COVID-2019 has in the mind of the market shifted from being a localized China and by extension Asia virus to a global phenomenon. Asia went through fear and panic are few weeks ago while the world watched but did not react greatly as equities continued to rally to new highs outside Asia. All this has changed dramatically over the last week or so, with markets initially spooked by the sharp rise in cases in Italy and Korea, and as the days have progressed, a sharp increase in the number of countries recording cases of infection.
The sell off in markets has been dramatic, even compared to previous routs in global equity markets. It is unclear whether fading the declines is a good move given that the headline news flow continues to worsen, but investors are likely to try to look for opportunity in the malaise. The fact that investors had become increasingly leveraged, positioning had increased significantly and valuations had become stretched, probably added more weight to the sell-off in equity markets and risk assets globally. Conversely, G10 government bonds have rallied hard, especially US Treasuries as investors jump into safe havens.
Markets are attempting a tentative rally in risk assets today in the hope that major central banks and governments can come to the rescue. The US Federal Reserve on Friday gave a strong signal that it is prepared to loosen policy if needed and markets have increasingly priced in easing , beginning with at least a 25bps rate cut this month (19 March). The question is now not whether the Fed cuts, but will the cut be 25bp or 50bp. Similarly, the Bank of Japan today indicated its readiness to support the economy if needed as have other central banks.
As the number of new infections outside of China is now increasing compared to new infections in China, and Chinese officials are promising both fiscal and monetary stimulus, China is no longer the main point of concern. That said, there is no doubt that China’s economy is likely to tank this quarter; an early indication came from the sharp decline in China’s official manufacturing purchasing managers’ index, which fell to a record low of 35.7 in February, deep into contraction territory. The imponderable is how quickly the Chinese economy will get back on its feet. The potential for “V” shape recovery is looking increasingly slim.
Volatility has also risen across markets, though it is notable that FX volatility has risen by far less than equity or interest rate volatility, suggesting scope for catch up. Heightened expectations of Fed rate cuts, and sharp decline in yields, alongside fears that the number of virus cases in the US will accelerate, have combined to weigh on the US dollar, helping many currencies including the euro and emerging market currencies to make up some lost ground. This is likely to continue in the short term, especially if overall market risk appetite shows some improvement.
Markets will likely struggle this week to find their feet. As we’re seeing today there are attempts to buy into the fall at least in Asia. Buyers will continue to run into bad news in terms of headlines, suggesting that it will not be an easy rise. Aside from watching coronavirus headlines there will be plenty of attention on the race to be the Democrat Party presidential candidate in the US, with the Super Tuesday primaries in focus. UK/Europe trade talks will also garner attention as both sides try to hammer out a deal, while OPEC will meet to deliberate whether to implement output cuts to arrest the slide in oil prices. On the data front, US ISM manufacturing and jobs data will be in focus.