A month on since markets first became aware of coronavirus and the issue is still at the forefront of most investors' minds. The majority think it will only have a temporary impact on the global economy, with a V-shape recovery being priced in by equity markets.
Despite the widely-documented negative effects on trade, output and supply chains, as well as warnings from prominent corporations such as Apple and Puma, it is assumed that central banks will act quickly to underpin a swift economic recovery. However, this optimism sits uneasily with other markets such as gold and US Treasuries. It also conflicts with incoming economic data, as well as with evidence that already historically low interest rates are having a diminishing impact in terms of promoting growth.
Economic data collected before the outbreak of the Covid-19 virus showed that major economies were already beginning 2020 on a soft footing. Industrial production and core retail sales in the US slipped in January. Industrial output fell 0.3 per cent month-on-month, negatively impacted by warm weather and production shut-ins at Boeing. Headline retail sales rose by 0.3 per cent month-on-month but underlying core retail sales were unchanged.
Although this data does not suggest a US recession is imminent, the Federal Reserve is alert to downside risks and the possible negative effects on the US economy, and the markets are discounting a 25 basis point cut in the Fed funds rate at some point this year.
Meanwhile the eurozone economy recorded negligible gross domestic product growth in the final quarter of 2019, expanding by just 0.1 per cent. Germany’s economy recorded no growth in the fourth quarter. The weak data puts the eurozone economy in a poor negotiating position as it needs to counter higher tariffs imposed by the US on its aircraft industry.
The US administration raised tariffs on imports of EU aircraft to 15 per cent from 10 per cent previously, threatening to bring the EU and US closer to a trade war. The weak economic data for the eurozone will also hamstring the European Central Bank into keeping rates on hold with a bias towards cutting for the foreseeable future, weighing on the outlook for the euro, which has been one of the worst-performing currencies over the last month. Negative interest rates have done little to secure an economic recovery in the eurozone, and they might actually be responsible for holding the recovery back by discouraging banks from lending.
Having fallen below $1.09 against the US dollar, the euro has been trading at its lowest level since early 2017. Germany’s ZEW index of investor confidence collapsed in February with the assessment of current economic conditions falling to minus 15.7 from minus 9.5 in January while the expectation index slumped to 8.7 compared with 26.7 a month ago. Germany’s economy is drifting with no clear sign of momentum and may be at risk of serious downturn now that it is a target for the US administration’s hawkish trade agenda.
Japan also reported weak data for the last quarter of 2019 with its economy shrinking by 6.3 per cent at an annualised rate in the fourth quarter of last year. The World Trade Organisation also warned that the Covid-19 outbreak would pose a serious risk to global trade volumes for the start of 2020, compounding a drop in volumes last year catalysed by the US-China trade war.
This has particular relevance for emerging markets such as Singapore, Korea and Taiwan. Singapore’s non-oil export data have shown few signs of any recovery and the Singapore government last week downgraded its GDP growth forecast for 2020 to a contraction of 0.5 per cent. It also announced an extensive fiscal support programme to help fight the impact of the Covid-19 outbreak on the economy. South Korean President Moon Jae-in is warning that the South Korean economy faces an “emergency” situation as a result of the coronavirus, while Taiwan just announced 12.8 per cent year-on-year decline in January export orders, their worst performance since 2013.
Equity market optimism about the likely speed of economic recovery post-coronavirus appears increasingly at odds with the incoming data as well as warnings from key countries, corporations and even other markets. It might even be said that the easy monetary policy equity investors are banking on may not help the situation much either.
Tim Fox is chief economist and head of research at Emirates NBD