Markets are in better shape but they haven't priced in the warnings on what's to come

Markets ended April in good shape, with major indices rallying and optimism growing that movement restrictions will be eased this month as countries enter the next phase of the coronavirus crisis.

Despite economic data demonstrating the devastating effect of lockdowns over the past two months, many investors think their relaxation will give way to recoveries in the second half of the year with the hope the negative fallout will be short-lived, especially if a treatment or vaccine for Covid-19 is found.

Markets, however, are still overlooking warnings from policymakers that returns to normality could actually take much longer. The European Central Bank’s chief economist Philip Lane says it could take at least three years for the eurozone’s economy to recover to where it was before the crisis. Markets are also overlooking warnings from scientists that a vaccine will take much longer to be found, while companies are becoming more circumspect about the outlook issuing cautionary guidance or even no guidance at all due to the immense challenges they are facing. As such, there are still plenty of reasons to remain wary of the pace and extent of recent equity market recoveries.

Casting a further shadow over the future is the resurrection of the issue that dogged markets throughout last year – the US-China trade dispute – as US President Donald Trump calls for China to be held accountable for the coronavirus pandemic. Somewhat ominously, markets started the first day of this month by dropping sharply following tweets from Mr Trump demanding an investigation into Covid-19’s origins and hinting at retaliation against Beijing. Mr Trump is clearly weighing the political benefits that might accrue from threatening China as the US approaches the presidential election in November, which might outweigh any perceived costs to the economy and even to markets.

It is not certain yet what path Mr Trump will choose to go down, but the mere mention of a return to tariffs and the possible consideration of cancelling debt obligations to China are clearly things that make financial markets very nervous, especially so soon after the trade war ended and in the midst of the worst global recession in decades.

Having signed the first phase of a trade deal in January, which wound down trade tensions between the US and China and brought an end to the introduction of new tariffs, markets were hopeful that phase two talks could begin later this year.  This now looks very unlikely, especially with political pressures in Washington starting to build.

Mr Trump’s opinion poll ratings are consistently trailing those of his likely Democrat rival Joe Biden, and in the past 70 years no president with ratings as low as Mr Trump’s (in the mid-40 per cent) at this stage of a campaign have then gone on to win. With time running out in the run up to November, and with the economy unlikely to give him the clear validation he assumed it would prior to coronavirus, populist moves against China seem to be a likelihood in the coming months.

However, with jobs and the economy at risk, playing the China card will not be as straightforward as it was last year. The White House will have to tread very carefully in articulating its case, and more importantly in implementing it. Last week’s volley of accusations blaming China for the pandemic might simply be a case of testing the water, to assess the market reaction and also the effect on Mr Trump’s ratings. Depending on what they show, the Trump Presidency will have to decide how far it can go in terms of reigniting a trade war.

The other dynamic that needs to be taken into account is the progress countering the coronavirus itself. Should the easing of movement restrictions proceed without giving rise to a resumption of Covid-19 cases, then it may be calculated that risks can be taken in the area of trade and tariffs. But if the markets start to become vexed again by prolonged restrictions and easing delays, which is a clear possibility, then the danger of adding another source of tension may become a risk too far.

Tim Fox is chief economist & head of research at Emirates NBD