What is on the coronavirus cards for global markets?

After the surprise Fed rate cut, continued volatility is expected in the next few weeks

China's manufacturing plunged in February as anti-virus measures shut down much of the world's second-largest economy. Photo: AP

What a difference a few weeks make in the markets.

Since my last column on February 11, the rapid spread of Covid-19 has ramped up economic growth fears and resulted in heightened sell-offs. US equities have corrected more than 16 per cent after the Dow stretched to its all-time high above 29,500 to drop as low as 24,683 late Friday. The S&P 500 and Nasdaq shed more than 16 per cent in seven trading days.

After gold rallied to $1,689 (Dh6,203) on February 24 — a more than seven-year high — it has corrected to trade below $1,600 at the time of writing.

And into the early hours of the US open on Tuesday, in an unprecedented move not seen since the start of the financial crisis back in 2008, the US Federal Reserve has cut the Federal Funds Rate by 50 basis points as an emergency measure.

This will set up for a very interesting few weeks leading up to the actual schedule rate decision on March 18, when the Fed was expected to cut.

Before the surprise move, much of the US Dollar weakness emanated from the prospect of an interest-rate cut by the Fed. We saw a sharp reversal in the euro to US dollar rate, as the pair found itself amid a nice buying spree and comfortably trading above $1.11 levels after dropping to a 34-month low of $1.0780 on February 20. With the premature Fed announcement on Tuesday this should relieve some selling pressure on the greenback.

Meanwhile, disruption to Chinese manufacturing and output will become more of a worry, more than two months into this developing story. Data from China released on Saturday showed that Chinese manufacturing PMI dropped to 35.7 during the month of February versus an expected 46 reading. China’s private-sector Caixin Manufacturing PMI released Monday also slowed to 40.3 from an expected 45.7. Non-Manufacturing PMI was even more anaemic, coming in at 29.6.

A reading below 50 on these three benchmark indices represents a contractionary economic environment and vice versa. Typically, the effects on output are felt at a lag which means the data docket will likely worsen more aggressively into the start of the second quarter — and this should see global markets more susceptible to sharp downsides.

With so much volatility and uncertainty driving markets, and following this rather historic emergency rate cut, we can expect more global central banks to come to the rescue. The Bank of Japan kicked off the trading week Monday with a statement that they “will closely monitor future developments and will strive to provide ample liquidity and ensure stability in financial markets through appropriate market operations and asset purchases”. The BoJ immediately acted by offering to buy up to 500 billion Japanese yen (Dh17bn) in government bonds in a bid to increase liquidity.

This was preceded by US Federal Reserve chairman Jerome Powell’s comments last Friday that the Fed would “act as appropriate” in a bid to support the economy. This sparked speculation that the Fed would be prepared to act as early as Monday’s opening. While it took just one day extra, the Fed delivered their cut.

At the time of writing, markets are still digesting the surprise move and what will be more interesting will be the Fed’s stance on March 18. Are they to deliver an additional cut or will they hold fire?

This is how quickly the rhetoric can change amid such fast-moving developments. Considering this and the current market turmoil, it would prove to be premature to build positional trades and instead a wait-and-watch approach should be adopted.

Markets will bounce back after the aggressive sell-off last week, and the surprise rate cut will be welcomed by equity markets and US Dollar bulls. It is likely the US dollar index will pare some of its losses and move slightly higher following today’s historic move.

Considering the expected volatility, it's also worth keeping an eye on the US treasury yield curves as well. All tenors (one-year, two-year, five-year and 10-year) were trading below the Fed Funds Rate before the emergency cut — the last time this occurred was in 2008. If these yields continue to lag below the Federal Funds Rate then this could provide further insight that the Fed is not quite done acting this month.

All things considered, I would wait to look at short opportunities in the euro to US dollar pair only above $1.1280 levels. My British pound to US dollar rate target of $1.2740 given on February 11 was easily achieved this past week, and my recommended gold entry at $1,490 levels still holds.

Gaurav Kashyap is a market strategist at Equiti Global Markets. The views and opinions expressed in this article are those of the author and do not reflect the views of Equiti