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From green to a shade of vermilion is the latest story for risk appetite over the past 24 hours.

This reflects pressure from a variety of sources. New US tariffs on European exports are under consideration (See Quick Hits) while fresh cases of Covid-19 are registering against the backdrop of economies opening up. Finally, in the wake of the Nasdaq hitting a new peak this week, there is little shortage of angst about ever-loftier valuations, prompting a modest pullback in risk appetite.

Of all these elements, the trajectory of new Covid-19 cases looms as the most important factor in the near term, given what that entails for any recovery in economic activity. The general view is that localised containment measures will prevent the need for broader shutdowns that weigh even more on an already dour global economic outlook from the IMF.

As shown via the FT, cases are accelerating in parts of Texas, Florida, Arizona and California.

Covid-19 cases continue to surge in the south and west US. Seven-day rolling average of new cases, by number of days since 10 average cases first recorded

Ian Lyngen at BMO Capital Markets observes:

“A longer road to the new normal certainly wouldn’t be a positive for risk assets, but much less damaging to the outlook than a full shutdown.”

But a longer and winding path of recovery towards a “new normal” still leaves a deep economic pothole. Indeed, the latest IMF outlook estimates that global gross domestic product at the end of 2021 will be 6.5 percentage points smaller than it was at the start of this year.

Marc Ostwald at ADM Investor Services highlights this chart of US leisure/recreation footfall levels and observes:

“Urban areas with the highest GDP remain much further away from recovering to pre-Covid-19 levels than lower GDP/more sparsely populated areas, per se underlining that the path to recovery still looks likely to be a long one.”

And for all the focus on the sharp rebound seen by asset prices, led by tech stocks and an investment grade credit market, bolstered by the hefty presence of the Federal Reserve, one equity market signal suggests a degree of wariness prevails.

Measures of implied volatility for equities remain elevated, when looking at the Vix for the S&P 500 and that of the Euro Stoxx 50. The US Vix has an average reading of 19.6 since its inception in 1990. At a current level above 30, this measure remains in the red zone.

Julian Emanuel and Michael Chu at BTIG highlight via this chart:

“In 30 years of data, Vix between 25 and 45 has been accompanied by large net declines for the S&P 500; positive stock returns are skewed toward the low volatility regimes (January and early February 2020) and the market reversals from the ‘blowout’ vol spikes (March/April).”

Monetary and fiscal stimulus efforts are doing a good job for now of averting attention from the danger that the rebound in economic activity from shutdowns eventually settles into one of low growth, and beyond the tech juggernauts, the prospect of broad earnings per share not meeting current expectations.

One notable beneficiary of the current uncertainty has been gold, with the price back at an area last seen since 2012 near $1.780 an ounce — up 16 per cent on the year and 25 per cent over 12 months — bolstered by a broadly weaker US dollar and negative real yields that are adjusted for inflation. But the push towards $1,800 an ounce lacks conviction, which should merit a warning for near-term bulls.

Saxo Bank’s Steen Jakobsen notes that gold’s latest rally has not triggered “a cascade of fresh buying” and that suggests many investors already own the commodity. Steen adds:

“The break occurred without a similar move from silver which remains perched below $18/oz.”

So a push towards $1,800 an ounce requires a bigger drop in the dollar and much lower real yields. The US 10-year Treasury real yield is about minus 0.66 per cent, quite a shift from minus 0.36 per cent earlier this month. The benchmark set a low around minus 0.9 per cent in late 2012, and a push towards that area is required for further gains in the price of gold.

This chart via Bill O’Donnell at Citi, clearly highlights the relationship between real yields and gold.

With even the 30-year Treasury real yield below zero, the message from the bond market is one of stagnant long-term growth, an outcome that suggests a lot more stimulus beckons to arrest such an outcome. In that climate, demand for gold — a non-yielding asset — duly rises, reflecting concern that central banks will do all they can to foster inflation and a weaker currency.

The steady decline seen in US real yields during recent months has been accompanied by bond market expectations for inflation over the coming decade rising towards 1.4 per cent, from a March nadir of 0.55 per cent. Higher inflation expectations from here rely on deeply negative real yields.

John Normand at JPMorgan thinks gold pushing through $2,000 an ounce requires a descent in 10-year real yields, into a minus 1 per cent to minus 2 per cent range.

Quick Hits — What’s on the markets radar?

Tariffs are back making waves with the US considering new levies that amount to $3.1bn on a range of exports from France, Germany, Spain and the UK. This reflects the US-EU spat over aircraft subsidies and stuck in the middle of all this, the WTO has opened the door to both the US and Europe for being able to retaliate.

Analysts at Brown Brothers Harriman speak for many:

“This is not the time to engage in a trade war and [we] simply cannot believe that the WTO can’t come up with a better solution.”

The US is looking at deploying further fiscal stimulus and even delaying the filing of taxes beyond an already extended deadline of July 15.

Paul Donovan at UBS Global Wealth Management says:

“So far, fiscal policy has been about transfer payments — less a stimulus, more an antidepressant. As lockdowns end fiscal policy will need to move to address the spare capacity that has built up in economies and labour markets — which means more than delayed tax payments.”

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I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.

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