Risk assets rose strongly through much of January, only to surrender the gains and more into month end as the corona virus outbreak in China created a rush to quarantine that threatens to cut into improving global economic growth prospects. Australia’s ASX 200 showed an isolated and strong rise in January, up 5.0%, but that was partly a matter of timing with the biggest one-day falls in international share markets occurring on 31st January after the Australian market had closed for the month. Otherwise major international share markets fell in January with falls ranging from 0.2% for the US S&P 500 to 3.4% for Britain’s FTSE 100, partly influenced by Brexit on 31st January and the start of an eleven month transitional phase of negotiations with the European Union introducing a new collection of uncertainties around Britain’s relationship with Europe.
While concern around the spread of the corona virus has reduced investors’ appetite to take risk in the immediate term, it seems unlikely to us that risk aversion will last long. Even though there are several unknowns relating to the corona virus (as there have been with every other new virus in the past), what is known is that it produces flu-like symptoms that prove fatal for some but the large majority recover in a comparatively short time. Few cases have occurred outside the area of initial infection, Wuhan city in China and those that have are linked back to Wuhan. Quarantining restrictions applying to those infected or in likely incubation phase have been applied rigorously in Wuhan and increasingly tight travel restrictions and quarantine procedures between China and elsewhere are limiting the spread of infection.
Most likely, because of the travel restrictions and quarantining, the corona virus will peak comparatively soon and infection rates will start to decline. There will be some reduction in economic growth in China, attributable to the virus and Australia with its strong links to China in goods and services trade, will also suffer some knock-on effects.
These near-term corona virus-related detractions to GDP growth are most likely to be evident in Q1 and Q2 2020 and are likely to be partly compensated later in the year. Also, the detractions in the near-term are coming at a time when recent indicators of economic activity have been mostly stronger than expected in many parts of the world, including the US and especially in Australia.
The influence of stronger economic readings combined with central banks keeping monetary conditions very accommodating, provide the foundations for rekindling appetite for risk assets once excessive concern about the economic impact of the corona virus starts to moderate.
The extent of the turn to risk aversion in markets at the end of January, apart from showing in the sharp falls in share markets was also evident in wider credit yield spreads and strong buying of safe-haven government bonds. The US 10-year bond yield fell 41 basis points (bps) in January to 1.51%, while the 30-year Treasury yield fell by 39bps to 2.00%. The rally in US government bonds occurred despite the Fed leaving the Fed Funds rate unchanged at 1.75% at the late-January policy meeting and providing an upbeat assessment of US economic conditions.
Australia’s 10-year government bond yield fell by 42bps in January to 0.95% running counter a run of stronger than expected November economic data, slightly higher than expected Q4 CPI (+0.7% q-o-q, +1.8% y-o-y) and fading hope of another cash rate cut when the RBA monetary policy committee meets this week. Two near-term detractions to Australian economic growth – severe bushfires and the corona virus - are promoting strong government bond buying in the near term, however a sudden and possibly big upward shift in bond yields is possible if market perceptions of downside risk to growth turn from lasting to temporary.
The first stage of this change in market perceptions about Australia’s growth outlook may come if the RBA leaves the cash rate unchanged at 0.75% this week and provides some emphasis on the positive turn in recent economic data. The RBA may also note that the recovery from the bushfire crisis is likely to be in full swing later this year aided by the Government’s commitment to spend what is needed as promptly as possible to assist recovery.
When the RBA releases its quarterly Monetary Policy Statement later this week the forecasts of GDP growth, inflation, unemployment and wages are likely to be similar (if not a touch stronger for 2021) compared with those produced three months ago. Those forecasts three months ago sealed three months of no change in the cash rate at 0.75%. The forecasts to be released later this week are likely to provide no compelling reason for a rate cut for the next three months and probably much longer.