Coronavirus Worries Still On The RiseWith coronavirus worries on the rise, the market continues to struggle with the unenviable task of factoring in absolute terms its implied economic devastation. Given that China has rapidly increased its role in the global supply chains, the market continues to price in the worst case, negative growth shock scenarios.
For the most part, traders are flying blind, knowing nothing about the actual implication of NCoV for global growth. Still, instead, they are taking cues from the medical professions epidemic risk assessments. However, given what’s known at this stage amid China’s massive and continuous contribution to the worldwide economy – the direction of travel in growth proxies makes sense. And while the viral headwinds are likely to be transitory, the timing and extent of the damage are unknown.
The market reaction has been both swift and one-sided. Still, it’s probably too early to discount the recent price action summarily a classic risk-off then rebound, especially with the market fear index going through the roof. At this juncture, traders are still very much uncertain about which road to take (trade or fade), but there remains a growing sense in the market that contagion levels could get worse before they get better.
Risk proxies rather than the liquidity pumped equity markets offer the cleared guide for investor reaction to the outbreak. Gold and USTs are bid, Brent crude collapsed below $60/barrel, and the Stoxx Europe 600 tanked amid one of the worst risk pummelling in several months as the market risk lights continue flickering between amber and red.
What’s even more unnerving is that risk appetite typically stumbles in February after the holiday shopping bonanza effect on the data wilts, and now we’re looking down the barrel on forecasts that are below consensus on a slew of new February data including ISM, auto manufacturing and payroll.
And while comparisons between the SARS and coronavirus are beyond tricky. But for those looking to play the big rebound play, keep in mind in 2003, the entire backdrop was completely different as most risky assets were already at the lows, not highs, after the tech bubble blow up and US recession. So, looking at the stream of rebound comparison is invalid on some many levels. But this will be for a future discussion.
Oil is down significantly on Coronavirus fears, falling below $60/bbl. for the first time since Oct-19. As a point of comparison, the IEA noted in 2003 that the SARS outbreak that year had a sharp impact on oil demand in the short term, but a quick recovery followed this.
However, oil remains under pressure in early trading this morning as a result of fears that the spread of the coronavirus in China and beyond will adversely impact global oil demand. Despite a pronouncement from Saudi Arabia that the virus will have minimal impact on consumption, traders are correctly focusing on the assessment of the medical profession while continuing to reflect on the possible downside risk of a global pandemic. Let’s face it, in the finely balanced oil markets, OPEC can control supply but demand devastation from a rapid spread of a mutant virus they can’t.
But with a massive haircut to China’s GDP yet to be calculated as a result of the domestic virus break out, it’s hard to argue the direction of travel, especially given the current oil price linkage to the Chinese economy.
However, with a tentative price base forming, there is some thought the market is pricing in close if not beyond worst scenarios, and all the while there remain expectations that OPEC will do whatever is necessary to keep prices from falling off the cliff.
Gold is performing well in large part because of the slump in US yields since the new year. This fact seems to be offsetting the impact of a strong US dollar to a more considerable degree. And with the Fed on hold, so a risk-off induced break lower in yields could be relatively unobstructed, which would be very bullish for gold. Rates have now broken the downside range as the global risk-off due to the coronavirus outbreak continued over-night, bullish for gold.
The anticipated Wuhan flu contagion triggered sell-off in equity markets will likely drive gold demand over the short term, and strategic buyers could for the “Wu-flu” to spread at a faster pace in the coming weeks. The more rapid pace of contagion will represent another significant headwind to global growth, bullish for gold.
Now focus is shifting to the Fed, all eyes and ears will be honed on Chair Powell’s FOMC presser and who the Fed responds to questions about the financial stability risks created via the Fed’s liquidity injection due to balance sheet expansion.
There’s no blueprint for unwinding the balance sheet without some element of risk. But the fear heading into this FOMC meeting is a communication misstep. At some point, the Fed will need to communicate a temporary pause in the Fed’s repo activities as it can’t go on forever. But given the virus-induced massive risk wobble, the last thing the Fed wants to do is reduce the Repo buffer; they would have felt more comfortable with the S&P 500 100 points higher.
For now, the safe-haven USD bid on coronavirus is the thing that matters, but once global growth fears stabilize, the “Bernie Sanders on the move” factor, which is a definite negative for the US dollar, will start to matter. It’s not an absolute binary as there are too many forks in the US election prediction tree, but US election risk gets brought forward once again and limit the dollar gains (Another reason to own gold)
The Australian Dollar
The Aussie got smacked with the ugly stick overnight as the triple whammy negative of iron ore tanking, the A$ correlation to a dramatic sell of in the Yuan. And the negative knock-on effect from a likely downgrade in China’s economy raises bets the RBA will cut interest rates sooner than later.
This article was written by Stephen Innes, Asia Pacific Market Strategist at AxiTrader