Risk assets suffered very sharp falls in March, with considerable volatility during the month. The factors driving almost all of the sell-off were the rapid spread of covid-19 infections around the world, especially in Europe and the United States; the damage to economic activity and companies from the quarantining measures taken by governments to try and flatten the curve of infections; and government and central bank policy actions aimed at cushioning the worst of the recessionary effects from the quarantining measures. While there is less uncertainty now than at the start of March about policy priorities relating to covid-19 – saving lives and trying to prevent health services from being overwhelmed, while spending freely, back-stopped by central bank bond purchases to try and limit the economic cost – the rising uncertainties are what happens after the covid-19 infection curve flattens? Those uncertainties still point to more downside for risk assets over the next few months.
Returning to what happened in March, all major share markets suffered very sharp falls ranging from 10.5% for Japan’s Nikkei to 21.2% for the ASX 200 and coming after falls ranging 8% to 10% in February. The US S&P 500 fell by 13.5% after falling by 8.4% in February. In most cases, major share markets finished the month above their intra-month lows, boosted at times by announcements of income rescue measures running to more than $US 4 trillion across major economies, plus emergency cuts to central bank official interest rates and announcements of greater QE bond buying programs and liquidity support measures for financial intermediaries.
With these massive income support measures for companies and households, the problem remains that shutting down the activities of many companies to contain covid-19 spread will severely reduce company earnings and even with near-term income support there is doubt about if and how long earnings will take to recover.
Another increasing area of uncertainty is what happens once covid-19 infection curves flatten? Until we have the ultimate solution to the covid-19 crisis, a widely available vaccine, reducing covid-19 quarantining restrictions runs the risk that infections start to lift again, resulting in a return to strict quarantine measures. There is already some evidence of this problem in Singapore, a country that successfully limited infections but is now experiencing a resurgence of infections and imposition of stricter control measures.
China, where covid-19 started back in December, is another country that has successfully contained infection rates and is starting to re-open parts of its economy. March purchasing manager reports show a better-than-expected rebound with manufacturing PMI lifting to 52.0 from 35.7 in February and the services sector PMI to 52.3 from 29.6. These apparently encouraging signals that China’s economy is starting to lift are tempered by concern that as the economy re-opens it may come with an unwanted resurgence in the covid-19 infection rate.
The impact of covid-19 continued to show on other financial assets during March. Credit spreads widened sharply, especially for higher risk credits in March. The development of an oil price war between Russia and Saudi Arabia also highlighted the vulnerability of high leveraged US energy companies.
Government bonds enjoyed safe-haven bidding support during March although at times trading in bonds was erratic. The US Federal Reserve cut the funds rate twice between policy meetings taking the rate down to 0.25% and announced unlimited QE support. Over the month the US 10-year bond yield fell 48 basis points (bps) to 0.67% while the 30-year treasury yield fell by 36bps to 1.32%. The first signs of the severe damage to US economic activity are starting to show in labour market statistics. Non-farm payrolls fell 701,000 in March and the unemployment rate rose to 4.4% from 3.5% in February. These numbers are likely to be much worse in April, indicative of the severity of the US economic downturn and likely to push US bond yields lower notwithstanding the massive increase ahead in US Government borrowings to fund its $US2 trillion plus covid-19 related stimulus.
The Australian Government in conjunction with State Governments through the National Cabinet and in full consultation with the RBA has launched an impressive program of spending initiatives to support household income and allow those businesses either closed or badly-affected by covid-19 restrictions to “hibernate” through the crisis. Essentially the Federal and State governments are lifting spending on temporary income-support measures and can borrow with confidence to fund the measures. the RBA is the back stop for the additional borrowing buying short-dated bonds and semi-government securities to ensure the 3-year government bond yield does not lift above 0.25%. The cash rate has been cut twice to 0.25% and 0.25% is also the RBA lending rate to support lending by banks.
In March the Australian 10-year bond yield fell by 8bps to 0.73% and rather like the US, notwithstanding a sharp lift in Government borrowings and the risk at some stage that the AAA sovereign rating may be downgraded it is still likely that government bond yields will fall further. While Australia appears to be flattening the covid-19 infection curve and the local experience with covid-19 has been more contained in general than in Europe and the United States, the problem for Australia is the same as elsewhere, whether to start easing quarantine restrictions after two or three months of infection rate curve flattening or wait the indeterminate period (perhaps 12 months, possibly much longer) keeping the economy depressed until a covid-19 vaccine is widely available.
The period over the next few months where Australia and other countries make difficult decisions about what risk to take with relaxing quarantine retrictions and re-infection risk and return to tighter quarantine controls spells periodic return of high uncertainty in financial markets. It is difficult to say with any confidence whether the economic downturn will be confined mostly to Q2 with recovery later this year or whether the economic downturn will linger throughout 2020. As a result, it is not possible to say with any confidence that risk assets have bottomed. It is also likely that already very low longer-term government bond yields may move lower.