A Global Pandemic and its Impact on Financial Markets

Tom Porcelli, Chief US Economist

• A contraction in US economic activity is expected in Q2. RBC’s base case is for an outright contraction in output with services consumption being particularly hard hit. If COVID-19 follows similar pattern as other viruses and begins to fade as spring rolls around, the economy could stabilize in Q3 and re-accelerate modestly in Q4.
• Newly announced fiscal measures are being under-appreciated by the markets, as an example: $50 bln in loans through the Small Business Administration (SBA) and pushing back tax filing date beyond April 15 would be the equivalent of $200 bln of aid. The goal should be to alleviate the cash crunch that many businesses are enduring.  That is how policy makers can help mitigate job losses.
• There are also “automatic stabilizers” that need to be considered. The ability to refinance mortgages and lower energy prices are, on net, additive for US consumers.  Again, these could help mitigate some of the strain on consumer balance sheets.
• There is no doubt the Fed will do even more. The Fed has other tools at its disposal beyond just cutting rates to the Zero Lower Bound (ZLB).  Further action on QE and possibly restarting some of the “alphabet soup” of lending programs witnessed during the Financial Crisis are surely going to be considered in the name of ensuring ample market liquidity.

Lori Calvasina, Head of US Equity Strategy

• RBC lowered 2020 S&P 500 price target forecast to 3479 from 3460 with 1 per cent growth expected vs. 7 per cent previously. We expect the brunt of the pain across US equity market to occur early on in the year with the bulk of the economic impact in the new year and a recovery slowly trickling as news about the virus improves.
• Reduced 2020 S&P EPS forecast to $165 from $174 (5 per cent reduction), to reflect a significant but short-term impact of the virus.
• Real GDP forecast is for a fall of 1 per cent in Q2 with a stabilization in Q3 and a recovery in Q4, with 100 bp of additional Fed rate cuts, a slowdown in industrial production in Q3, margin contractions of about 25 bp, some modest pickup in share buybacks v.s. Q4.
• US equities are pricing in a recession. This may be premature, however. We anticipate an expected decline of earnings of about 10 per cent, less severe than we have seen in past recessions, with a median earnings decline of 17 per cent.
• On positioning, we have moved to ‘neutral’ on growth vs. value against a previous bias on value. We upgraded healthcare from market-weight to overweight, lowered financials from overweight to market-weight.
• On sector ratings, generally, we want to have a balance between growth (Healthcare), defensive (Utilities) and cheap cyclicals (Industrials).

Peter Schaffrik, Head of European Rates and Economics Strategy

• Situation is dramatic in Italy because early measures were not taken fast enough and the health system is now overwhelmed, and it looks like a humanitarian catastrophe despite very strong measures in place. Will spread to the rest of Europe in a matter of time, with France, Spain, Austria, Belgium, Germany, Ireland closing all schools and many businesses.
• The economic activity slowdown will be significant. The authorities are responding with monetary action: rate cuts by 50 bp by the BoE.
• The corporate sector as a whole is facing severe constraints because revenues are falling and, therefore, they need liquidity to bridge this period of time – however long or short it may be. Liquidity provision measures are key: the BoE is providing a term lending facility and the ECB has rolled out a new TLTRO and increased QE program with another 20 bln euros, and capital relief measures for the banking sector. However, this will not be enough and governments and fiscal authorities are being called upon. What is needed is a tax moratorium to help corporates and guarantees from governments for bank loans.
• EU could mull suspending debt level limits as set by the Stability and Growth pact.

Elsa Lignos, Global Head of FX Strategy

• Positioning in the majors (EUR/USD, USD/JPY) is close to neutral while options market looks broken. Both the yen and euro have recorded substantial moves in both directions over the past days.
• Key point to focus is on US front end rates - not because it drives speculative positioning but what it means for structural asset allocation and hedging decisions on those underlying assets.
• With the Fed slashing rates and pumping in liquidity to ease funding pressures, we expect a persistent drip of yen and euro buying throughout the year, to reach levels not seen in a long time.
• Canadian $: some weakening already but further room for downside based on our fitted framework.
• Sterling: EU-UK negotiations going on in the background though largely being ignored. UK government issued significant fiscal & monetary stimulus package last week, but the country is in a situation of triple deficits (budget, current account, private sector savings) which makes fiscal stimulus potentially sterling-negative.

Craig Wright, Chief Economist

• We expect Canada to fall into a recession this year with activity forecast to contract in the second and third quarters, leaving annual growth at a meagre 0.2% The depth, breadth and duration of the recession and the strength of the recovery will depend on the response of monetary and fiscal authorities.
• Investor, business and consumer confidence are all struggling from the shocks associated with COVID19 and the severe dislocations in energy markets.
• Consumers in Canada are not well positioned for these shocks given the elevated debt levels. The housing sector is expected to soften over the next couple of quarters as uncertainty with respect to the economy and income prospects outweigh support from lower interest rates.
• The Bank of Canada is expected to continue to lower interest rates with the overnight rate expected to fall to 0.25% over the next couple of months. Fiscal policy is also ramping up to offset some of the economic pain with large stimulus expected given Canada’s solid federal fiscal position.

Michael Tran, Global Energy Strategist

• Unchartered situation across oil markets with both a price war between Saudi Arabia and Russia and a global pandemic, a negative supply shock and a negative demand shock all happening at the same time.
• Since OPEC failed to agree a large production cut of 1.5 mln b/d, and Saudi Arabia increased production to a record high of 12.3 mln b/d, the market find itself awash with oil with a surplus of over 4 mln b/d globally.
• Without the OPEC cut, the market is left to its own devices to search for self-balancing mechanism.
• In order for prices to recover, demand must either improve or supply has to go down. Given the spread of COVID-19, we have cut our demand forecast by 1 mln b/d. We cannot count on demand bailing out the market over the nearer-term: supply will have to go down ultimately. Russia and Saudi Arabia are gridlocked, with every oil producing country and company caught in the crossfire, US shale is therefore most likely to be the first to buckle. After a tremendous amount of growth over the past decade with the US shale boom, at $40 US a barrel, production starts to struggle. We fear a long, protracted price war and therefore expect WTI prices averaging the mid-30s for much of the balance of the year.
• The only bright spot is Chinese activity appearing to be rebuilding and improved markedly over the past two weeks.