Coronavirus (labelled 2019-nCoV by the World Health Organisation) fears have sent shockwaves through global communities and financial markets in recent days. When the SARS outbreak occurred, China’s economy represented 4% of the global economy, today that number is over 16%. If the virus follows a simple progression model (i.e., assume a 53% increase in cases as reported, where each infected person transfers the virus to 2 to 2.5 people) then by 20 February 2020 we can expect to have over 100 million cases of Coronavirus worldwide, according to China National Health Commission Daily Reports (chart below).
This assumes the virus continues to follow the actual growth rates seen over the last 12 days. A successful quarantine/isolation of infected communities or a development of a vaccine/cure can clearly have a large impact on projected infections, but notwithstanding the situation is changing quickly and has vast human and economic impacts at a time when the global economy is only just showing tentative signs of recovery from a weak 2019. The ability to quarantine the virus will be more problematic and comparisons to the SARS epidemic are difficult given the increase in global travel numbers over the last decade.
For now Chinese cities are closed. Chinese New Year holidays have been extended across the country until 2 February 2020, with some cities and provinces, such as the major provinces of Guangdong, Zhejiang, Jiangsu, not to resume work and school before 9 February 2020. These three provinces are numbers 1, 2 and 4 in China in terms of GDP. Whilst the reported mortality rate is low, at around 3%, the long incubation period of two weeks is making identifying infected cases difficult during the peak travel period of Chinese New Year. This makes the virus harder to isolate.
The outbreak began in Wuhan in December, home to 11 million residents. Wuhan is at the centre of China geographically and connected to all major Chinese cities by road and high speed rail (one of 4 national rail hubs) and is an important engine of the Chinese economy. Putting aside the human tragedy for a moment, let’s look at the economics. Exact modelling of the impact on the Chinese economy is very difficult, however a two week shutdown is likely equivalent to >1% of Chinese GDP, a three week impact is likely equivalent to >2% GDP. The overall impact of the SARS virus in 2003 resulted in over 2% of GDP, but the GDP base was much higher at 11% growth. It is likely that Chinese businesses will halt for a prolonged period, travel will cease which will lead to a plunge in the demand for oil on an already oversupplied market (this can have material implications for high yield bonds – very energy heavy complex).
Although mainland media quoted Chinese infectious diseases expert Li ¬Lanjuan on Monday as saying a vaccine targeting the coronavirus was being developed, this will take up to a month to manufacture and will require testing before it could be deployed.
Trying to connect the dots is incredibly complicated, as markets are also concerned that China is withholding the true state of the outbreak. As with any thematic that is gripping markets and causing risk aversion, the circuit breaker can only be a cure or a plateau in the number of cases of people around the world contracting the virus.
The economic impact is very likely to already be material for global growth – which will be another body blow for the fragile domestic economy. Given the asymmetry we have noted in most Central Banks (ease on bad news, do nothing on better news), we think this can bring policy makers to the rate cutting table faster than otherwise predicted in 2020. Overall, pressure on bond yields, while it may ebb and flow, will mostly be downwards and the foreign exchange markets will be torn between seeking haven currencies and seeking yield, but the US dollar, Japanese Yen and Swiss Franc are likely winners, whilst we expect the Euro and China-sensitive emerging market currencies may be losers.
In our December 2019 post − Tail risk hedging your portfolio using currency, we highlight any interesting paper authored by staff from the Bank of England (and co-authored by staff at the European Central Bank) on currency risks and looking into the idea of safe-havens in FX markets. As the authors note, their results largely match 'market talk' but they can quantify the effects.
"The Australian dollar remains top of ranking in terms of an increased likelihood of a sharp depreciation (large downside entropy), while at the opposite end of the spectrum there are a series of currencies with large upside entropies that join the yen as ‘safe havens’, notably the Swiss franc and the US dollar."
As to why a certain currency attracts a safe-haven assessment, the paper concludes that current account deficits and positive interest rate differentials as the most robust indicators of increased chances of seeing a sharp depreciation in the event of a tightening in global financial conditions.