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Ahead of the curve: More stimulus

August 17, 2020

A commentary by Jürgen Lukasser, Chief Investment Officer of LGT Bank Österreich, on the corona crisis and how the resulting economic standstill is taking their toll: in the second quarter, the economy on both sides of the Atlantic deteriorated dramatically.

Ahead of the curve: More stimulus

The corona crisis and the resulting economic standstill are taking their toll: in the second quarter, the economy on both sides of the Atlantic deteriorated dramatically. In Germany, gross domestic product (GDP) fell by 10.1% between April and June, and in the US, economic output contracted by 32.9% on an annualized basis (-9.5% compared with the previous quarter). Analysts had expected an even sharper decline of 34.5%. Nevertheless, this is a historic economic slump: the last time the US economy experienced a similar contraction was in 1940, and even during the financial crisis twelve years ago, US GDP shrank by no more than 8.4%. Without the dual stimulus of the US government and the Federal Reserve, the current economic downturn would probably have been much more dramatic. The only ray of hope at present is that GDP development is a lagging indicator and market observers expect growth of over 15% in the third quarter. Leading indicators also indicate that not only the US economy but also the global economy is continuing to recover. However, the data also show that although we are still in a V-shaped recovery, the momentum is beginning to weaken. Once again, the focus is on US consumers, who benefited from the government's fiscal package 1.0 until the end of July.

Since August 1, the Americans have to manage without the additional liquidity funds that the government had decided on to mitigate the consequences of the Corona crisis. In Washington, Congress is currently discussing a stimulus package 2.0, but the negotiations are proving far more difficult than expected. The Democrats have put forward a USD 3.4 trillion stimulus package, while the Republicans only want to provide a cash injection of USD 1.1 trillion. However, there are significant differences not only about the amount of the aid, but also about who should receive it. Experts expect a breakthrough in the negotiations in the first half of August. A compromise is likely to result in a much smaller aid package than the Democrats are demanding in their proposal. The greatest agreement between the parties is probably on cash payments, which, as mentioned, expired at the end of July. Republicans and Democrats want to keep them at about the same level as the first fiscal package in order to keep consumers happy. There are, however, two points on which there is still an enormous need for discussion. One is unemployment benefits and the other is state and local aid. The ideas could not diverge further: The difference between the two parties' plans amounts to USD 1.34 trillion, which is more than the total volume of the second aid package that the Republicans want to finance at all. Nevertheless, we expect an agreement, as in three months time not only the presidential elections will be held, but many members of congress will have to stand for re-election.

While it is a fairly complex task to estimate the long-term implications of these stimulus packages, these measures prevent us from dealing with the exceptional and unique situation that Covid-19 has created in the short term. Central banks are striving to keep capital markets liquid and governments are trying to protect consumers and jobs with huge cash injections. The implications for investors are clear: without risk, there is a negative return. The challenging enviroment has thus worsened in this respect and should continue to drive up the price of gold in the medium term as well as keeping the equity markets in a “buy-the-dip” mode. Investors must expect a correction of 5 to 10% at any time. Only when long-term interest rates or real interest rates rise, will there be a change in this situation.

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