Multi Asset Boutique
China is no longer the only country where entire cities and regions are in effective lockdown due to the respiratory disease caused by a new coronavirus – now it’s also Italy and South Korea (see chart 1). While the number of “Covid-19” cases in the world’s most populous country has exceeded 77,000 (with the number of new infections apparently in decline), Italy and South Korea reported 157 and 833 cases, respectively (as of early February 24). This raises the likelihood of wider travel bans and other restrictions that might at some stage affect the economy in countries other than China as well.
In northern Italy, about 50,000 people in ten cities were quarantined as of February 23. Further measures include the cancelling of the carnival in Venice and a four-hour long disruption of rail traffic between Austria and Italy. While it is too early to gauge the impact on Europe’s third-largest economy, it is worth noting that most cases occurred in the economically strongest Italian region of Lombardy – it accounts for 25% of the country’s GDP – with Italy’s financial capital Milan also hit. Another important region, Veneto, reported some infections as well.
In South Korea, the authorities declared the “highest alert level”, which enables authorities to lock down cities and traffic routes. This triggered the United States to raise the travel alarm level for South Korea and Japan. The latter country with 147 confirmed cases ranks third behind South Korea (833) and Italy (157) in terms of confirmed cases. Moreover, New Zealand prolonged its travel bans to and from China.
The latest “flash” purchasing managers’ indices (PMIs) for the euro zone were better than expected but the underlying numbers point to future weakness in growth. The US, Japan and Australian PMIs showed quite a negative impact on the services sector, mostly stemming from the coronavirus. But US companies also seem to suggest more cautious spending ahead due to fears of a wider economic slowdown and election uncertainty later in the year. Japan’s growth was already hit by the increase in the value added tax in October 2019, and sentiment has hardly recovered since. The aggregated PMIs of the already available February flash PMIs from the USA, Japan, the euro zone, and Australia show that service sentiment was hit more severely than manufacturing.
Past epidemic crises have shown that the economic impact is usually sharp and temporary. Unfortunately, the source of the virus is China, which generates around 16% of global economic growth, and is a leading player in supply chains and the tourism industry. Therefore, we have lowered our 2020 GDP growth forecasts for China (to 5.5% from 6.2%) and emerging markets significantly. Japan is also likely to be hit hard, having started the year on a very weak footing already following a sharp drop in economic activity. We also downgraded our growth expectations for the first quarter in the euro zone from 0.3% down to 0.1%.
The impact on global growth is in our opinion rather moderate (0.2 percentage points). However, we expect this epidemic crisis to be no different from past crises in terms of its temporary nature:
1. We observe that new infection cases in China seem to have peaked recently, which argues for a return to normal economic activity (economic rebound) by early March. Nevertheless, we will have to constantly observe the economic resumption process and review our economic forecasts in case of a too slow progress.
2. Chinese authorities conducted an aggressive monetary policy stimulus and pledged additional fiscal stimulus in the order of 1 percentage point of GDP.
3. Global liquidity is ample with the Fed moving towards another rate cut, in our opinion. Other central banks (the Bank of Japan and the European Central Bank in particular) are unlikely to change their loose policy stance anytime soon.
Markets seem a bit too complacent with important investors’ sentiment data still not far from euphoric territory at a time when new infection cases outside of China start to rise. Therefore, we believe that market volatility is likely to last longer arguing for a rather risk-neutral positioning. As we stick to our medium-term view of global economic stabilization, we believe that buying opportunities will open up in DM and EM as soon as the virus impact is more clearly contained and the economic damage has shown up in hard economic data in China and developed markets.
With inflation expectations already trending lower because of the global virus disruptions and negative market sentiment, rate pricing for monetary easing has increased in the short-term, pushing bond yields to very low levels again. We expect yields to rebound quickly if the virus impact on growth has reached its peak. Until then, however, we may continue to observe higher volatility in financial markets and further episodes of “risk-off“ moves in equities (see chart 2), with government bond yields staying at very low levels or grinding even lower (e.g. in the US).