“Do or Do Not. There is No try” – Yoda
This week we saw uncertainty over Australia’s immediate economic outlook increase again, as Sydney’s lock-down restrictions were tightened further and extended for at least two weeks to the end of July and based on recent stats this could be extended yet again. A clear indication of the strength of the Australian economy was the recent jobs numbers which put employment at 1.2% above pre-pandemic levels and saw the unemployment rate drop to 4.9%, its lowest level since 2010. Whilst concerns over the economic impact of these recent lockdowns grow each affected state has rebounded strongly, offsetting much of the immediate loss. With their labour markets strong, government assistance in place and Australia’s vaccine drives now gathering pace, this is again likely to be the case for Sydney and Melbourne. Of course, the duration and severity of the lockdowns are clear risks this time given the highly contagious nature of the delta variant. The speed of vaccination is growing but, it is still well below what is needed to get the latest strain under control – below are numbers as of 19 July 2021.
Once thing that can be said for certain is that Australia has become incredibly resilient in the face of adversity – the Westpac–MI consumer sentiment index rose 1.5% in July. Unsurprisingly, sentiment in Sydney, and NSW more broadly, was hit hard by the current lock-down and this was before the tightening of restrictions last Friday. Still, confidence in the state remains above–average, which should provide a solid foundation for the recovery.
The big question, looking further afield is, are the wheels starting to come off the US equity market rally and what are the implications for bond yields? Monday this week saw significant falls in all major equities’ indices on the back of a growing number of delta variant COVID cases. Just when we thought it was safe to go back in the water, it seems we are potentially facing a repeat of the crisis we saw last year. This could once again cause further shutdowns and, hamper the current US economic recovery which in turn will certainly put the brakes on the prospect of higher interest rates moving forwards. This was evidenced by the fall in the US 10 Year Bond Yield to 1.19%. One thing is for sure, with yield curves around the world starting to flatten rising interest rates are no longer a foregone conclusion which suggests this period of record low interest rates may persist for longer than most people thought. One could liken it to the experience with COVID, once believed to be eradicated is now back with a vengeance.
The chart below illustrates the inverse correlation between COVID cases and the US equity market and conversely the positive correlation with bond prices. It shows how the recent rise of the new Delta strain has led to material weakness in the US equity market and, a subsequent rally in bond prices as expectations of interest rate rises get pushed a little bit further out.
In terms of a theme for this week, it’s worth taking another look at the US Volatility Index (chart below) or what is sometimes referred to as the “fear index” and what it means for financial markets. With the VIX currently at 17.91, risk is said to be fairly priced. In fact, anything between 10 and 20 suggests markets are in equilibrium. Below 10, markets are complacent and above 20 markets are overly fearful. This flies in the face of common sense which suggests valuations on risk assets now are extremely stretched and ready to burst. With the latest COVID strain bringing back memories of what happened Q1 2020 it certainly raises the question as to whether we could be facing another similar shock. If the VIX is anything to go by, markets are telling us that all will be ok.