Submitted by Michael Every of Rabobank
It is perhaps a bit remarkable that we have seen the biggest one day [ZH: soon, two-day] gain in the Dow Jones index since 1933 and a 9.5% gain for the S&P 500 index yesterday. Where a day earlier Senate blocking the US government’s stimulus bill was reason for another sell-off, yesterday just the prospect of a deal appeared to be sufficient to propel the Dow to its biggest one day gain in almost a century. And that was just on the rumours of a deal. This morning (European time) it was confirmed that the Republicans and Democrats have reached a deal on the ‘phase 3’ stimulus package. The S&P mini and Dow mini futures are both indicating a positive open for the US market again, although gains appear to be more modest in the wake of the deal.
Yet, as we noted yesterday, it is hardly surprising that the two parties managed to reach an agreement. There are lockdowns in multiple US states to avoid the spread of the virus, and a quick response was necessary. With the upcoming presidential elections, both sides had too much to lose if this dragged on for too long.
Indeed, for President Trump a re-opening of the US economy cannot come soon enough, as he is worried that the “cure could be worse than the disease.” In a Fox news interview yesterday the President said: “Easter is a special day for me […] wouldn’t it be great to have all the churches full? […] You’ll have packed churches all over our country. I think it’ll be a beautiful time.” Now, there is nothing against giving people some hope in these dark moments, but such comments obviously sent shivers down the spines of the virus experts. Is Trump being the cautious optimist, or careless? That said, at the state and local level policy makers are coping with the reality of acceleration numbers of people infected and the immediate consequences of mass (temporary) layoffs and this is where the importance of the USD 2trn bill comes in.
The exact contents of the bill are yet to be released, but going by joint comments by Senate Majority Leader McConnell and Senate Minority Leader Schumer, the bill will provide support for both Americans and companies. Amongst other things, the bill is said to include four additional months of unemployment insurance. To get the Democrats to sign off on the various support measures for companies, that are being hit by the crisis, including a large bailout for airlines, the bill now limits share buybacks and bonuses as long as a company is on government support. Another positive take-away for equity markets is that it appears that the US is going down the route of state aid, rather than nationalisation of various troubled companies or even sectors.
Similar large fiscal packages were already being developed in Europe to support businesses and employees. There, funding remains the biggest question; particularly for those countries that already had weak debt metrics prior to the virus outbreak. Germany had already made some concessions with respect to the EU’s budget rules, but it has been resisting joint debt issuance. Instead, it looks like support is building for ESM credit lines. After an ECOFIN call last night, Eurogroup President Centeno stated that there is “very broad support” for allowing each Eurozone member to borrow up to 2% of its GDP from the ESM. However, the finance ministers did not reach an agreement on the specific modalities of these credit lines. And these conditions are key in avoiding new fragmentation concerns. But even if the conditions for the use of these credit lines were to be “light”, this wouldn’t solve the stigma attached to using this facility. This means that countries may be unwilling to draw on the facility if they fear it would harm their ability to access money and capital markets. In other words, the ‘ESM solution’ may not be a sufficient solution to prevent upward pressure on spreads as borrowing requirements skyrocket in the coming months.
It is therefore no surprise that, in the call, ECB President Lagarde once again strongly urged governments to consider the joint issuance of “coronabonds”. Firstly, this solution would circumvent the stigma problem. Of course, it would also make the ECB’s job a lot easier if they can just start buying those without having to worry about following the capital key or the need to counteract fragmentation risks being priced in. But for now, several Eurozone member states have dismissed the idea, albeit without categorically ruling it out either. The conclusion, then, must be that more market pressure is likely to be a key factor in forcing a decision.
Meanwhile… Another day, another lockdown. And this one is for real. With just a couple of hours’ notice, India’s Prime Minister Modi announced that all 1.3 billion Indian citizens(!) should stay inside their homes for the next three weeks. This nationwide shutdown follows a number of decrees that had gradually become more stringent, as elsewhere in the world. Indians are in for some very tough times. Supply chains will be significantly disrupted and farmers are worried that the coming harvest may fail to reach the many people who depend on these crops for their survival (even as food shops, pharmacies, gas stations and banks would be exempt). Moreover, the economy is powered by daily labourers doing manual work, and only a very slight minority is able to carry out work in the comfort of their home. For some, the cure may unfortunately be worse than the disease.
Yet, as it stands, the Indian government appears to be ahead of the curve. With only 500 cases or so being reported, a shutdown is precisely what a large nation with dense cities and an underfunded public health system needs to do. Yes, it’s draconian, but how could they reasonably expect the Indian citizens to practice ‘social distancing’ in the big cities? The population density of Mumbai is approximately 73,000 per square mile, making it one of the most densely populated cities in the world. Or what about Dharavi, a locality in Mumbai, and the world’s second-largest slum with a population density of 717,780 per square mile? Well, we can only hope that these measures will keep the spread of Covid-19 under control…
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