By Michael O’Neill
You work sixteen hours and what do you get?
Another day older and deeper in debt
Saint Peter don’t you call any Canadians yet
We need three hundred years to pay COVID debt
There used to be just two sure things in life: death and taxes. In the post-COVID-19 world, there are three certainties: death, taxes, and gargantuan government deficits.
In 2015, the incumbent Conservative Government thought balanced budgets were essential and a sign of a fiscally responsible government. They reported a budget surplus of $1.4 billion and predicted it would grow to $4.6 billion by 2020.
The 2016 Liberal government disagreed. They immediately repealed the Balanced Budget Act because Prime Minister Trudeau believed “budgets balance themselves.” So far, they don’t. The Government made a passing reference to fiscal responsibility, say it “continues to manage deficits carefully while delivering real results that grow the economy, create jobs and improve the quality of life for the middle class and people working hard to join it.”
The COVID-19 pandemic changed that. World governments flipped a switch and shut down their economies. Mandatory business closures, travel bans, and “isolate-at-home” orders were implemented in major centers. Central banks slashed interest rates and renewed quantitative easing measures. Zero interest rate policies are the norm, and negative interest rates a growing concern.
Budget deficits expanded from a child’s birthday balloon to the size of the Goodyear blimp.
The US deficit is forecast to soar to $3.8 trillion in 2020 or 18.7% of GDP. Canada’s policymakers are frugal in comparison. The Parliamentary Budget Office projects a $252 billion deficit or 12.7% of GDP. Those deficits are primarily due to government measures to support laid-off workers because of pandemic fighting measures.
The US lost around 22 million jobs between March and April. Canada lost about 2 million jobs in the same period.
Nothing is more attractive to a market bull than a matador’s red cap, or zero interest rates. Soaring deficits and Depression-era magnitude job losses were no reason to keep equity markets at their COVID-19 lows. The S&P 500 rallied 42% since March 23. Workers were not so lucky. Of the 22 million Americans who lost their jobs since the crisis began, only 2.5 million got their jobs back.
Canadian’s were in the same boat. The S&P/TSX rose 41% since March but only 289,600 jobs were recovered in May compared to the 2 million jobs that evaporated since the onset of the pandemic measures.
Traders saw the employment reports and shouted, “Let the good time roll.” The world-wide easing of lockdown restrictions turbo-charged positive risk sentiment, while better than expected employment reports convinced traders that they had seen the worst from the pandemic. For many, the Fed’s zero interest rate policy and President Trump’s demand for negative rates, mean US interest rates will remain unchanged for quite some time, making equities a safe bet. FX traders agreed. The US dollar sank, driven by a 27% rally in AUDUSD.
“Reality distortion Field” describes the equity market economic outlook.
Apple (AAPL: Nasdaq) employees and readers of Walter Isaacson’s biography of Steve Job’s are familiar with the term “reality distortion field.” That’s the term used to describe the Apple founder’s ability to convince others to believe almost anything by using charm, charisma, and hyperbole.”
It is also an apt description of FX and equity trader’s economic outlook. They are behaving as if its business as usual and the pandemic is just a memory.
Central banks beg to differ. Their legions of economists, and analysts continuously warn that uncertainty around how the economic recovery will unfold remains high. On June 10, the FOMC statement said: “The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” On June 4, the European Central Bank (ECB) noted “While survey data and real-time indicators for economic activity have shown some signs of a bottoming-out alongside the gradual easing of the containment measures, the improvement has so far been tepid compared with the speed at which the indicators plummeted in the preceding two months.”
The Organisation for Economic Development didn’t mince words in their economic outlook, released June 10.
They titled it “The global outlook is highly uncertain.” Their forecast is a 6.0% drop in global economic activity, and a jump in global unemployment from 5.4% to 9.2% in 2020.
Canada GDP could fall 8.0% or 9.4% in the event of a COVID-19 repeat, with unemployment at 9.4%. The Canadian economy is extra-vulnerable due to low oil prices. Domestic growth was faltering alongside the collapse in oil prices, and the pandemic accelerated the slide. Oil prices have rallied significantly from their lows but at current levels ($38.90/b), are still 40% below January’s peak.
“The global outlook is highly uncertain.”
Traders are not listening.
Market risk sentiment is out of whack with the central bankers’ view of economic reality.
Market optimism centers around expectations that local and foreign economies are returning to normal. That is a dubious conclusion. The evidence suggests that the new economic landscape will greatly differ from its predecessor.
Commercial real estate will have to contend with empty spaces because a plethora of businesses could not survive nearly three months of zero income. The hospitality and travel industries are decimated. Restaurants will need to adjust their business models to contend with post- COVID-19 seating restrictions and increased costs from cleaning and social distancing measures. Fewer employees mean fewer jobs and few seats mean higher prices. Airlines slashed staff. Those jobs are not coming back until the public feels safe traveling. How many employees who enjoyed working from home are eager to jump onto the crowded, petri-dish of public transportation? Those are just the obvious issues.
Geopolitical tensions are other concerns that could stymie a global recovery. The US election has inflamed China/US tensions as President Trump scapegoats Beijing to distract voters from his administration’s failures. Is Joe Biden mentally capable of being President, and if so, would he live out his first term? North Korea and South Korea are feuding again. The European Union and the UK have reached an impasse in their latest leg of trade negotiations, which raises the risk for a no-trade deal exit from the EU on December 31, 2020.
Hoping for the economy to return to normal may be a bad bet, which means you will keep working sixteen hours and getting deeper in debt.