The virus sickens stock markets
Negative news relating to the outbreak of the novel coronavirus has now started to hit equity markets. Last week’s complacency is no more.
As we feared last week, the reality of Chinese closures, damaged supply chains and worried consumers has hit world equity markets. The wall of money central banks have been injecting led people to anticipate a short, sharp decline and recovery which they could look through whilst driving shares higher.
Suddenly, investors show concern that the virus is not yet under control. They see that it is spreading to South Korea, Iran and Italy and may spread further. They ask themselves more taxing questions about how much output and income China is now losing this quarter, and what impact will falling international travel, reduced high-end luxury purchases, fewer trips to shops, entertainment and conference venues, less oil demand and the other signs of consumer worry have on world growth and company profits.
Central bank support
It is true the central banks are trying to avoid too sharp a slowdown. The People’s Bank of China has made small reductions in interest rates, has made cash available to markets on a large scale, and has made special lending facilities available through banks to the business sector in the worst affected sectors and provinces. They are well aware of the trouble for cashflow amongst many businesses unable to hit normal levels of sales and output.
The Bank of Japan and the European Central Bank (ECB) are continuing with their programmes of quantitative easing initiated before the crisis. The Fed has been keeping markets liquid since late last year. The Chinese central bank can take further action – and it may need to. It could cut the Reserve Asset ratio more. This controls how much cash and capital commercial banks need to keep for any given volume of lending, and has been progressively lowered from 16.5% in the middle of 2018 to 10.5% today. It can guide the Loan Prime Rate down further, as it has been doing in small steps recently. It can continue money market operations to ensure plenty of money available in markets. Chinese policy seems to be shifting a bit from enforcing a strict shut down and isolation in badly affected areas, to wanting more people to go back to work.
Italy has announced that it is locking down settlements where there has been a virus outbreak. The EU authorities have not been keen to intervene, and there is no specific virus response yet from the ECB.
The ECB under new leadership from Mrs Lagarde has just embarked on a year-long consultation exercise to explore the general question of what they should mean by “price stability” and how they can improve public understanding of what they do. They will not consider changes to their founding Treaty, nor to banking supervision. It is difficult to see what she wants to get out of this review, other than the opportunity to hear from the public what they think of their central bank.
Eyes elsewhere at the ECB
There is no briefing of any immediate special measures to combat the additional downturn caused by the virus. The Consultation wishes to hear about “employment, social inclusion, climate change and financial stability” which are all current concerns of the ECB. Mrs Lagarde has stressed in the past the wish for the ECB to make its contribution to green finance. The EU looks to member states to reflate to help the economies, whilst keeping the strong disciplines over debts and deficits which impede fiscal reflation in all but a handful of well-disciplined states, led by Germany.
Various emerging market countries are likely to see more monetary relaxation as they seek to fend off the worst consequences of the Chinese supply interruptions. They have more scope, with considerably higher average interest rates than the advanced world. The world could benefit from more growth in India, Brazil and the other leading EM nations, though they face the headwind of reduced global trade and are not immune to the knock to confidence either.
The virus will accentuate some of the trends we have witnessed in recent months. People under movement restrictions or fearing infection will shop online more than they will go to shops. They will seek downloaded entertainment more than going to restaurants and cinemas. The worst affected areas so far are those sectors that depend on international travel, on commodities and energy needed for Chinese manufacturing, and on tourism, events and retail visits. Although the relatively easy money background helps sustain markets, it looks as if there will be further reality checks from numbers for output and profits before this crisis blows over.
For more information please get in touch 020 3504 8307 or email us at email@example.com
John Redwood is Chief Global Strategist at Charles Stanley & Co. Limited, which is authorised and regulated by the Financial Conduct Authority.