Rabo: Positive Vaccine News Means Central Banks Will Have To Disappoint Tyler Durden Wed, 11/11/2020 - 11:19 By Edwin de Groot, head of macro strategy at Rabobank Most European equity markets still showed gains in the range of 0.5% to 1.5% yesterday, with Spain’s IBEX standing out with a 3.4% gain. US equities, on the other hand, were broadly unchanged, but with tech stocks clearly underperforming. Government bond yields inched up several basis points on both sides of the Atlantic. In currency space, movements were modest, with NZD being the odd one out, appreciating no less than 0.8% (more on that below). One could argue, then, that some sense of reality returned to markets as investors are trying to gauge the point where economies will be allowed (and are able) to return to ‘normal’. This, of course, in the wake of the news on Monday that the Pfizer-BioNTech was the first to report stage-three clinical trial results, claiming 90% effectiveness. Without going into the many questions that are still out there on the vaccine itself, for the economy (and markets) the key question of whether the economy can return to ‘normal’ hinges crucially on whether and when a significant share of the population (say 60% or more) has been inoculated. Surely, governments will go into overdrive to achieve such goals. European Commission President Von der Leyen stated yesterday that “tomorrow we authorize a contract for up to 300 million doses of the vaccine”. And while German health minister Jens Spahn warned in a news conference yesterday that the vaccine would not be available before Q1, he expects it to be approved quickly. Altogether this points at mass inoculation starting in the course of 2021H1. Such a trajectory –if copied by other European countries– would broadly match the assumptions we made earlier this year when assessing the prospects for the economy in 2021. In other words, it merely confirms our assumptions rather than really putting things in a different light. But the recent developments obviously take away a number of, but certainly not all, uncertainties. And this is probably the best way to view the market reaction since Monday. But for markets, we would argue, this is not the end of the story. For starters, there is still a sizeable period of time that needs to be ‘bridged’ before we are actually get there. Reports on the spread of Covid-19 are not encouraging in many places, with in excess of 142,000 of new daily infections in the US being just one of them. More importantly, perhaps, is how central banks will operate as we remain in the ‘twilight zone’ in the next few quarters. After all, action often leads to reaction. If interest rates markets were to move ahead and expectations would turn too quickly this raises the risk of a sharp turnaround in market sentiment. That would not only nip the recent rally in the bud, but could even have economic repercussions. After all, governments are likely to be needing more cash first, in order to mitigate the economic impact of their new containment measures. Case in point is Italy. Bloomberg reports that Italy may need to spend as much as 10 billion euros ($11.8 billion) a month to support businesses and workers. If the lockdown measures stay in place until March (which does not seem unreasonable), this would cost the Italian government between EUR40-50bn (3% of output) according to ‘people familiar with the discussion’. As has been demonstrated earlier this year, this does not necessarily have to be a problem if governments and central banks cooperate, but in the light of the vaccine news flow it may prove harder for central banks to outdo on the dovishness demonstrated earlier this year. On that note, comments by ECB’s Knot and the RBNZ decision carry some weight. As expected the RBNZ announced a Funding for Lending programme overnight stating that it will reduce banks' funding costs and reduce interest rates. The Large Scale Asset Purchase Programme will continue up to NZD100 bln with the Cash Rate on hold at 0.25%. The Bank also warned that progress has been made on its ability to deploy a negative Cash Rate. The RBNZ is one of the first central banks to react to this week’s positive news about a vaccine. It says that "while recent news on vaccine developments is positive, there remains a long and uncertain lag before widespread vaccine deployment may be achieved". New Zealand has been very successful at preventing the spread of the coronavirus but says that the shock to the economy "is very large and persistent and inflation and employment targets will remain below the remit targets for a prolonged period". The markets, however, were not listening to the dovish overtures. New Zealand’s success in containing the pandemic combined with optimism about a vaccine meant that the central bank’s warning about a negative interest and the potential purchase of overseas asset fell on deaf ears and NZD/USD pushed higher. Knot yesterday said that the vaccine new “confirms that we can be hopeful”. It is of course not a surprise that one of the Council's more hawkish members takes the Pfizer news as a good moment to push back a bit. And indeed, the prospect of a viable vaccine probably reduces the likelihood of the worst case scenarios when the ECB next convenes. And while this definitely does not eliminate the need for further policy action (especially after the pre-announcement last month), diverging views in the Council could reduce the size of the upcoming stimulus somewhat. Recall that -prior to the October meeting- analyst consensus saw an ~500bn increase in asset purchases, whereas we called for a more modest 250bn in December. We since found support for a somewhat smaller increase in Lagarde’s steering towards a broader stimulus package (we additionally expect LTRO easing), as well as this virus news. If more Council members agree with Knot’s assessment, we should start to gradually see more verbal guidance carefully steering towards such an outcome, if the ECB wants to avoid potentially disappointing the market in December. To that end, particularly the reactions of the neutral to more dovish ECB members to the vaccine news will be of interest. The RBNZ and Knot comment highlight the risk that markets may take the vaccine news flow itself as a cue (rather then what central banks say themselves). This would either imply that central banks may have to disappoint at some stage or that they will have to ‘manage’ expectations in the period ahead. Both scenarios could push up rates or dent risk appetite.