In the past week, we have gotten updates from many governments on their plans for either the ease or extension of Covid-19 restrictions. As has been the case throughout the outbreak, responses have varied with the US announcing a phased approach to re-opening, the UK extending the lock-down for at least 3 more weeks and in Europe, some countries are lifting restrictions (e.g. Italy, Spain, Germany) while others (e.g. France) have extended their lockdowns.

A briefing from the White House indicated that as many as 29 states could be re-opened soon based on outlined conditions related to their containment of the virus. The re-opening is meant to occur in 3 phases with each phase lasting at minimum 2 weeks. Despite the guidelines provided by the Federal government, ultimately, the decision rests with the state governors but this guidance does increase the pressure for states to begin easing containment measures sooner rather than later.

Equity markets grasped at the news of re-opening as a positive sign and the S&P 500 posted gains on the announcement. In fact, the S&P 500 has managed to recover more than 50% of its Coronavirus related losses.

Chart 1: S&P 500 Index

Source: Bloomberg

This buoyancy in the stock market has been observed even as recent economic data releases from the US paint a grim picture, with indicators at record lows. Factory output has dropped to its lowest level since 1946 and jobless claims have spiked at the end of March and into April with 22 million Americans (13% of the labour force) filing claims over the 4-week period.

Chart 2: US Industrial Production and Capacity Utilisation

Source: Federal Reserve Board

Chart 3: US Jobless Claims

Source: Bureau of Labor Statistics

However, the White House has projected that with the easing of restrictions, the economy will rebound strongly but many analysts expect economic activity to remain weaker for longer. Bank of America’s recent survey of fund managers showed that:

  • 7% are projecting an L-shaped recovery (a prolonged recession akin to the 1930s).
  • 15% are expecting a V-shaped recovery (a sharp drop in growth followed by an equally sharp rebound)
  • 22% expecting a W-shaped (where a rebound is followed by a subsequent slump due to a second wave of the outbreak)
  • >50% expect a U-shaped recovery (where the recovery will be prolonged over multiple quarters)

Therefore, while stock markets seemingly look to the re-opening of economies as the signal or turning point for economic recovery, a V-shaped recovery still seems unlikely. Indeed, the IMF has said that Covid-19 is likely to result in the worst global recession since the Great Depression and will lead to a lasting economic impact. Without an effective treatment and a vaccine, lifting of restrictions will likely not result in a quick return to normalcy as production/ consumption levels will not rebound to pre-coronavirus levels immediately.

As a result, from a currency perspective, in the coming months, dollar strength will likely persist. Oddly enough some of this support is partially derived from the poor economic data seen from many countries including the US. As we have mentioned previously, the dollar benefits during risk-off periods due to its perception as a safe-haven currency. Additionally, while the market has been flooded with US dollars driven by government stimulus implemented in the past month, the Fed has announced that it plans to scale back its Treasury purchases from $30 Bn to $15 Bn per day. Furthermore, as earnings season kicks off and S&P 500 companies begin to release financial data, recent optimism may be checked and we may see a re-kindling of risk aversion sentiment, benefitting the dollar.

Elsewhere, while the European Union has published a joint roadmap to coordinate the lifting of Coronavirus restrictions across the EU, the euro will likely remain vulnerable due to a lack of coordinated fiscal response to the virus.

Author: Nirvani Sookdeo