Will Mass Immunization Turn Out Negative For Markets?

Mass immunization against COVID-19 could begin as early as mid-2021 – sooner than policymakers and market participants expect. And when it does, the US economy will be off to the reopening races. Policymakers could be slow to reduce support, which would see the curve steepen and equity markets sell off. Consequently, the Fed could face an uncomfortable choice between inflation stabilization and financial stability.

What if Mass Immunization Started Tomorrow?

Rather than the disease itself, it has been policies intended to slow the spread of the epidemic and contain public panic that have caused the COVID-19 downturn. Yet both government-mandated business restrictions and public panic will cease with mass immunization, and a fast return to economic normality could follow.

Louisiana’s experience following Hurricane Katrina gives a sense of the timeframe involved in a return to pre-COVID-19 activity levels. Due to massive infrastructure destruction in New Orleans, Louisiana took two years to return to the pre-hurricane employment levels. This time around, with no physical destruction, a return to pre-epidemic employment could take just two quarters. Some of the reasons for this are; 1) most employers will probably survive largely intact thanks to ongoing re-openings, exceptional policy support and a rise rather than spike in bankruptcies and 2) the unemployed remaining highly employable.

COVID-19 Vaccine: This Time Around it’s Different

Mass immunization could happen around mid-2021, faster than most policymakers and market participants expect. The fastest vaccine ever produced was the Ebola vaccine that took four years from start to mass distribution in 2019. This was a quantum leap from previous vaccines, the development of which had stretched over decades. This time around industry professionals, as well as the Good Judgement Project ‘super forecasters’, expect mass distribution of a COVID-19 vaccine around mid-2021, which would make for about an 18-month production and mass distribution cycle.

This ambitious goal is plausible in my view because more than 125 vaccine candidates are already in pre-clinical trials; the scale of resources mobilized is unprecedented; pharmaceutical companies stand to make very large profits; new technologies have been deployed; and testing, production and distribution are being run in parallel rather than sequentially.

Policymakers Will Have Very Little Time to Unwind a Very Large Stimulus

Based on a December 2020 announcement of vaccine selections and on mid-2021 mass distribution, the economy could return to its pre-crisis employment level (or about 5% unemployment) by December 2021 (Chart 1). This recovery speed would be unprecedented but then so is the nature of the downturn, basically a government-induced economic coma.

Policymakers are unprepared for such a scenario and would face a quandary. In order that the economy gets to the point of mass immunization with its full supply capacity, monetary and fiscal policies will have to remain very supportive until then. But once mass vaccination begins, the closing of the output gap will happen rapidly. Policymakers will have to calibrate the withdrawal of support in such a way as to engineer a soft landing, which is likely to be challenging.

The Market Consequences of Mass Immunization

The US economy is therefore likely to be hurled into a very fast-paced recovery with an unprecedented amount of fiscal and monetary stimulus. The huge build-up of liquidity, not only at money market funds and banks but also at the Fed where reserves could be headed north of $4tn by end-2020, is likely to translate into either CPI or financial asset price inflation.

CPI inflation appears more likely than asset price inflation for two main reasons: with the Fed likely on hold until 2022, the yield curve is likely to steepen; a steeper yield curve could lead to an equity selloff as equity markets are likely to get to mid-2021 with elevated valuations. Following the March-April policy stimulus, markets are back in TINA (there is no alternative) mode where low yields, low growth and headline macro risks lowered by Fed support create a bid for equities, even at unattractive valuations (Chart 2). The SPX could easily rise by another 10/15% from current levels. A rise in inflation expectations could, however, create concerns that the Fed ability to support markets will diminish. In this context, curve steepening could lead to an equity selloff.

With financial markets selling off, MMF and bank deposits are more likely to fund pent-up consumption and investment, including residential real estate, rather than financial asset purchases. In turn, this will add momentum to the recovery and validate rising expectations of growth and inflation.

Because markets are forward looking, the sequence of policies and economic moves I have described could get discounted as soon as the announcements of mid-2021 mass immunization become credible, sometime in 2021 H1. If so, this could create an uncomfortable situation for the Fed where it could face both a risk of rapid closing output gap and of marked equity and bond markets selloff. It will take all of the Fed’s expertise to keep both inflation and financial markets under control.