The coronavirus continues to ravage mainland China unabated with confirmed cases exceeding the 20,000 mark while deaths have now climbed above 425. However, for now global markets view this as "China only" issue. Investors won't panic unless the deaths start to show up ex-China especially in the West as home country bias pervades. However, this has started happening and there are reportings across the globe.
Hyundai suspends some South Korean plants operations due to lack of parts arriving from China. Japan pm Abe mulling expanding entry refusal due to virus. South Korean woman tests positive after visiting Thailand.
- US S&P 500 index trading 3.5% below recent all-time highs
- UK FTSE 100 index has declined just over 5% from the January peak
- Brent has also moved sharply lower with the international benchmark declining 13% within the past two weeks
- Commodity currencies, the Australian dollar, Canadian dollar and New Zealand dollar have all lost significant ground.
- Safe havens such as the US dollar and Japanese yen have been the winners.
The coronavirus will continue to disrupt the Chinese economy with a sharp first-quarter slowdown. Dangers to the global economy will be magnified by the fact that US-China trade has been damaging. China’s share of global trade has also risen sharply and supply-line dependency has increased. Global growth overall is liable to weaken to the lowest since 2008/09 after first-quarter weakness, but with a recovery from the second quarter. The main short-term impacts will be weaker global equities and a decline in oil prices.
In currency markets, the Japanese yen and Swiss franc exchange rates will continue to gain support with the Euro also securing limited support. Commodity currencies will remain vulnerable with the Australian dollar notably at risk. Pound Sterling will be vulnerable if the global economy slows. Peak fear is likely during the current quarter.
Coronavirus outbreak intensifies
An outbreak of a new disease was reported in the Chinese city of Wuhan in late-December 2019. After initial uncertainty, the virus was identified as a new coronavirus officially known as 2019-nCOV.
Coronaviruses cause a range of symptoms from mild in the common cold while others are more severe and likely to lead to pneumonia. Officially, the number of cases as of Monday February 2nd has increased to near 17,500 with the number of deaths over 360. International estimates of infection rates based on the global spread have suggested the number of cases in China is very substantially higher. The Lancet, for example, estimated that the number of cases in Wuhan must have been over 75,000 as of January 25th and much higher by now. The number of international cases is still limited at around 140 with one reported death outside China.
How deadly is this virus?
Although there is a high degree of uncertainty, the virus’ mortality rate appears to be around 2%. Another notorious coronavirus was Severe Acute Respiratory Syndrome (SARS), first identified in November 2002 and traced back to China’s Yunnan province.
Between November 2002 and July 2003 close to 8,100 cases reported with 774 deaths across 34 countries. The mortality rate for SARS was, therefore, just under 10% while in the 2012 Middle East Respiratory Syndrome (MERS) outbreak the death rate was over 30%.
Another valid comparison would be with influenza, although there is a large range of mortality rates depending on the strain. The 1918 epedemic had a death rate of around 20%, but, in most years, the mortality is around 0.2%. The potential impact on the global economy should be measured if the mortality rate is held at 2% or lower and long-term health is not compromised.
Is it treatable?
Any vaccine for the virus is likely to unavailable for several months, but alleviation of acute symptoms would be beneficial.There have been reports that a combination of HIV and anti-flu drugs has been successful in treating patients with the coronavirus. Any successful treatment would increase confidence that the overall impact could be much less severe even if there is a global pandemic.
The containment battle continues
China has responded forcefully in an attempt to limit the virus’ spread. Many cities internally, including Wuhan, are now under lockdown. Foreign nationals returning to the UK from Wuhan are being put into quarantine in an attempt to limit the contagion threat, but the risk profile remains high.There has been a substantial increase in air travel since the SARS outbreak. The number of air passengers in China increased to over 600mn 2018 from 56mn in 2001 while the number of rail passengers has increased by over 50% despite a decline from historic peaks. This increase in volume will substantially heighten the risk of infection being transmitted across China and internationally.
The World Health Organisation (WHO) has declared a global emergency, but it was optimistic that containment efforts would be successful and also called for international borders to remain open.The number of cases reported internationally is still low, but inevitably there will be a significant increase over the next few days.Many global airlines, including British Airways have suspended all flights to China in the short term and the US Administration has issued a level-4 alert which advises US citizens not to travel to China.
Chinese New-year holidays extended
During the lunar new-year period, a huge number of people travel within China as workers return to their home towns for the festive period. This mass transit made it much harder to contain the virus.Chinese authorities have extended the new-year holidays to at least February 10th with property-developer Evergrande, for example, stating that it would extend the break until February 16th with no fresh construction until February 20th.
Chinese financial markets re-opened on Monday after an extended new-year break.Ahead of the open, the Chinese central bank stated that it would provide CNY1.2trn in liquidity. There were also technical changes with out-of-hours futures trading suspended and investment rules relaxed to prevent forced selling.Commercial banks have also been requested not to call in loans for companies in infected regions and increase overall lending.Chinese officials have offered reassurance with a raft of comments from the National Development and Reform Commission (NDRC).
The NDRC stated that it was confident of minimising the economic impact and the effect will be only short term. Micro measures will also be taken such as the release of pork stockpiles. It also will guide small and medium-sized companies as soon as possible to provide basic services.
How have global markets reacted?
Global risk appetite has inevitably deteriorated across all asset classes.Equity markets have weakened with the S&P Index trading 3.5% below recent all-time highs. European and Asian bourses have also come under pressure with sharp losses in Hong Kong of over 10% despite a slight recovery on Monday.
The UK FTSE 100 index has declined just over 5% from the January peak. The overall market reaction, however, has been relatively contained.
Oil prices decline sharply
There will be an impact in undermining oil demand, especially if there is a significant damage to global travel. Oil prices have already declined with WTI dipping to 4-month lows below $52.0 p/b. Brent has also moved sharply lower with the international benchmark declining 13% within the past two weeks and trading at the lowest level since December 2018 before a marginal recovery.OPEC may bring forward its scheduled meeting to February and consider deeper cuts production cuts, but demand concerns will continue and investment banks have cut their forecasts.
Citibank has slashed its first-quarter Brent oil estimate to $54 a barrel from $69. Reductions in projections for the following two quarters are based on its view the virus will have a longer and deeper impact than previously anticipated. It said the global crude benchmark could fall as low as $47 a barrel, which would be the weakest level in two and a half years.
According to Bloomberg, oil demand in China, the world’s biggest importer, has dropped by around 3 million barrels a day, or 20% of total consumption, according to people with inside knowledge of the country’s energy industry.Citi cut its second-quarter crude forecast to $50 a barrel from $68 and its estimate for the following three months to $53 from $63. It revised up its fourth-quarter projection to $58 a barrel from $57.
Wider losses in commodity prices
As well as a slide in oil prices, there have been sharp losses across the commodities complex with copper also at 4-month lows with a January decline of close to 10%.Iron ore prices quoted in China also declined very sharply by over 10% as the Dalian market re-opened on Monday following the trading suspension.
Defensive assets strengthen
Within currency markets, there has been increased support for the Japanese yen and Swiss franc with USD/JPY retreating from 8-month highs above 110.00 to trade at 3-week lows just below 108.50 while EUR/CHF is at 33-month lows below 1.0700. USD/CHF has also come under further pressure to near 0.9600 and close to 3-year lows.
Investors will also be attracted by assets with high liquidity. In this context, US Treasuries will also gain significant support as they remain the most liquid global asset.The yield on the 10-year bond has already declined to 3-month lows near 1.50%. The US dollar index has already lost ground and a lack of yield support will undermine the dollar.US markets are, however, the most liquid in the global economy which will attract funds. Liquidity levels will be extremely important over the next few weeks.
Concerns over a lack of liquidity will tend to undermine emerging-market currencies. Asian currencies will be at risk if regional infections increase.Any further decline in energy prices would continue to undermine the Canadian dollar. Wider losses in commodity prices would continue to damage the Australian dollar. Gold would tend to gain support, although buying has been measured so far. Chinese and Asian investors could be drawn to cryptocurrencies with bitcoin trading close to 2-month highs.
Pound Sterling will not be immune
Commodity-linked currencies have come under sustained pressure with heavy losses for the Australian dollar with the AUD/USD exchange rate at 4-month lows.Pound Sterling has made strong gains with the GBP/AUD exchange rate trading at 3-year highs near 1.97 before a correction. There have also been gains to 6-week highs for GBP/CAD and GBP/NZD.Sterling was boosted last week by the BOE decision not to cut rates. Nevertheless, the UK economy is dependent on global trade and Sterling will tend to be vulnerable if there is a notable damage to the global economy.
What will be the Chinese economic impact?
China’s official PMI manufacturing index was little changed at 50.0 for January from 50.2 the previous month while the non-manufacturing index strengthened to 54.1 from 53.5 previously. The Caixin PMI manufacturing index, however, retreated to a 5-month low for January. Starbucks has closed half of its outlets in China and those that are open are suffering from stock shortages while McDonalds has closed hundreds of outlets.
If Chinese factories remain closed or operate at reduced capacity, strains in the global supply chain will intensify.Bloomberg Economic estimated that first-quarter Chinese consumption growth will dip by more than half from the 5.5% recorded in the fourth quarter of 2019.JPMorgan on Wednesday, revised China's growth projections down to 4.9% for the quarter, from 6.3%. Sectors like tourism, transportation, offline retail, and entertainment will be hit the hardest,. "The Lunar New Year holiday is usually the golden season for consumer spending, and the fear factor and stay-home control measures have almost paralyzed the above-mentioned vulnerable sectors."
Global economy also tipped to weaken
Global tourism will certainly feel the impact given that the largest number of international visitors comes from China. Thailand has already cut its 2020 GDP forecast due to the impact of reduced tourism.Official data, however, will not capture the coronavirus outbreak for at least another two weeks. There will certainly be a significant impact in the data for February which will start to be released later this month.
In this context, markets will be flying blind to some extent with a lack of hard evidence over the potential impact.In this situation there is the temptation to fear a worst case scenario which will increase the risk of asset prices coming under renewed selling pressure.There is no doubt that the global economy will be damaged by the coronavirus, but the key uncertainty is how serious the impact will be and how long the crisis lasts.
Since the SARS outbreak in 2002, China’s share of global economic output has increased by over 300% to 17%. This factor will inevitably magnify the impact and it is also the case that global companies find it extremely difficult to find alternatives to Chinese components, especially in the electronics sector. Even if the actual impact of the virus is limited, there will be a risk that fear will increase sharply within the population and cause a much bigger impact on both trade and growth dynamics.People may decide against returning to the large cities after the New-Year break which would be important in undermining activity as businesses are unable to res-start production.There will also be a risk that international travel into China will be curtailed even more seriously as fear discourages business and leisure travel.
Global equity markets were close to record highs when the crisis erupted and emerging market sentiment was also strong, increasing the risk of a more substantial correction. Emerging market (EM) risk conditions have mostly simply mean reverted here and are still rather far from flashing red – especially in the case of emerging market credit spreads. Given how badly EM currencies have stumbled merely on some mean reversion, we hasten to warn that performance can deteriorate much more sharply if our risk indicator plunges deeply into the red in coming days/weeks.
Trade friction will magnify the impact
The economic impact is likely to be magnified by on-going US-China trade frictions. Trade between the US and China has already been disrupted by trade wars and imposition on tariffs on US and Chinese exports. Tensions have been eased by a signing of the phase-one trade deal, but the underlying dispute has had an important impact in disrupting supply chains and underlying exports.It is important to note that the bulk of existing tariffs are still in place and are continuing to put important stresses on the US and Chinese economies.
Chinese companies are already in a more vulnerable position which will make it more difficult to adjust and respond to a fresh crisis. Chinese industrial profits, for example, recorded a 6.3% annual decline for December after an increase of 5.4% the previous month.Weaker financial positions within the Chinese corporate sector will also increase the risk of collapses. The global economy overall is also liable to be vulnerable given supply disruptions.Any move by President Trump to cut tariffs on China would have a notable positive impact on global risk sentiment.
Will Chinese politics change?
There has also been some speculation that the coronavirus would have an important impact in undermining the Chinese Communist Party, especially if the authorities are seen to have responded poorly to the crisis.Geo-political tensions are also liable to increase, especially given the extent of mis-information across global social media. Diplomatic efforts will need to be crucial in helping to avoid escalating tensions and further damaging the global economy.
Asian economies are most at risk
The economies most vulnerable from a Chinese slowdown are South Korea, Hong Kong, Thailand, Malaysia and Japan.The Hong Kong economy was already vulnerable late in 2019 with the underlying slowdown in China compounded by on-going political protests.
In global terms, the US impact is relatively limited given the size of the domestic economy. According to White House economists, the potential impact on first-quarter US GDP growth is likely to be around 0.2%. According to Goldman Sachs “the fast-spreading coronavirus will knock 0.4 percentage points from annualised growth in the US over the first quarter of 2020, as Chinese tourism to the US dips and exports of American goods to China take a hit. Its central forecast is for a partial rebound in US growth in the second quarter, but the risks are “skewed towards a larger hit”.
A change in the news flow could lead to increased domestic risk-aversion behaviour or a sustained tightening in financial conditions. A larger outbreak of the virus in the US or the fear thereof could lead to a decline in domestic travel, commuting and shopping.
Central banks and governments will provide support
Global central banks have been cutting interest rates over the past year in response to concerns over the trade and growth outlook, especially given the imposition of tariffs. A total of 49 central banks cut interest rates during the course of last year. Central banks have started to feel slightly more optimistic over the outlook, but any sustained damage from the coronavirus would trigger fresh unease. Overall, the bias for monetary easing is likely to continue with an on-going willingness to cut interest rates if necessary.Last week’s Federal Reserve policy statement made only a slight reference to the virus, but comments from officials will be monitored closely.Expectations of central bank action will tend to protect risk sentiment to some extent and also cushion the global economy, although scope for action is limited.International governments are also likely to engage in supportive efforts with increased budget spending.