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Bold fiscal budgets to fight the pandemic

TOM2403

The covid-19 pandemic came as an exogenous shock to the economic growth outlook. Given that the pandemic is the driving force behind the financial market correction, this makes the current bear market conditions event driven. An event-driven bear market also implies that the current financial conditions are not comparable to the 2008 financial crisis, when market corrections were pricing in structural issues in the economy. In fact, current financial markets are mirroring the uncertainty we are all experiencing in our day-to-day life, with social distancing, quarantines and lockdowns becoming the new norm but nonetheless are not expected to last forever.

As governments march on with their mission to flatten the curve and slow down the growth rate of number of covid-19 cases, economies are experiencing sudden stops in activity. It is very clear that economic data has a lot of catching up to do in order to reflect the unprecedented conditions the whole world is currently facing. Given the lagging nature of productivity data, past economic data has become stale. However, forward-looking indicators have already started to reflect the ongoing economic challenges. In the week ahead, business climate indicators, manufacturing PMIs, business confidence and consumer sentiment indicators for both the US and Europe are expected to be negatively impacted by the current economic scenario. On the other hand, given the increasing amount of companies communicating the expected negative impact from the pandemic, a bottom up approach that starts at the company level has long indicated an inflection point in the economic outlook.

The pandemic has led governments to weigh one main trade-off: choosing between economic growth and public health. Given the extreme covid-19 response measures across the world, it is very clear that public health has become the number one priority. In order to bridge the negative economic impact from the extreme response measures, monetary policies have focused on accommodative measures to ease financial conditions. More importantly, governments have recognised the economic cost of contagion measures and to various extents brought forward their own funding packages.

From an investor point of view, despite that the size of fiscal stimulus is material, the tools through which the funding is channelled into the economy is equally important. So far, there is France’s plan to nationalise businesses, commercial paper buying in the US and loan guarantee schemes in Europe. However, fiscal stimulus should be targeting both households and businesses. Ensuring adequate health care services to the public is something all governments are striving for. More importantly, however, governments should follow UK’s example in directing funding to business through subsidised salaries, which would help ease pressure on business’ cash flows and thus safeguard jobs. This in turn should help keep consumer confidence high and savings rate low, such that consumers would be confident to spend when economic conditions normalise.

In planning their fiscal budgets, governments must match the unimaginable measures used to flatten the curve with an equally bold financial package and communicate their ability to adjust the measures as the impact from the pandemic becomes more understandable. Such measures would aim to ensure that the current bear market does not spill over to more structural economic issues and thus remains event driven, whereby the recovery would be just as fast as the correction.

Disclaimer:

This article was issued by Rachel Meilak, CFA Equity Analyst at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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