting Stage 4 lockdown restrictions in metropolitan Melbourne.
ASSET CLASS RETURN OUTLOOKS
Vanguard has updated its 10-year annualized outlook for broad asset class returns through the most recent running of the Vanguard Capital Markets Model® (VCMM), based on data as of June 30, 2020. Our 10-year annualised nominal return projections for Australian dollar investors are as follows:
Source: https://www.vanguard.com.au/adviser/en/article/markets-economy/economic-and-market-update-aug2020