Risks on coronavirus rising
The spread of the coronavirus, or COVID-19, has entered a new phase. Rather than the number of cases in China, the focus has shifted to the number of countries recording infections.
As part of this shift the market reaction has transitioned from the bond and currency markets to include the equity and credit markets. Until recently, the bond and currency markets had moved quite substantially, but equity and credit markets had not reacted materially.
While it’s common to say equity and credit markets have just been slow, I think there is more to it than that. The resilience of growth assets likely reflects the:
• fall in interest rates − in that investment is an opportunity-cost exercise (to buy one asset, I need to sell another);
• expectation this will be a temporary, v-shaped shock, like SARS; and
• US is still growing at 2 per cent.
The last two foundations are now under stress.
“While there is no reason at this stage to expect conditions to be as severe as 2009, the risk of a global recession, however defined, is rising.”
While extrapolation is not necessarily advisable, given the number of variables in play, the number of reported COVID-19 cases outside China shows a worrying trend. It implies up to a million people could be affected by the end of March. It will be important to track the number of new cases against this quite pessimistic potential path.
During the first phase of the outbreak the focus was very much on domestic demand in China and the supply chain effects through the rest of the Asia Pacific region and the world. This phase still has quite some way to run.
China’s February manufacturing PMI at 35.7 is comparable to the sort of outcome seen during the financial crisis. While businesses are restarting operations in China, the vast majority are operating well below capacity, and many restrictions on the movement of people remain.
Through this next phase, which has emerged over the past week, the condition of domestic demand in affected countries will be increasingly the focus.
In the most-affected countries, large gatherings are being discouraged and schools delayed, and discretionary consumption is likely to be heavily impacted. There is also likely to be a shift in the containment focus.
Up to this point much of the risk assessment has related to the quality and vigour of the Chinese response as well as the accuracy of the reported infection data. That focus is likely to shift to other countries, particularly the US, and the quality of their bureaucratic responses.
ANZ Research retains a watching brief on this part of the economic landscape, as public confidence is an important variable under current circumstances.
In some ways, one of the strengths of the US also leaves it vulnerable during periods such as this.
For countries where the bulk of credit is provided through the banking sector, a degree of maturity and coordination between financial service providers and regulators can work to ensure a temporary (albeit severe) disruption has as few legacy effects as possible.
The priority is to prevent what should be a temporary fall in economic activity from transitioning into a systemic shortage of liquidity and widespread bankruptcies. In the US up to two-thirds of credit is provided through the financial markets. These are much less amenable to such coordination and maturity of action.
A particular issue during this period will be policy complications. Easier monetary policy, for instance, while helpful, is unlikely to fill the hole left by disrupted supply chains, increasingly cautious consumers and businesses facing a high degree of uncertainty about the current environment and the medium term.
Equally, fiscal policy may ameliorate some of the loss of demand, but calibrating policy is extremely difficult when both the depth and duration of the downturn are unpredictable, conditions very fast moving, and the movement of people and resources restricted.
High debt levels will make themselves felt. Consequently, one of the most important policy responses, both for financial markets and the economy, is the quality of a government’s medical and logistical decisions.
The tragic death rates in Wuhan, at this stage higher than in other areas, may at least partially reflect the fact the medical care system was quickly overwhelmed by the number of patients. Markets will likely be concerned about similar under resourcing if it starts to emerge in other jurisdictions.
While it’s too early to confidently consider what some of the medium-term implications of the current phase might be, it does highlight the G-Zero climate in which the world is now operating.
G-Zero is a term Ian Bremmer, economist and President of Eurasia Group, has used to characterise the fact the G20, G7 and other global institutions are no longer functioning particularly well.
Consider on January 30 the World Health Organisation declared a Public Health Emergency of International Concern, but suggested travel restrictions were not required. Controls on movement in Wuhan had already started by this stage. On February 1 the US announced travel restrictions anyway. China remonstrated. Other countries followed, and they now total more than 70. And some countries have also followed China’s lead with domestic movement restrictions.
On February 22 the International Monetary Fund’s Managing Director, Kristalina Georgieva, said international co-operation was “essential to the containment of COVID-19 and its economic impact”. But the world doesn’t seem to be co-operating particularly well.
During stress events, at the time we most need global leadership and co-operation, the mechanisms we have in place don’t function well. This is the essence of a G-Zero world. It is a fundamental shift.
Overall this set of conditions present a substantial near-term challenge to the global economic cycle. The global economy grew 4.0 per cent in 2017, and had slowed to 3.1 per cent last year. Some further slowdown seems certain.
While there is no generally accepted definition of a global recession, global growth in the ‘2s’, coupled with rising unemployment, is likely to feel like one. Those conditions have only been seen twice in the last two decades – in 2009 and 2001.
While there is no reason at this stage to expect conditions to be as severe as 2009, the risk of a global recession, however defined, is rising.
Richard Yetsenga is Chief Economist at ANZ
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