The Coronavirus Brings Global Growth Concerns Back Into Focus
At the turn of the year, a number of people in Wuhan, China were diagnosed with a novel respiratory virus. The patients exhibited fever, coughing, and difficulty breathing, but the source of their illness was unknown and vaccines were ineffective. Highly contagious, the coronavirus spread to more than 17,000 people in January, killing more than 300 – most in China.
China and the rest of the world have taken extreme measures to limit the contagion. Wuhan, one of the largest cities in the world with a population of more than 11 million, has been virtually quarantined, and several countries, including the United States, have placed limitations on foreign travel.
The coronavirus is reminiscent of the 2003 SARS outbreak, which reportedly infected more than 8,000 people and killed more than 700, but was likely worse than official numbers show – developing China did a notoriously poor job of containing and reporting the virus. The SARS outbreak had a tangible effect on the Chinese economy (nominal GDP growth, recently spurred by the country’s entry to the WTO, declined by 2%), but the effects ultimately proved short-lived.
Much has changed since SARS. China has become a global economic powerhouse. Their Gross Domestic Product has more than quintupled in value, now trailing only that of the United States, and their position in the international supply chain is unmatched. Unprecedented middle class growth has made consumers more powerful than ever. Now, China’s global scale has economists wary that the coronavirus could harm more than just the health of the populous. Markets have responded accordingly.
Dr. Copper, known for its advanced degree in economics, was hit hard over the past few weeks. The metal, which has wide-ranging use in most economic sectors, fell 13% from its mid-January peak and now hovers precipitously near multi-year support.
Similarly, fears surrounding an economic slowdown in one of the world’s largest consumers of energy have helped fuel a 20% drop in the price of Crude oil, sending it to the lowest level in over a year.
The concerns have forced more than 50 S&P 500 companies (about 1/4 of the constituents that have reported over the past 2 weeks) to address the virus on quarterly earnings conference calls. Most have said it’s simply too early to tell the magnitude of changes, but nearly all have been negatively affected in some way. Notable consumer brands like Starbucks, Apple, and McDonald’s have all temporarily closed stores as a result.
The coronavirus will surely be an attractive scapegoat should the world economy weaken, but it doesn’t deserve all the blame. Growth expectations have been revised lower numerous times over the past year, as evidenced by 2020 GDP estimates for each the United States, Eurozone, and China.
Central banks around the world have been increasingly accommodative in an effort to reverse that trend. Our own Federal Reserve lowered its benchmark interest rate 3 times in 2019 and ended its balance sheet normalization process several months ahead of schedule. Since September, they’ve rapidly re-grown the balance sheet in an effort to stabilize overnight repo markets.
Following the October 30, 2019 rate cut though, FOMC members maintained that growth concerns had faded and monetary policy was in a good place. Those concerns have now been brought back to the fore. Fed Chair Jerome Powell had this to say about the coronavirus:
“First, it’s a very serious issue and I want to start by acknowledging the significant and considerable human suffering that the virus is already causing. There is likely to be some disruption to activity in China and possibly globally based on the spread of the virus to date and the travel restrictions and business closures that have already been imposed.
“Of course, the situation is really in its early stages, and it’s very uncertain about how far it will spread, and what the macroeconomic effects will be in China, and its immediate trading partners and neighbors, and around the world. So in light of that uncertainty, I’m not going to speculate about it at this point.”
Despite Powell’s assertion that it’s too early to understand the effects, market participants are confidently predicting the Fed’s response – they’ve already priced in 2 more cuts before the end of the year. Longer-term rates have come down sharply, too. The 10-year U.S. Treasury rate has dropped to 1.5%, from 1.9% at year-end.
It’s not just expectations of Fed action bringing rates down – changing dynamics in the fixed income markets seem reflective of more serious concerns about the global economy. A portion of the yield curve has inverted once again, and credit spreads are widening. Last week, interest rates on investment grade corporate bonds (both those rated A and BBB) reached new lows, while rates for junk-rated issuers climbed higher. The default risk premium is still low relative to historical levels, but the trend is cautionary.
Of course, the frightening aspect of the coronavirus is its uncertainty. Should it fail to be contained, its global impacts could be monumental. But as with all crises, it pays to keep them in perspective. In this decade-long economic expansion, we’ve survived several such potential epidemics: MERS (2013), Ebola (2014), and Zika (2016) among others. Each had the potential for global economic disruption, yet economies and markets quickly recovered. In the words of Mr. Powell, “We’ll just have to see.”
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