Stock indexes had a strong week, rising more than 2%, fuelled by a further decline in real interest rates (now at ~-1%). As at writing, the S&P 500 is only ~1% away from its February 19 closing high of 3,386 (~8% for the S&P/TSX with a February peak at 17,944). Admittedly this is a stunning realization, considering that unemployment rates globally are near levels last seen through the Great Depression. That said, in the near term, the stock market does not always groove with the economy and the abundance of liquidity, along with promises for more, is keeping stocks afloat. Speaking of liquidity, we heard this week that the Federal Reserve is contemplating shifting its monetary policy toward “average inflation”. This would mean tolerating inflation above its 2% objective – in other words, holding its policy rate near the zero bound for a very long time. The Fed, in our view, strongly wants to lift inflation along with expectations. As such, beyond an oversold bounce, the cyclical bottom in the US$ is likely lower while the cyclical peak in gold should be higher. This is all constructive for commodities, as suggested by a surge in the gold-to-bond ratio lately (more details in our mid-week note published Thursday).
Our focus this week is on US lending conditions. As we show in our Chart of the Week, US domestic banks have been tightening lending standards on loans in Q2 at their fastest since the GFC. This is consistent with the economic distress most households and companies find themselves in following imposed lockdowns. Interestingly, total demand for loans (second panel) has not cratered as much as it did back then. But looking at the internals of the report, all components have plunged, with the exception of residential mortgages. Combining bank tightening and demand for loans, we can see that current conditions are matching 2001 recession levels but that we are still far from the GFC peak. Hopefully, Fed and government actions will filter through the economy and prevent bank lending from causing the seizure of an important piston of the economic growth engine, as was the case in 2008-09. Nevertheless, this atypical tightening in lending conditions, along with the unusual decline in bond yields despite global growth reacceleration, reinforces our view that banks will not behave like early cyclicals this time around.
Regarding economic data this week, the Canadian economy added 419K MoM net new jobs in July (from 953K in June). Meanwhile, exports rebounded in June (+17.1%), thanks to the motor vehicles and parts sector. Last, the Markit mfg. PMI advanced to 52.9 (from 47.8), reflecting the gradual reopening of the economy. In the US, we learned that nonfarm payrolls came in at 1.76M (vs. 1.6M exp.), with leisure & hospitality and retail trade among the big winners. Nonfarm payrolls remain 11.4M jobs below year-ago levels but the recovery over the past three months (~9M jobs) is encouraging. Initial jobless claims also declined 1.2M (from 1.4M) while PUA claims dropped by 250K such that “total” unemployment claims fell ~500K WoW. As for PMIs, the ISM mfg. (54.2) and service (58.1) indexes also improved, but the employment components remain in contraction territory at 44.3 and 42.1, respectively. Hence, while economic statistics have been encouraging lately, the recovery appears fragile. Elsewhere, in Japan, the core Tokyo CPI came in at 0.4% YoY (from 0.2%), much below target – meaning the BoJ can keep the printing press rolling. In China, the Caixin mfg. PMI advanced to 52.8 in July (from 51.2) but the service PMI weakened to 54.1 (from 58.4). As for trade statistics, exports advanced 7.2% YoY last month (from +0.5%) while imports declined 1.4% following a 2.7% increase in June. China being the world’s biggest consumer of commodities, a sustained rebound in imports is likely needed to support demand. Finally, in India, the mfg. and service PMIs remain weak at 46 (from 47.2) and 34.2 (from 33.7). But the RBI left its target rate unchanged at 4% (vs. 25bps cut exp.), citing the recent flare-up in inflation statistics.
Please note that the next Portfolio Strategy Incubator will be published on August 26, 2020. We will continue to publish our Financial Market Performance reports on our usual schedule.
Chart of the Week
