LONDON (Reuters) - What if we’re still locking down this time next year?
Although markets are optimistic about an emergence from the COVID-19 pandemic in 2021, there remains a gnawing fear that infections could persist despite vaccine rollout plans.
The second big wave is hitting hard through the northern winter, with restrictions tightening again in London, New York, and across Germany, Italy and large parts of Europe. Even Japan has been forced to suspend travel subsidies around New Year.
Alarmingly, there are also signs the virus may be mutating in a pernicious way just as vaccines arrive. Britain’s government said on Monday the exponential rise in new infections in London may be partly linked to a new variant.
While it’s unclear if this variant is more infectious or severe, or if it might render vaccines less effective, UK scientists said studies were required “at pace”.
Such questions go to the heart of anxieties among investors who have for months now chosen to look through the pandemic and bet on a rapid economic recovery next year, helped by long-lasting monetary and fiscal policy supports.
Despite the vaccine breakthroughs in November, some 30% of respondents to Bank of America’s monthly global fund manager survey identified a persistence of COVID-19 as the biggest tail risk to otherwise hyper-bullish market positioning.
A Deutsche Bank client survey this month also identified a mutating virus that dodges vaccines as their biggest risk for the year ahead.
But what would another year of pandemic or even failure of the first vaccines really mean for investment assumptions?
Clearly anything delaying the return of economic activity to pre-pandemic levels is hugely costly in terms of government spending, lost revenues, household incomes, corporate earnings, jobs, business failures and debt defaults. And positioning for recovery is at extremes already.
But investors have seen through nine months of setbacks and relapses, and a delay to effective vaccination could lead them to double-down on assumptions of ever deeper and longer central bank and fiscal props and refresh their appetites for lockdown “winners” in the technology sector and elsewhere.
The same BofA investor poll showing persistent coronavirus tail-risk fears also has optimism on stocks at its highest in almost three years, and the most positive view ever on corporate earnings improving. That sits easily with over 50% expecting vaccines to materially improve economies by the middle of 2021.
An early casualty of a prolonged pandemic could be last month’s dramatic rotation to investments associated with ‘normalisation’.
Investors might reverse their rush to small cap stocks or cyclical and regional laggards over technology and pharma; European and emerging market equities over Wall St; and a weaker dollar and gold along with higher oil and industrial commodities.
These trades have already tired and started to ebb over the past couple of weeks, with Big Tech outperforming yet again.
STING IN THE TAIL
But the biggest risk is surely that the policy supports that kept the world going through 2020 finally hit the buffers.
What if governments get squeamish about ballooning deficits and debt, or central banks hit legal, political and banking pushback against their ever-expanding balance sheets or moves towards negative interest rates. What if investors become edgy about “whatever it takes” pledges?
The Centre for Economic Policy Research’s annual “Geneva Report” on the world economy this week reckoned the cost of years of pro-cyclical monetary and fiscal policies was a “gradual erosion of policy space” to deal with shocks like this.
The “one-two policy punch” required to tackle the banking crash 12 years ago and this year’s pandemic have left historically high public debt and near-zero interest rates across the maturity spectrum in the world’s major economies - leaving them dangerously exposed to trouble ahead.
If “the hands of our economic policy boxer are somehow tied, even innocuous shocks - let alone the COVID-19 shock - could snowball into tail events”, warned the authors.
They concluded that the better “policy mix” between institutionally independent monetary and fiscal policymakers during this crisis was encouraging in maximising wiggle-room without instability created by reliance on extremes in either.
But they implored governments to better co-ordinate globally - missing in this year’s economic response - and aim together to push historically low equilibrium real interest rates, so-called ‘R*’, to a safer middle-ground.
“Restoring resilience through a joint effort to raise R* globally is the insurance the world needs against further global accidents,” the CEPR report said.
The author is editor-at-large for finance and markets at Reuters News. Any views expressed here are his own.
by Mike Dolan, Twitter: @reutersMikeD; Value chart by Thyagu Adinarayan, Editing by Catherine Evans
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