Coronavirus continues to impact markets, but are we past the eye of the storm?
Coronavirus, or COVID-19, continues to create stress across financial markets worldwide. Of particular interest now is the UK budget and if coronavirus has affected it. Chancellor of the Exchequer Rishi Sunak may have had to make some last minute changes. Patrick Brusnahan speaks to experts on the possibility, as well as coronavirus’ impact across the globe
Dean Turner, economist, UBS Global Wealth Management
One after another, central banks slashed interest rates last week in response to the coronavirus outbreak. The European Central Bank (ECB) meets to decide its interest policy on Thursday this week. In our view, an interest rate cut is likely to feature as part of a package of measures the ECB announces as it does its part to mitigate what is likely to be a sharp blow to economic activity.
As for the Bank of England, it seems likely it will follow the herd in due course. There is much speculation as to whether the Bank will act before it meets on 26 March 2019. When speaking to politicians last week, incoming Governor Andrew Bailey did not seem in too much of a hurry. Of course, this is not Bailey’s decision to make alone. Moreover, Mark Carney is still, as we write, in office, so we cannot rule out anything at this stage. However, on balance, it is likely that they will hold off for the time being for a couple of reasons.
First, rate setters at the Bank will want to see what the Chancellor of the Exchequer delivers in this week’s budget. Previous plans have been junked. The chancellor will now focus on measures that will help households and businesses adjust to this latest economic shock. Big-ticket election pledges—more police, more nurses, more infrastructure—are likely to be in the budget. However, the chancellor has had his ambitions curtailed by a need to keep a little back in case there are further shocks in the weeks and months ahead.
Second, the Bank will want to see what the ECB does. As mentioned above, we think a rate cut is likely, but this alone will not be enough to mitigate the current slowdown. Financial stability and measures to ensure the flow of credit into the European economy are arguably more important at this stage. Thus, there is a chance that the ECB will not cut interest rates at all, and will instead focus on macro-prudential policies. If they opt for this path, it will send a clear signal to European governments that they need to do their part on fiscal policy.
On balance, it seems likely that the Bank will have no choice but to follow the herd and cut interest rates on 26 March. In addition, we should expect to see other measures announced to support the flow of credit into the economy. However, is this the type of medicine the UK economy needs at this point?
Interest rates are already very low, not just in the UK, but globally. Cutting borrowing costs by a few basis points from here is not going to be enough to embolden a company to open a new factory and hire workers, nor will it encourage consumers to buy from shops or inspire them to book a holiday. However, cutting rates and ensuring financial stability will have an important signalling effect in the short term. It should give households and businesses confidence that things will return to some semblance of normality when the current shock passes. In time, it should also support the rebound in economic activity when it comes, hopefully making up some of the ground that has been lost. The greater the policy response, the stronger the bounce back is likely to be.
Joshua Roberts, associate director, Chatham Financial
This week had been pencilled into financial market participants’ diaries as one to watch for months. On Wednesday, the UK Government is set to unveil its first budget, billed as one of the most radical in recent years. SajidJavid’s shock resignation added another layer of intrigue: now, the chancellor reading from the red box will be the relatively unknown Rishi Sunak – although many suspect the script will have been written by Number 10 rather than the Treasury. And yet, events have overtaken us. Sunak’s debut will now be overshadowed by the market turmoil resulting from Covid-19’s ever expanding reach.
There has been no shortage of drama so far. Last Tuesday saw an emergency rate cut of 0.5% by the Federal Reserve – its first unscheduled announcement since the heights of the financial crisis in 2008. Meanwhile, US Treasury yields spent the week in free fall. The ten-year yield breached record low after record low to sit at its current level of below 0.5%. The same story was seen across the maturity spectrum: today, for the first time ever, the entire US yield curve going out to 30 years is below the 1% mark.
The expectation is that Tuesday’s cut was only the beginning. Economists at Goldman Sachs, for instance, expect further cuts of 0.5% at each of the upcoming Fed meetings in March and April. Meanwhile, the European Central Bank and Bank of England have also indicated their preparedness to act – although with EUR and GBP rates already at (or near) historic lows, it is unclear how much firepower is left at their disposal. Nevertheless, the Bank of England is expected to make at least one 0.25% cut at the next Monetary Policy Committee meeting, on 26 March.
Unsurprisingly, the monetary policy action took place amid a feverish equity market. By the time the Fed made its surprise announcement, the S&P 500 had already recorded its fastest ever correction (defined as a drop of more than 10%) in just six days. Equities across all global markets are showing much the same trend, and there is no sign of any slowing yet. Monday saw shares face their worst session since the financial crisis, and many major indices have slumped by up to 20%.
Against this backdrop, most governments might choose to delay significant announcements on trade policy until global markets have stabilised somewhat. But not Saudi Arabia. On Sunday night, the Kingdom announced that it would be dramatically increasing its oil production and selling crude at heavy discounts, starting next month. The move follows a failure to agree production cuts between Opec and Russia, creating a flood of supply just as demand is faltering due to the coronavirus. Accordingly, oil prices plunged by as much as 30% in the first few seconds of the market opening on Sunday evening. At the time of writing, they are still more than 20% below their pre-weekend level.
Market moves of the magnitude that we are currently seeing inevitably invite comparisons to the 2007-2008 financial crisis – and this is certainly the biggest global economic shock we have seen since then. But it is important to recognise the differences between the two. The last crisis represented a prolonged shock to demand, with households and businesses facing a long slog back to recovery after the financial system froze. With the exception of oil, Monday’s shock is to both supply and demand, with large scale factory closures and travel restrictions harming both production and consumption of goods and services. The upside of the current situation is that we can expect a comparatively swift recovery after the threat of the outbreak has passed, with both supply and demand returning to normal levels relatively quickly. On the downside, scope for central banks to address the problem with monetary easing is much more limited. Rate cuts and quantitative easing are not effective tools for fighting a pandemic.
And so, in the UK at least, we return to Sunak’s budget on 11 March. Following its election pledge to “level up” the country, the government had already indicated that a significant loosening of the fiscal taps was ahead. Now, with Covid-19 about to place a significant strain on the NHS, public services, and businesses around the country, Number 10 needs to make good on its promise. For some time, central bankers around the world have been issuing warnings about the limits of monetary policy, and the need for government spending to take up some of the slack. With a global recession on the cards, now is the time for those warnings to be heeded.
Robert Bergqvist, chief economist, SEB
We are in a serious but not impossible situation. A “Black Swan” coupled with a developing story is creating uncertainty. We have seen stabilisation in China on the number of new cases of COVID-19, but the virus is now spreading rapidly in other countries. The key question should be not if but when the disease will retreat. And the biggest challenge right now is how to handle uncertainty.
Globally the risk of recession has increased. Governments and central banks around the world are cooperating to control the situation. A u-shaped recovery is the most likely scenario – primarily a “supply-side-shock”. Normalisation means consumption and production will resume. Both the time factor and policy support are important to limit economic damage, but disproportional measures can create economic and financial crises.
David Riley, chief investment strategist, BlueBay Asset Management
Today’s very strong US jobs report confirms that the Fed’s assessment that the US economy was in a ‘good place’ was reasonable, but that of course was before the global spread of the coronavirus including to the US.
Markets ignored today’s blow-out report as an irrelevant look into the past, but it does confirm that the US economy does have positive momentum as it now faces the negative shock of the spread of the coronavirus. A tight labour market will make companies more reluctant to lay-off workers if the economic shock from the coronavirus is judged to be temporary while household income from labour is rising above 4% supporting consumption.
The positive momentum in the US economy before the global spread of the coronavirus leaves it better placed than most to absorb the negative demand and supply shock from the global spread of the coronavirus. But markets are sceptical that positive momentum will prove sufficient to avoid a meaningful and prolonged downturn in growth, not least because of the absence of fiscal action and at least so far an under-whelming health policy response.
The Fed enters the ‘black-out’ period ahead of the FOMC meeting on the 18th March but it will be developments in the spread of the coronavirus in the US and the response of companies, consumers and government that will determine whether it validates market expectations for further 50bps rate cut rather than today’s bumper jobs report.”