Bedrock’s Newsletter for Friday 24th of July, 2020
24 July 2020


 Friday, 24th of July 2020


“A paranoid is someone who knows a little of what’s going on.”

– William S. Burroughs


After a strong start to the week, markets turned down on Thursday when weak US jobs data hinted that the coronavirus outbreak in the country’s South could halt the momentum behind the US recovery, and Secretary Pompeo and President Trump made hawkish statements on China’s hegemonic ambitions in Asia. The US-China split is deepening on a daily basis, putting the phase one trade deal struck last year in doubt and risking a major strategic confrontation between the world’s two largest economies. Just this week, the US ordered the Chinese consulate in Houston to shut over spying claims, and China responded by closing the US consulate in Chengdu. Against this backdrop, the S&P 500 fell -1.2% on Thursday leaving it up +0.3% for the week, with futures indicating further losses on Friday. Tech stocks are particularly vulnerable to the dispute given the sector’s strategic importance to both countries and the extensive trans-Pacific technology supply chains. As a result, some shine finally came off the ‘stay-at-home’ trade this week as some of the pandemic’s economic winners retraced. Across the Atlantic, the Stoxx 600 Index was also up +0.3% over the first four days of the week. However, the pan-European benchmark has since shed -2.0% on Friday morning as markets adopt a more risk-off posture. The best performing region this week has been EM, with the MSCI EM Index up +2.1% as of Thursday evening (in USD). That said, dollar weakness is playing its part, and Chinese mainland stocks are down sharply this morning (c. 5%) so how the index trades at the open is not clear.


In fixed income, IG and HY spreads have continued to narrow this week thanks to the significant central bank support. So far this month, there have been large gains in credit, with a >100bps tightening in the US HY spread and double digit spread moves across the board. Many companies face extraordinary near-term funding stresses due to the pandemic, and the market saw a dangerous liquidity squeeze in the middle of March which understandably spooked investors and sent bond yields skywards before central banks intervened. Nevertheless, investors have bet that Jay Powell et al. will prove as generous going forward as they have been so far and will be able to paper over the cracks in corporate balance sheets until ‘normality’ returns. Whether they succeed depends on how long that recovery takes.


With regards to the recovery, the latest fundamental data paints a mixed picture of developed markets. Initially having lagged the US, Europe now appears to be pulling ahead. Indeed, flash PMIs released this morning were a homerun for major European economies as the UK, Germany, Italy, and France all beat estimates for manufacturing and services sectors. Services has had a particularly strong rebound in July: the Eurozone services PMI printed at 55.1 (vs. 51.0 expected and 48.3 for June) while the UK figure came in at 56.6 (vs. 51.1 expected and 47.1 for June). Meanwhile, for the first time in almost four months the US saw an uptick in initial claims for unemployment benefit. Since weekly claims peaked at 6.9m in late March, there has been a steady decline in the rate of job losses in America. However, as the virus returns with a vengeance to Texas, Florida, California, and elsewhere, progress appears to have stalled. The US PMI data will be released later today and may not confirm this loss of momentum, but the jobs numbers alone are little comfort for the President as November’s election creeps closer.


As political uncertainty rises in America, the EU appears to be experiencing a rare moment of political consolidation. After months of haggling over the terms of a European financial package for struggling industries and states, a joint Franco-German push for cooperation has finally resulted in a deal. The EUR 750bn recovery fund will combine EUR 390bn in grants and EUR 360bn in loans for the hardest hit sectors, and, as the first common counter-cyclical fiscal instrument at the EU’s disposal, it sets an important precedent. The actual size of the fund (which is not insubstantial) matters less than the signal it sends to markets that EU states can cooperate on a major domestic challenge rather than fragment along North-South lines. In the end, to bring the so-called ‘Frugal Four’ (i.e., the Netherlands, Denmark, Sweden, and Austria) on-board with the plan, the EU handed them additional rebates on the next seven-year EU budget (also agreed this week) so at least some of cash would come their way. Since Germany switched sides to join those countries in favour of the plan in May, a deal was odds-on. However, that the agreement has now been finalised with limited bloodletting is still a positive for markets. Sadly, the other key European negotiations (towards a Brexit agreement) have not progressed in similar fashion. Big disagreements on fishing and state aid rules may yet scupper a comprehensive agreement before year-end (and 31 July is nominally the end of the line). This helps to explain why European assets and currencies have not popped this week and the binary risk on GBP in particular gives us pause.