The coronavirus onset in China and escalating policy response has hit global markets over the last week investors fear that it will hurt global growth. The policy response has shut down many key transport nodes and forced quarantines of urban areas where over 50 million people live. Meanwhile, many international airlines and stopped flights to China, while China has frozen international and internal tourism. Typically, the greatest economic impact of an epidemic come from the mitigating policies to stop the spread of disease as they dampen economic activity in the hopes of avoiding a worse outcome. This note looks at some of the potential macro and market impacts and highlights the signposts to watch over the coming days, weeks and months.
The economic and market impact depends on the duration of the outbreak and persistence of mitigation strategies. Based on past examples, it could take well until the summer to sound the all-clear for the Coronavirus, though markets may focus on a) whether the infection rate plateaus and b) the pace of quarantine measures, readjusting to growth outlooks as these return to a new normal. At present Chinese authorities are extending the lunar new year holiday to allow for quarantines and reduced transmission.
Sectors most at risk are consumption goods, especially travel and luxury goods, as well as energy consumption. Heath care producers and those producing affiliated products may outperform. So far, Chinese officials have shown themselves able to keep supplying food and basic materials to quarantined areas and there are few reports of major prices pressures, though that is something to watch. Moreover, the pressure on health care facilities in China and affected areas, is likely to undermine broader health care and health care costs.
The persistence of the outbreak would add to pressure on CNY and thus on the EM currencies which are correlated (both Asian FX and commodity FX). These market reactions will likely outpace the GDP impacts. Globally the growth impact may be modest, but reinforces my view that economic growth in 2020 will fail to pick up much from 2019. This in turn will keep global central banks on an easy footing, with some EM central banks and Canada extending/beginning their easing cycle. This trend in turn, will likely benefit risk assets later in the year as the search for yield continues.
Overall, the outbreak and response is likely to dampen growth in China and Hong Kong in Q1, reinforcing other vulnerabilities in locations like Hong Kong which were already in or near recession, and limiting the impact of stimulus on growth on the mainland where growth had been picking up. There is also a likelihood that some global businesses may take this opportunity to speed up their efforts to reduce labor force in China. Globally the overall growth impact may be modest, but reinforces our view that economic growth in 2020 will fail to pick up much from 2019. This in turn will keep global central banks on an easy footing, with some central banks including several emerging markets and Canada extending/beginning their easing cycle. This trend in turn, will likely benefit risk assets later in the year, maybe even in the spring.
Past examples are imperfect:Past examples like SARS and even the Ebola outbreaks had limited impact on global growth, but did impact their epicenters – estimates suggest that SARS and policy response shaved off 0.5-1ppt of GDP in 2003 in China, and 0.5ppt in many affected Asian countries, while having less than 0.1ppt impact on affected countries like Canada. There was a noticeable and recurrent global market impact from SARS, though this likely reflected the impact on more open global economies like Canada, Hong Kong, Singapore, Australia rather than that of China which was a much smaller part of the global economy, global production, global commodity demand, and global asset pool in 2003 than it is today.
Several factors account for the greater market interest versus past cases.
- Valuations were already stretched, especially for US equity and corporate bonds, leading many investors to take profits. This compares to relatively less expensive assets in 2003, and higher global growth potential.
- The oil market is one of the main transmission mechanisms of the broader reassessment of demand and the associated repricing reinforces pre-existing concerns about the scale of oil and gas demand growth in many economies like China and India. Following the seeming de-escalation of tensions between Iran and the U.S. the oil price has returned to a level more consistent with fundamentals of ample oil supply, and sluggish demand, which will keep OPEC+ struggling to balance the market. While US oil supply is unlikely to expand as much as in 2018-19, it will likely add more than 1 million barrels per day.
- Both China and Chinese consumers have a bigger impact on the Global economy now. China is the second largest economy and largest trader, while consumption now is the biggest driver of local growth, meaning that the economic impact of a hit to consumption is bigger than in 2003 (when exports and government led investment was the major growth driver).
- The scale of quarantines and shut-downs of transportation and public sites is much greater. This adds both to the fears of the public (the big transmission mechanism) and the direct and indirect macro impacts. As factory holidays are extended and official tourism outflows and flows within the country stop (but informal ones creep up), the weak macro start to the year is likely to be more pronounced.
- Quarantines will also impact production levels, with many factories in China likely to extend their Lunar New year closures and take longer to ramp up, especially in Hubei province. While other regions may return to operations more quickly, expect the typical LNY effect of dampening growth to be much greater this year and its possible holidays could be extended further. There is typically a slower growth in Q1 due to lengthy holidays around the Lunar new year, these will likely be longer and more pronounced in 2020. It may also make Chinese officials less likely to allow losses in credit markets and may complicate commitment with the Phase 1 deal, though the latter will not be clear until late in 2020. Meeting the purchase targets was already likely to be difficult. Now it is likely to be more so.
Its also useful to provide updates on some of the other catalysts we are tracking especially trade risks which I highlighted as an upside and downside risk in last week’s scenario piece. The core scenario still seems to be on track of persistent tariffs, but few new ones. In the background, trade risks will remain simmering, but significant pain will be deferred due to the political cycle in the U.S. and the past approval of deals. President Trump sees a political gain from recent trade deals (USMCA and Phase 1 with China) and is unlikely to make meaningful progress on further deals with China in this term. This shifts attention to the trade pressures with the European Union, particularly over autos, digital tax and agriculture. Realistically, progress is likely to be at best a truce rather than a major break through. EU-US trade irritants will likely increase, contributing to some pressure on EUR (the exact opposite of President Trump’s policy objectives) and select automakers. However, EU countries are likely to focus on de-escalation with the US, kicking the can down the road in terms of acute shocks, lest they divide EU members.
Having been in the UK last week, its worth adding a quick note on Brexit, to which most economic actors are resigned. While a hard Brexit is well on course, it is no longer the acute uncoordinated Brexit that was a risk in 2019 at various points. This argues for a slow grind outcome for the UK economy as some sectors continue to adjust staff, net migration continues to contract and businesses remain uncertain about future trade rules. That said, it reduces the risk of an acute adjustment, and some capital inflows may return. Watch for market worries over the coming months as EU deadlines approach before the summer. Similarly, I am not optimistic any broad deal with the UK will be signed until after the US election and official Brexit trade deadline of year end. Not only is the list of bilateral irritants growing (UK approval of Huawei, digital tax, food processing, health care), but also achieving a deal in a few months is a very tight turn around, suggesting any deal would be an MOU for future discussion. The broader environment maintains uncertainty for businesses and long-term investors. This argues against a significant growth revival and reinforces the view in my recent growth outlook.
Green investment, especially in the EU and some emerging markets, will be among the major sources of big investment projects and is behind moderate fiscal easing. However, the government spending impulse is unlikely to boost growth much given its small volume and implementation challenges. Clarity on rules and standards for ESG and decarbonization will be key to whether signals contribute to more persistent investment. At present this looks like a factor more relevant for 2021+ growth and an upside risk.