Government’s risk of insolvency puts pressure on markets

After three months of strong positive reaction, based on surprise at the intensity of monetary and fiscal stimuli provided by the governments of different countries, especially in the United States, the financial markets have started to move sideways. This can be seen in the American (S&P 500), European (STOXX 600) and Brazilian (IBOVESPA) stock markets, and in exchange rates (DXY and R$/US$, for example), which for months fluctuated in relatively narrow ranges. In the meantime, two main variables have determined investors’ mood swings.

One is the pandemic’s dynamics. Signs of progress in the discovery of an effective vaccine have generated optimism and increased risk appetite. On the other hand, indicators showing the resurgence of the pandemic have pushed asset prices downward, apart from government bonds in developed economies.

This is partly what happened in the last few weeks, when there was a worsening of the pandemic in Europe, with a significant increase in COVID-19 cases, which already exceed the peak of the first wave. It is true that this is partially caused by greater testing now. This helps to explain why, despite the strong acceleration in new cases, the daily number of deaths, despite increasing, has remained low and far below the level recorded during the first wave. This may limit the use of measures to restrict urban mobility and close businesses.

Several European governments have implemented measures to restrict mobility, and some epidemiologists have called for total lockdowns. This has led global markets to fall back, together with increased risk aversion and appreciation of the U.S. dollar. Markets believe that the economic recovery will only persist when mass vaccination is guaranteed. Despite advances in the development of various vaccines, companies are unlikely to obtain the necessary approvals before the end of the year. It will then be necessary to produce and distribute the vaccines on a large scale, prolonging the period until the health situation is under control.

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