From the Economist’s Chair: Dog Days

Author David Fyfe, Argus Chief Economist

The Covid-19 caseload is rising again and commodity markets have lost some of their earlier optimism, so a steady hand will be required to implement policies that help avoid another phase of blanket lock-down.

The “dog days” of summer represent the time of year when the dog star – Sirius - rises before the sun, traditionally in late-July. Nowadays we equate the phrase with hot weather and indolence, but for the ancient Greeks, ominously, it could also herald “war, fever or catastrophe”. Fever we already have, but the jury is still out on catastrophe and war.

Most base-case forecasts still predict a gradual world economic recovery through the rest of 2020 and into 2021, as global lockdowns to combat the first phase of the Covid-19 pandemic are progressively unwound, replaced, where necessary, by more localised restrictions on travel and activity when coronavirus cases are resurgent.

Governments and central banks have risen to the occasion with substantial and ongoing stimulus; progress has been made in new drug treatments and vaccine development; and after a patchy start, test and trace capability, crucial to avoid another phase of blanket economic lockdowns, is greatly improved.

Recent macro data readings too support an impression of ongoing, U-shaped economic recovery: Purchasing Manager Index (PMI) surveys have nudged back into expansionary territory, travel indicators are rebounding, equity markets are back where they were pre-crisis and energy and metals demand is recovering, as witness crude oil, iron ore and copper prices now between 50% to 90% above March/April lows.

Early-year commodity price weakness also encouraged supply-side adjustments that will ultimately help rebalance global commodity markets - curbing US shale oil production and encouraging impressive voluntary supply cuts by Opec+, while concerns on mine supply resilience have supported metal price recovery.

China, two months ahead of the rest of the world in exiting lockdown, has acted as a template for broader re-opening and economic recovery. Indeed, much of the bounce seen in crude, iron ore and copper prices can be attributed to Chinese re-stocking through the crisis, with import volumes for first-half 2020 up by 5% to 10% year-on-year.

China’s agricultural commodity imports grew even more strongly, due to African swine fever and ambitious import targets negotiated with the US at end-2019.

However, it’s too early to simply dismiss the dog days option. Last month’s “Paint it Bleak” blog post illustrated a deliberately extreme oil demand scenario should a broad resurgence in Covid-19 necessitate widespread re-introduction of lockdowns and cause a corresponding “double-dip” for the world economy.

Covid-19 global new cases, daily; Global Covid-19 deaths per day & 7-day average

Click image to view full-scale

That remains a tail-risk event, but since the late-June blog, prevailing market optimism has been diluted by worrisome signals from the Covid front-line and financial markets alike.

Coronavirus lockdowns, although economically crushing, had nonetheless by May flattened the global profile of both Covid-19 cases and deaths. Subsequent re-opening has however seen a resurgence in cases, first in the US, but more recently also in Asia and Europe. Caseloads continue to rise in Latin America and Africa too.

Some have attributed higher US cases (now rising by 65,000 per day) simply to increased testing, but data reveal the ratio of positive cases per test has doubled from one in every 25 tests in mid-June to one in 12 by late-July.

The broad realisation now is that Covid-19 impacts, rather than being a one or two quarter phenomenon, will likely linger through 2020 and into 2021.

Market optimism has been dented as a result. Crude price recovery has levelled off, market structure regaining contango after briefly flirting with backwardation, amid higher anticipated Opec+ August supplies, a bottoming-out of US drilling levels and higher shale production.

And while high North American summer temperatures are lending support to US gas prices, copper and iron ore markets have also eased since mid-July. An impressive initial bounce in Chinese manufacturing in March and April has since moderated on anaemic export markets and flooding disruption in southern China.

Geopolitical tensions have also returned to the fore, with tit-for-tat consular expulsions from the US and China. Diplomatic spats, ranging from civil rights in Hong Kong, to territorial disputes in the South China Sea and supply chains for technology and medical supplies, are ongoing.

Gold & USD index

There are risks too of a Turkey-Egypt stand-off on opposite sides of the battle for control in Libya, and more generally a febrile atmosphere as November’s US Presidential election nears.

The US Federal Reserve has acknowledged concerns over a possible weakening in employment and consumer spending by extending emergency credit programmes to the end of the year.

Markets are also spooked by uncertainty over the US Administration’s plans for a renewed economic rescue package when initial aid provisions start to unwind by end-July.

Confidence in one safe-haven asset – the US dollar – has shifted instead to gold.

Record-high gold prices and record-low yields on US 10-Year Treasuries is a combination that clearly flags increased market uncertainty over prospects for an imminent and smooth economic recovery. The market is finely poised between cautious optimism and foreboding.

More than ever, this highlights the importance of cohesive government policies on virus control, international diplomacy and emergency economic support. If achieved, these could still help ensure that the dog’s bark remains worse than its bite.

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