In lieu of our usual Weekly Bulletin, we are publishing special reports to discuss the market reaction to evolving news on the coronavirus outbreak. We would stress the following observations as developments continue to unfold.

Stocks rose again last week on the back of new massive stimulus policies announced by Japan and the Eurozone to counter the economic shock caused by the COVID-19 quarantines. This unprecedented global stimulus (now up to 26.5% of global GDP) increases the odds of a solid recovery in the second half of the year—from the U.S. to the Eurozone to Japan and China.

Historic News from Europe: The news coming out of Europe is truly historic and a game changer. After the 2008 global financial crisis (GFC), the major flaw of the euro—monetary union without fiscal union—led to the European sovereign debt crisis. Concerns over the stability of the euro have lingered ever since—last week’s announcement significantly reduces these concerns. Importantly, COVID-19 has now broken the taboo of common bond issuance in Europe. Last week, German Chancellor Merkel, French President Macron and EC President von der Leyen hatched a plan to issue common bonds that will finance a EUR 750-billion recovery fund as part of the European Commission Multiannual Financial Framework. The EC will then allocate EUR 500 billion of grants (not loans) to EU nations as long as they adhere to European principles.

The unified front by the three most senior European politicians reflects elevated support for the EU among all European nations and an understanding that economic ruin in the smaller nations could capsize the core nations. This suggests that fiscal risk sharing should increasingly become common in Europe. Unsurprisingly, Italian, Spanish, Portuguese and Greek bond spreads (relative to Germany) all narrowed significantly following the announcement.

These latest developments takes Eurozone fiscal stimulus from 21.2% of its GDP to 27.6%, which when combined with monetary stimulus so far announced (8.3%), lifts total Eurozone stimulus to 35.8% from 29.5% in mid-May. Encouragingly, European financial conditions are now the easiest they have been in eight years.

Japan’s Massive Stimulus: Last week’s news out of Japan boosts fiscal stimulus from 19.2% of its GDP in mid-May to a stunning 40.3%, which when combined with monetary stimulus already announced (20.0%), lifts total Japanese stimulus to 60.3% versus 33.7% in mid-May—a massive amount and now the largest in the world.

U.S. Stimulus is also Massive with More to Come: The stock market rally that started in late March occurred after swift action was announced by Washington policy makers. The size of this response is staggering. Importantly, combined fiscal and monetary policy in the U.S. will have a more invigorating impact on the recovery than the measures passed in 2008-2009 (where a muted economic recovery followed). They represent a larger share of output than during the GFC (10.5% versus 6% of GDP for the government spending and 15.2% versus 8.3% for the Fed’s balance sheet expansion). Moreover, the Fed is buying a much greater percentage of the Treasury’s bond issuance than during the GFC. This suggests the combined monetary and fiscal easing should have an even greater effect because the private sector is not financing as much of the government’s largesse.

There are also plans for a follow on fiscal package. Congress is expected to approve a final pre-election fiscal package sometime in June or July that could add another $1 trillion to the total. That package will likely be a mix of rebates, extended and reformed unemployment insurance benefits, state and local relief, and additional relief and COVID-19 liability protections for businesses.

Watching China’s Recovery Path Closely: China was the first country to witness the painful impact of COVID-19 and the quarantines needed to fight the disease. It was also the first country to control the virus’ spread and, most importantly, to escape the lockdown, along with being the first to enact economic stimulatory measures. The results are encouraging: industrial production, domestic new orders, and to a lesser extent, retail sales, are all experiencing V-shaped recoveries. China’s bond market is also beginning to signal a recovery with longer-term interest rates rising, despite short-term interest rate cuts by the People’s Bank of China.

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