Short-term headwinds but clouds lifting next year

Good news on the COVID-19 vaccine front has raised hopes that we can get back to some kind of normality more quickly than previously thought. Phase 3 trials from both Pfizer/BioNTech and Moderna have shown very high efficacy of 95% and if authorities approve the vaccines, they will be ready to be rolled out starting within a few months.

However, in the meantime, both the US and Europe are facing a tough winter. The US has seen a further acceleration of the spread of the coronavirus lately and hospitalisations have reached a new high. Many states have imposed new restrictions to reduce contagion, hurting economic activity in the service sector in particular. Europe is seeing improvement following similar lockdown measures but concerns linger over more waves as social gatherings pick up around Christmas and the colder weather leads to more contagion. Hence, limitations such as caps on social gatherings and opening hours for bars and restaurants could last for a long time.

On the economic front, we already see signs of slowing activity. High frequency data point to slowing growth in Europe and some survey data have rolled over. In the US and Europe, we expect to see a renewed downturn in Q4 and Q1 before we project a recovery from Q2, when the effect of the vaccine roll-out and warmer weather could lead to a removal of restrictions more permanently. Next week, we are set to get Flash PMIs for November in both the US and the euro area, where we expect to see a setback in service PMI. The German ifo business confidence index is also due for release and may take a small hit from the new restrictions related to the COVID-19 pandemic.

Uncertainty has arisen over the EU Recovery Fund this week. Hungary and Poland vetoed the ratification of the EU budget and the recovery package over concerns about the rule-of-law mechanism. The German Council presidency and other EU leaders have so far tried in vain to placate their concerns. Overall, we do not expect the new row to scupper the whole EU budget and next-generation EU package and a compromise solution remains in everyone's interests, as the economic costs of the pandemic mount and Eastern European countries are among the biggest beneficiaries of the recovery fund funds. However, the unanimity requirement in the EU budget approval process opens up the risk of further delay in the flow of funds in 2021.

Chinese data for industrial production and retail sales in October were strong, underlining the robust recovery. However, we expect the growth momentum to lose some pace soon, as the effect of the stimulus fades from Q1 and exports suffer from the downturn in US and Europe.

Brexit negotiations are entering a crucial phase and the two sides are still struggling to come to agreement. However, it is not unusual for a deal to be reached last minute and we still see 60% probability a deal will be reached this year.

Stock markets have been mixed this week, as the rally following positive vaccine news is tempered by the worsening of the US coronavirus situation. Bond yields drifted lower as short-term economic weakness may trigger more central bank easing. EUR/USD continues to move in the 1.17 to 1.20 range seen since the summer months.

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