During February falls in major share markets were very sharp coming off high points for several markets in the third week of the month. Over the month falls ranged from 8.2% for Australia’s ASX 200 to 9.7% while the falls from peaks in the third week to the end of the month were well above 10%. Even in the US where economic readings remained strong in the month, the S&P 500 fell by 8.4% over the month. Corona-virus numbers are starting to rise in the United States increasing the risk of softer growth in the near term, but the underlying strength of the US economy based on near full-employment (the latest unemployment rate reading for February due later this week is likely to be around 3.6%, near a 50-year low) and strong household income growth is likely to prevent US growth sliding too far.
The corona-virus threat in the US also makes it more likely that the Federal Reserve will cut interest rates and that fiscal stimulus of some magnitude will occur. The Administration was always likely to try and spend more running towards the Presidential election in November. The corona-virus threat mutes political opposition to more spending and probably increases the chance of spending rising in the near-term.
In China, the daily number of new corona-virus cases peaked in early February and has declined sharply since. Outside the epicentre of the corona-virus outbreak in Hubei province the extended lunar New Year holiday break that closed many businesses is slowly finishing and the authorities are looking at support measures for businesses crippled by the extended break. The economy will take several months to recover from the deep trough in activity in Q1 although President Xi has promised to take whatever measures are necessary to return the economy to a 6% y-o-y GDP growth trajectory by the end of 2020.
Elsewhere in Europe and Asia new corona-virus cases are expanding notably in Iran, Italy, South Korea and Japan. Containment measures in countries where cases are growing will reduce growth initially before any stimulus measures can take hold.
The impact of corona-virus is also showing on other financial assets. Credit spreads widened in February although the change was relatively small compared with the falls in share markets. Demand for safe-haven assets was high and government bonds rallied strongly. The US 10-year bond yield fell by 36 basis points (bps) in February to 1.15% while the 30-year yield fell by 32bps to 1.68%.
In Australia, although the RBA left the cash rate unchanged at 0.75% at its February policy meeting, the 10-year bond yield fell by 14bps to 0.81% at month end. Also, the RBA’s latest economic forecasts released in its February Monetary Policy Statement still show the economic growth slowly lifting pace through 2020 and 2021 albeit with a double-disaster (bush-fires and corona-virus) dip in the first half of 2020.
Corona-virus developments are worse than the RBA allowed in the February Monetary Policy Statement, but one interest-rate sensitive part of the economy, home-buying activity is running very strongly – perhaps more strongly than the RBA allowed in its forecasts. Auction clearances on high volume were above 80% at the weekend in both Sydney and Melbourne and at a time when the news was worsening about the corona-virus outbreak.
Home buying activity appears to be immune and perhaps even spurred by the corona-virus outbreak as buyers compensate for less spending in areas such as travel and look to one asset that may rise in price. The issue is that the strength may prove short-lived, especially if Australia’s unemployment rate starts to rise as seems increasingly likely given the range of Australian businesses – tourism; education; importers and exporters – negatively impacted by the corona-virus.
Almost certainly there will be substantial Australian fiscal stimulus aimed at providing some support for business and household income. Policy change, however, will not alter the trajectory of the corona-virus outbreak. Even though lower interest rates also do nothing to counter what is essentially a medical emergency it is likely that easier monetary policy will be deployed at some stage to back-up fiscal stimulus. At some point (not necessarily at the RBA meeting this week) it seems likely that the cash rate will be cut from the current 0.75%, possibly in tandem with the Government announcing a fiscal stimulus package.
Interestingly, the policy stimulus measures could serve to intensify the bounce in the economy and risk assets once the corona-virus has peaked or a vaccine is announced. The problem is that timing the corona-virus peak, or the development of a vaccine is starting to stretch out and the risk is increasing of a short-term blip downwards in economic activity turning to something worse.