Economic Conditions Snapshot amid Coronavirus

TextileFuture’s Newsletter wants to pass on to you the results of the latest Survey in regard to the actual economic condition. This is why we publish the latest McKinsey Survey Results, and, in the second feature we provide an even more global view on the economic effects of Covid-19 by the Swiss globally active Swiss Bank UBS (including the investment side), in order to give you a most broad oversight of the actual situation.

Here starts the first feature:

Economic Conditions Snapshot, March 2020 – the latest McKinsey Survey Results

The contributors to the development and analysis of this survey include Alan FitzGerald, a senior expert in McKinsey’s New York office; Vivien Singer, a specialist in the North American Knowledge Center; and Sven Smit, a senior partner in the Amsterdam office.

Captions and Graphics courtesy by McKinsey

As the coronavirus outbreak unfolded at the beginning of March, the survey elicited sobering early appraisals, with expectations of significant business risks and stifled growth prospects for the months ahead.

In McKinsey’s newest survey on economic conditions, conducted during the first week of March, the coronavirus outbreak overshadowed all other threats to the global economy.1 Nearly nine in ten executives identified the outbreak as a threat to global growth—more than for any other factor.

Reflecting on conditions at the time, most respondents said that the outbreak was also a top risk to their national economies and to their companies’ growth over the next year. Since then, the public­ health situation has become more dire: the World Health Organization declared the outbreak a pandemic, the global count of confirmed cases and deaths has risen, and authorities in many countries have taken emergency measures to limit the spread of the disease.2

The progression of the outbreak has surely influenced executives’ views on the economy, but even the survey results from several weeks ago indicate the extent of their worries. Respondents already expected a stifled global economy in the months ahead. When asked about their home economies’ prospects, the deepest concerns came from respondents in the Asia–Pacific region— not surprising given the timing and spread of the outbreak.

Furthermore, the results show that many respondents expect their companies to change their globalisation strategies and foresee new hurdles to investments. Private sector respondents were more likely than in previous surveys to say, that their companies will alter supply chains in the next few years and that the risk of an economic downturn was keeping their organisations from investing in attractive opportunities.

However, a plurality of respondents continued to predict a positive near term outlook for their companies.

Concerns over the coronavirus outbreak’s impact loom

In early March, most respondents expected the spread of the coronavirus to be one of the biggest risks to growth for the global economy, their national economies, and their organizations in the months ahead. 86 % of respondents said the outbreak is a pressing threat to global economic growth over the next year (Exhibit 1). Concern about the pandemic, which we first asked about in this quarter’s survey, was most pronounced in the Asia–Pacific region, where 96 percent of respondents said it was a top threat.

Among all respondents, the coronavirus outbreak displaced trade conflicts, respondents’ chief concern throughout 2019, as the most commonly cited risk. Although trade conflicts became the third­most­cited risk overall—after the virus and geopolitical instability—they were an outsize concern in India and other developing markets.3

Looking at their national economies, two thirds of all respondents said the outbreak is a top risk to growth in the next year. It was the most commonly cited threat in each region except Latin America (Exhibit 2). With all eyes focused on the spread of the virus,4 trade policy changes (the most cited risk in the past three surveys) and geopolitical instability were no longer among the top five concerns. Slowing economic activity in China, the initial epicenter of the outbreak, was the second most cited risk. 39 % said slowing growth in China is a top risk—the largest share since we began asking about it as a threat to domestic growth in March 2016.

 Finally, the outbreak topped the list of expected threats to growth at respondents’ companies. 53 % of all respondents cited it as a risk.

Uneasy views of the global economy and conditions at home

After a more favourable turn at the end of 2019,5 sentiment on the state of the global economy soured in early March. Just 6 % of all respondents said conditions improved over the past six months, while 85 percent said they had worsened (Exhibit 3). What’s more, the share reporting a substantial decline in the global economy has grown over the past six months.6

Likewise, respondents were leery about the global economy’s prospects. 58 % said they expect conditions to decline in the  next six months – more than twice the share that predicted an improvement. Overall, three quarters said they expect the global growth rate to slow down.

Respondents remained more sceptical than hopeful about current and future conditions in their home economies. Overall, 62 % said their national economies had declined over the past six months, compared with 52 % six months ago. Respondents in all regions were more likely to report declining than improving conditions, which was also true six months ago. Those in the Asia-Pacific and developing markets were particularly downbeat compared with their peers in other regions (Exhibit 4).

Respondents also offered sombre outlooks for their national economies. Roughly half expected conditions to decline in the next six months—nearly twice the share expecting an improvement.

 Similarly, 58 % of respondents expected their economies’ growth rates to slow in the months ahead, but most said that the contraction would be minimal.

Across regions, respondents in developed economies were more likely than those in emerging ones to expect worsening conditions. Those in the Asia–Pacific and Europe expressed the most pessimism. Respondents in India and Latin America—who were less likely than those else­ where to see the virus outbreak as a risk to   their economies7—were less sombre (Exhibit 5). These sentiments were consistent with the timing and spread of the virus.

Changes to globalisation strategies

In light of the economic risks respondents saw in early March, those from large multinational companies said their organisations were examining globalization strategies and would make changes in coming years.8 87 % of respondents said their companies will alter globalisation strategies in the next three years. Respondents were more likely than they were in December to say that the strategic changes at their companies will include diversifying supply chains across countries and sourcing more from regional supply chains (Exhibit 6).

In addition, respondents at private sector companies of all sizes said that the risk of an economic downturn or financial crisis in the countries where their companies are based was affecting how their companies make investment decisions. Respondents were much more likely than they were one year ago to say that a potential downturn is a main reason why their companies are not investing in all attractive opportunities (29 %, compared with 15 % in March 2019) or why their companies have fewer attractive investment opportunities than they can fund (37 %, up from 23%).

 Even so, at the time the survey was conducted, respondents remained more likely to expect customer demand to increase than to decrease (39 % versus 28 %), as has been true for more than a decade. A plurality of respondents also expected their companies’ profits to increase in the months ahead—although the 42 % of respondents who gave that answer was the smallest share since June 2009.

The second feature starts here:

Covid-19 Scenario

The UBS House view of March 19, 2020 by guest author Marc Haefele, UBS Chief Investment Officer, Global Wealth Management

World leaders have made unprecedented decisions around the costs and benefits of temporarily restricting economic activity to limit the spread of an infectious disease. The social distancing measures now in place across much of the world –  ranging from the closure of entertainment venues, to travel bans, business closures, and restrictions on personal movement – will have a major economic impact. We estimate that the kind of restrictions now in place across many major economies could cut between 20 % and 40 % from private sector activity over the duration that they are enforced.

In response, the Federal Reserve has rolled out its entire Global Financial Crisis playbook in just three days. The European Central Bank has launched a Pandemic Emergency Purchase Program, backing its claim to do “whatever it takes.” Fiscal policymakers are ramping up their response too, with programs announced so far worth 16 % of GDP for the UK, 15 % of GDP for Germany, 15 % of GDP for France, and 10 % of GDP for the US. We believe these measures, and policymakers’ willingness to do more, will help us avoid a global financial crisis-style credit crunch. So far, however, the market impact of widespread restrictions on personal movement has overwhelmed this set of policy responses.

In this monthly letter, our goal is to examine how we see the interplay of health, monetary, and fiscal policy impacting markets, so investors can effectively evaluate risks and opportunities today. We have organized our thinking into three scenarios: upside, central, and downside, each determined by the answers to the key questions: a) how quickly economic activity can normalise, and b) how much policy responses can limit corporate bankruptcies and job losses.

In an upside scenario, some combination of high compliance with social distancing, viral seasonality, and/or pharmaceutical solutions means that virus infections in the major economies in Europe and the US follow the path of China and peak by early-April, allowing measures to be gradually relaxed from early-May onward. Government stimulus is sufficient to avoid lasting damage to the economy, and allow growth to begin a V-shaped recovery in the third and fourth quarters. By year-end we would expect the S&P 500 to trade around 2900 in this scenario.

In our central scenario, new cases of the virus generally peak by mid-April, allow- ing the most severe restrictions to be lifted from mid-May, although the virus proves hard to eradicate, meaning restrictions need to be reimposed intermittently in some countries for the remainder of the year. A coordinated monetary and fiscal response eventually provides the necessary funding to backstop affected businesses and industries, but it arrives too late to protect all. A U-shaped economic recovery takes hold around the fourth quarter. By year end we would expect the S&P 500 to trade around 2650 in this scenario.

In a downside scenario, containment measures do not prove sufficient to halt the spread of the virus, and new cases continue to rise in Europe and the US into May/June. We also see the virus spread again in China, requiring renewed restrictions there. Most restrictions in Europe and the US remain in place into June or July, and are reimposed intermittently for the remainder of the year. In this scenario, government policy would not meaningfully offset the lengthy demand shock, leading to a sharp rise in bankruptcies and joblessness. Companies would forgo significant revenue, and losses would be borne by shareholders, creditors, and banks. Economic growth would have an L-shaped profile through 2020. In this scenario, we would expect the S&P 500 to trade around 2100 by year end, although the actual trough may be lower, perhaps between 1650 and 1950, using historical bear markets as a guide.

While it is impossible to tell with any certainty which scenario will occur, we continue to believe that a disciplined, diversified, and far-sighted approach to investing will remain the best way to grow capital over the long term. The significant recent drops in markets mean that many portfolios will now hold a lower weight to equities than their long-term targets. We generally recommend rebalancing back to target allocations, although in volatile times addressing asset allocation gaps through averaging-in, or combining the sale of put options with the purchase of call options, may help investors reduce timing and overcome the human behaviours that drive underperformance.

We think investors should seek those stocks, with earnings that are relatively resilient to our virus scenarios, for example companies exposed to the 5G rollout in Asia, and global quality stocks; secular themes, that can benefit from the current situation like fintech, ecommerce, online gaming, and online education; as well as cyclical sectors, that face risks but which we think have been oversold, like China property stocks listed in Hong Kong, and Japanese automation and machinery companies.

For investors who can use options strategies, we recommend restructuring equity exposure with put/call strategies. The fear in the market allows investors to sell put options on both US and Eurozone equities to fund the purchase of call options at better prices. This strategy provides upside exposure to rallies, while also meaning automatic rebalancing into equities at lower levels should markets fall further.

In our portfolios, we have been taking action by diversifying our equity exposure using these options strategies. We are also diversifying into assets that we think are closer to pricing in downside scenarios. We now shift our overweight in emerging market equities to an overweight in emerging market hard currency sovereign bonds (EMBI), given that, in our view, these bonds looks closer to pricing our downside scenario than emerging market equities. We remain overweight US high yield credit, where spreads are close to our targets in a downside scenario. Given that we expect inflation expectations to rise from currently very low levels, we also overweight US TIPS versus highgrade bonds. We overweight a basket of select emerging market foreign exchange given very low developed market interest rates, and see the British pound as heavily undervalued relative to the US dollar.

How long will social distancing restrictions remain in place?

China has shown that the virus can be contained. It took two to three weeks after wide-scale quarantining measures were imposed for new cases of the virus to peak, and today, seven or eight weeks later, economic activity is close to returning to normality. Traffic in 19 major industrial cities is now at 89% of 2019’s level, and coal consumption is around 78 % of 2019’s level.

Similar types of restrictions on movement and activity have now been introduced across Europe and the US. In a good scenario, the social distancing measures in the US and Europe have the same effect as in China. This would allow new cases of the virus to peak by early to mid-April, and restrictions to be lifted from May and activity to normalize from around June. We could also reach the same result through pharmaceutical solutions, like anti-virals,  which help mitigate symptoms or development of a vaccine, or if it proves the virus spreads more slowly with warmer temperatures.

In a bad scenario, containment measures prove less effective in Europe and the US than in China. If halting the spread of the virus takes much longer and it continues to spread widely into May/June, restrictions would need to remain in place until June or July. Furthermore, the virus could resurface in countries or regions that had previously contained it, including China, requiring renewed intermittent restrictions for the remainder of the year. Softer restrictions would likely remain in place into 2021.

It remains too early to determine the success of social distancing in Europe and the US. The number of new daily cases continues to grow in most European countries, although a sign of hope comes from Vò, a town of 3300 people near Venice, where testing and retesting of all residents and tracking of their contacts have led to the number of new infections dropping to zero. According to the Wall Street Journal, health officials in Lombardy hope they will reach a peak number of cases within the coming week.

In our central scenario, we think that new cases of the virus in Europe and the US will generally start to peak by mid-April, allowing restrictions to start to be lifted from mid-May. However, the virus could prove hard to eradicate, and success will inevitably vary by country. As such, restrictions may need to be reimposed intermittently in some countries for the remainder of the year. We should also expect softer forms of distancing to persist in all countries throughout 2020.

Will governments provide enough support to prevent bankruptcies and job losses?

To stabilize markets, nations must show they are willing to socialize the costs of the temporary restrictions. It is now inevitable that GDP will contract in the second quarter across Europe and the US. The goal for economic policymakers now should be to help the private sector avoid job losses and corporate bankruptcies, allowing the economy to bounce back once restrictions are lifted.

Broadly, we estimate that, in order to do this, governments will need to transfer 1–2% of annual GDP to the private sector for every month that the restrictions remain in place. If properly structured, this would allow most small- and medium sized enterprises (the most important employers in most economies) to stay afloat, and provide some bailout packages for larger companies. Provided these transfers only occur for the duration of the crisis, and total less than 15–20 % of annual GDP, we think this can be achieved.

How do we calculate this? To pay most of the wages of half the SME employees in an economy would cost around 0.75 % GDP per month. Then, helping those at larger companies, for example in the airline, rail, hotel, retail, and leisure sectors, as well as covering some non-labour costs on top of that, gets us to a number between 1 % and 2 % of GDP.

Is this plausible? In short, we think it is, provided the total costs remain below 15–20 % of GDP. For context, between 2009 and 2012 the US government pro- vided fiscal support of more than USD 1.4trn, around 9 % of annual GDP at the time. US government spending more than doubled between 1942 and 1943.

Where do we stand today? Although the headline size of the packages announced, so far has been large (16 % of GDP for the UK, 15 % of GDP for Germany, 15 % of GDP for France, and 10 % of GDP for the US), the goal for elected officials now is to find the right mix between loan guarantees, deficit spending measures, such as payroll tax cuts, and direct support. Business loans and payroll tax cuts will not help if business owners decide to lay off staff, rather than take out government backed loans. But, the issue with government support appears to be more one of speed than willingness or ability at this stage. As such, our central scenario is that governments will ultimately do enough to avoid widespread bankruptcies and job losses, even if assistance comes too late, or proves too loose, to prevent some increase in unemployment.

The risk to our view, and the downside scenario, comes if restrictions last for more than five or six months. In this case, we think some governments may start to run up against the limits of their ability to fund themselves, and targeting help to affected businesses and individuals will grow increasingly challenging. If fiscal support needs to be reduced, or proves insufficient, bankruptcies and unemployment would rise sharply, both deepening the recession and slowing the recovery. Companies would forgo significant revenue. Shareholders, creditors, and banks would need to bear substantial losses.

Upside scenario. In our upside scenario, a relatively swift removal of virus restric- tions would mean no meaningful lasting damage to the economy, and the drop in interest rates should prove positive for both consumers, who can enjoy lower mortgage rates, and for risky assets, which are likely to attract inflows from inves- tors currently hiding in assets like Treasuries that offer near-term safety but meager long-term prospects.

We would expect the S&P 500 to reach 2,900 by year-end, a gain of 21% from 18 March levels, Euro Stoxx 50 to hit 3,050 (a 28% gain), and MSCI EM to reach 1,000 (27% gain). We would still expect USD HY to continue to see defaults of 3–4%, concentrated in the fragile energy sector and a few other structurally challenged sectors such as retail and leisure. But, despite the likely drag from these defaults, and rising government bond yields, we would expect 12-month total returns in credit to reach double digits (15–20% EMBI; 20–25% USD HY) from current levels.

Central scenario. In our central scenario, the coordinated monetary and fiscal response helps backstop most affected businesses and industries, and should help support markets through the course of 2020. But the negative effects of the economic contraction in the second quarter, some increase in unemployment, and intermittent restrictions through 2020, mean that the risk premiums remain elevated.

We would expect the S&P 500 to reach 2,650 by year-end, a gain of around 10 % from 18 March levels, Euro Stoxx 50 to hit 2,600 (a 9 % gain), and MSCI EM to reach 900 (14 % gain). For US HY, we would expect spreads to tighten from roughly 900bps to 550bps, and emerging market investment grade bond spreads to tighten to 450 bps to 630 bps.

Downside scenario. In a downside scenario, lengthy restrictions and reemer- gence of the virus mean that government and central bank support proves insuffi- cient to offset a sharp rise in unemployment and widespread bankruptcies. Share- holders and banks would need to bear the losses of significant forgone revenue. Any economic recovery in 2020 would be subdued, due to the negative demand effects of higher unemployment. Risk premiums would remain elevated through- out 2020.

We would expect downside by year-end of around 15% for the S&P 500 and around 25% for Eurozone and emerging market equities. That said, in this sce- nario, the actual trough of the market could be lower. In the three most severe post-war US bear markets, including the financial crisis, the market fell 42.6 %, 44.7 %, and 51 %—this would imply a trough of between 1650 and 1950 in the S&P 500, a further 20–30 % below today’s levels.

Meanwhile, we would expect US HY spreads to be at 1000–1500 bps by year end. This level is wider than their 2015 peak, when spreads reached 900 bps, although we think that the peak in spreads would likely fall short of the levels around 2000 bps reached during the 2008–09 global financial crisis. We would expect emerging market investment grade bond spreads to trade at 700–800 bps.

Where are the best risk-return opportunities?

On balance, we think markets, particularly the US HY and EMBI markets, are closer to pricing in the risk of our downside year-end targets materializing than our upside targets. However, as stated, there is meaningful downside for most asset classes should the envisioned virus containment and historic bailout packages fail to turn the tide on a situation that China seems to have stabilised in eight weeks.

Within equities, we see particular opportunities in those stocks with earnings rel- atively resilient to our virus scenarios, like companies exposed to the 5G rollout in Asia and global quality stocks; secular themes that can benefit from the current situation like fintech, ecommerce, online gaming, and online education; as well as those cyclical sectors which face risks, but which we think have been oversold, like China property stocks listed in Hong Kong, Japanese automation and machinery companies. At a time of elevated volatility, using put-writing or averaging-in strategies to enter these opportunities can be a way to mitigate timing risk.

How do I hedge against the risk of further declines?

We see four main approaches to hedging in the current environment: asset class diversification, geographic diversification, the use of alternative assets, and the use of dynamic asset allocation.

Asset class diversification. Bonds have worked as a diversifier in 2020, even if correlations have become unstable in some trading sessions. This has also borne out over the longer term. During S&P 500 bear markets the maximum drawdown has been 34.5 % on average, erasing 65 months of prior gains and taking 39 months to reach a new all-time high. However, for a 60/40 stock/bond portfolio, the aver- age maximum drawdown was 19.9 %, erasing 20 months of prior gains, and taking 30 months to regain the former cycle peak.

Looking ahead, with 10-year US Treasury bonds yielding little more than 1 %, the value of holding long-term bonds may appear more limited. But, even if the Federal Reserve proves reluctant to lower policy rates below zero, Treasuries still function as a form of portfolio insurance by helping to protect principal.

Geographic diversification. This crisis will present, and is already presenting, a significant challenge for individual countries. As we consider the variation countries are likely to experience in dealing both with the virus and with propping up the economy, the views I expressed in November 2017’s letter “Dealing with disaster,” remain as pertinent now as then:

“Since 1900 the world has seen at least a dozen hyperinflations, 20 recessions, almost 200 sovereign defaults or debt crises, two global financial crises, and 12 bear markets. The geopolitical picture was even worse: seven global pandemics, two world wars, hundreds of civil or regional wars, more than 2000 nuclear detonations, and revolutions in both the world’s largest and most populous countries. [Yet] all the episodes of potentially irreversible loss [in the past century], due to inflations, wars, and sovereign defaults, were localized. Concentrated regional risk was, and is, investors’ biggest potential wealth destroyer. Preventing unrecov- erable capital destruction has been about global diversification.”

Alternative assets. After rallying through the initial phase of the COVID-19 out- break, gold prices have plunged in recent days, due to investor deleveraging. From here, although volatility is likely to remain high in the near term, we think prices will be supported by uncertainty about the virus, low real rates, and a weaker dollar, and could be further supported if global government spending surges. We maintain our forecasts of USD 1600–1700/oz over 12 months. We also view the current situation as creating  potentially  attractive  investment  opportunities for private market investors. Historically, the best vintages for private equity firms have often coincided with dislocations in public equity markets, for example in 2001 and 2008. The current disruption may present opportunities to get Asian exposure at more attractive valuation levels. Opportunities for funds specializing in turnaround and distressed situations are also likely to increase the longer the disruption continues.

Dynamic asset allocation. Some investors might recall selling during the global financial crisis, or Eurozone crisis, but also failing to get back into the markets in time. A dynamic asset allocation strategy, based on a quantitative framework, can help investors dispassionately judge market information and economic data, allowing them to exit markets during volatile times, and, importantly, also reenter them when data suggests peak uncertainty has passed. Such strategies will likely never sell at the absolute peak or buy at the absolute trough, but they can increase the chance investors avoid the most volatile days, and regain exposure during a more sustained uptrend.

Asset allocation

In our portfolios, we have been taking action by diversifying our equity exposure, through using risk reversals to replace some direct equity exposure. We are also diversifying into assets that we think are closer to pricing in downside scenarios. We now shift our overweight in emerging market equities to an overweight in emerging market hard currency sovereign bonds, given that, in our view, EMBI looks closer to pricing our downside scenario than EM equities. We remain over- weight US high yield credit, where spreads are close to our targets in a downside scenario. Given that we expect inflation expectations to rise from currently very low levels, we also overweight US TIPS versus high grade bonds. We overweight a basket of select emerging market foreign exchange given very low developed mar- ket interest rates, and see the British pound as heavily undervalued relative to the US dollar.

We use risk reversals to take US and Eurozone equity exposure. Given high levels of market volatility, timing risks are high. We try to alleviate this risk by diver- sifying some of our equity exposure into option strategies, selling out-of-the-money put options on US and Eurozone equities to fund closer-to-the-money call options. This strategy allows us to participate on the upside in case of a sharp rally, for instance in the event of positive news on the virus or government stimulus, while also increasing equity exposure if markets fall.

We open an overweight to emerging market hard currency sovereign bonds (EMBI) versus high grade bonds.

We open an overweight to emerging market hard currency sovereign bonds (EMBI) versus high grade bonds. EM sovereign bonds look the most attractive asset class in the credit universe in our view. Yield spreads have widened to more than 600bps from 290bps at the start of the year, are at the 96th percentile of values in the last 15 years, at a post financial crisis peak, and are close to pricing in our downside scenario.

Technical factors have added to downside pressure, with record ETF outflows and illiquid market conditions, which have opened up an attractive risk premium. We estimate that EMBI high yield spreads of around 1,000 bps are pricing in a default rate of roughly 11 %. Oil-exporting HY issuers could face further downside, but are already trading at distressed levels with spreads in excess of 1,000 bps, and are only 10 % of the index.

Since 2000, there have been 52 months with EMBI spreads in excess of 500 bps. Subsequent 12-month total returns were positive in all cases, with a median return of 13 %. Risks to our position are near-term overshooting of spreads due to secondary market illiquidity, and/or further USD strength weighing on funding conditions.

We overweight USD high yield  (HY)  bonds  versus  high  grade bonds. HY bonds have suffered during the recent market correction, with illiquid market conditions exacerbating the spread widening. At current spread levels around 900bps, the asset class is pricing in defaults of 9–10 %, and is close to pricing in our downside scenario. In the near term, wider spreads are still possible under current market conditions, but we advise against selling in such an illiquid environ- ment, and see medium-term value in the asset class. Since 1987 there have been 42 months with spreads in excess of 800 bps, and subsequent 12-month total returns were positive in all cases but one with a median return of 24.5 %.

We overweight Treasury Inflation Protected Securities (TIPS) against high grade bonds. TIPS will outperform if realized inflation comes in above the current very low US five-year breakeven rate of 0.2%. As we don’t expect COVID-19 to have a long-lasting impact on forward US inflation expectations, we think such an outcome is likely.

We overweight the British pound versus the US dollar. Sterling dropped to its lowest level against the USD since 1985 on 18 March, trading below 1.15. The main reason for the move, in our view, was increased demand for dollar funding, reduced lending activity by global reserve managers, and less liquidity in US money market funds. Illiquid market conditions exacerbated the size of the moves, amid concerns that if London were locked down market liquidity would be severely impacted, though this has now been alleviated by renewed quantitative easing from the Bank of England. Looking ahead, sterling is significantly undervalued (our estimate of GBPUSD purchasing power parity is 1.57). And negotiations on the future trading relationship between the UK and the EU appear to be on hold and not a priority for either side, so the end of the transition period may have to be delayed beyond end-2020. Against this backdrop, as the Fed and other central banks coordinate to provide dollar liquidity across the globe through tools such as swap lines, we expect dollar funding concerns to dissipate, which could then lead to a sharp rebound in Sterling.

We overweight a basket of high-yielding emerging market currencies. We hold an overweight position in the Indonesian rupiah (IDR), the Indian rupee (INR), and the Brazilian real (BRL), funded by short positions in the Australian dollar (AUD), the Taiwan dollar (TWD), and the Swedish krona (SEK). Increased volatility and broad-based dollar strength driven by funding concerns have created a more challenging environment for carry trades, and our basket has undergone a correc- tion, but the construction of the basket (with high beta currencies on both sides) has smoothed performance. In an environment of low developed market interest rates, we expect the environment for carry trading to improve once dollar funding conditions normalise.