Updated: Mar 10, 2020
Risk assets responded to news about the spread of the coronavirus in February, following evidence of a peaking in new cases in China before then falling sharply on rising numbers of new cases outside of China, increasing the risk of a global pandemic capable of crunching growth. The threat of much weaker global growth and the uncertainty surrounding when the coronavirus will peak or when a vaccine will be developed are driving a sharp repricing of risks. Whether the downward pressure lasts, will depend upon the likelihood of weakened growth becoming self-sustaining through rising unemployment, prompting even weaker spending. Given the rising number of coronavirus cases outside China, the growth-crimping effects of necessary containment measures and still vague assurances of large ongoing “whatever it takes” policy stimulus measures to counter the economic damage caused by the coronavirus, the downward correction in risk asset values may still have some way go.
During February, falls in major share markets were very sharp coming off high points for several markets in the third week of the month. Over the month, falls ranged from 8.2% for Australia’s ASX 200 to 9.7%. The falls from peaks in the third week to the end of the month were well above 10%. Even in the US the S&P 500 fell by 8.4% over the month. Coronavirus numbers are starting to rise in the United States, increasing the risk of softer growth in the near term, but the underlying strength of the US economy based on near full-employment (the latest unemployment rate reading for February due later this week is likely to be around 3.6%, near a 50-year low) and strong household income growth is likely to prevent US growth sliding too far.
The coronavirus threat in the US also makes it more likely for the Federal Reserve to cut interest rates and for fiscal stimulus of some magnitude to occur. The Administration was always looking to spend more running towards the Presidential election in November. The coronavirus threat mutes political opposition to more spending and probably increases the chance of spending rising in the near-term.
In China, the daily number of new coronavirus cases peaked in early February and has declined sharply since. Outside the epicenter of the coronavirus outbreak in Hubei province, the extended lunar New Year holiday break that closed many businesses is slowly finishing and the authorities are looking at support measures for businesses crippled by the extended break. The economy will take several months to recover from the deep trough in activity in Q1 although President Xi has promised to take whatever measures are necessary to return the economy to a 6% y-o-y GDP growth trajectory by the end of 2020.
Elsewhere in Europe and Asia, new coronavirus cases are expanding notably in Iran, Italy, South Korea and Japan. Containment measures in countries where cases are growing will reduce growth initially before any stimulus measures can take hold.
The impact of coronavirus is also showing on other financial assets. Credit spreads widened in February, although the change was relatively small compared with the falls in share markets. Demand for safe-haven assets was high and government bonds rallied strongly. The US 10-year bond yield fell by 36 basis points (bps) in February to 1.15% while the 30-year yield fell by 32bps to 1.68%.
In Australia, although the RBA left the cash rate unchanged at 0.75% in February, the 10-year bond yield fell by 14bps to 0.81% at month end. Also, the RBA’s latest economic forecasts released in its February Monetary Policy Statement still show the economic growth slowly lifting pace through 2020 and 2021 albeit with a double-disaster (bushfires and coronavirus) dip in the first half of 2020.
Coronavirus developments are worse than what the RBA allowed in the February Monetary Policy Statement, but one interest-rate sensitive part of the economy, home-buying activity is running very strongly – perhaps more strongly than the RBA allowed in its forecasts. Auction clearances on high volume were above 80% at the weekend in both Sydney and Melbourne and at a time when the news was worsening about the coronavirus outbreak.
Home buying activity appears to be immune and perhaps even spurred by the coronavirus outbreak as buyers compensate for less spending in areas such as travel and look to one asset that may rise in price. The issue is that the strength may prove short-lived, especially if Australia’s unemployment rate starts to rise as seems increasingly likely given the range of Australian businesses – tourism; education; importers and exporters being negatively impacted by the coronavirus.
Almost certainly there will be substantial Australian fiscal stimulus aimed at providing some support for business and household income. Policy change, however, will not alter the trajectory of the coronavirus outbreak. Even though lower interest rates also do nothing to counter what is essentially a medical emergency, it is likely that easier monetary policy will be deployed at some stage to back-up fiscal stimulus. At some point (not necessarily at the RBA meeting this week) it seems likely that the cash rate will be cut from the current 0.75%, possibly in tandem with the Government announcing a fiscal stimulus package.
Interestingly, the policy stimulus measures could serve to intensify the bounce in the economy and risk assets once the coronavirus has peaked or a vaccine is announced. The problem is that timing the coronavirus peak, or the development of a vaccine is starting to stretch out and the risk is increasing of a short-term blip downwards in economic activity turning to something worse.