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The markets fall ill

The spread of a deadly coronavirus from China has brought global equities off highs. But world markets also have to face up to possible changes in US monetary policy.

The spread of a deadly coronavirus from China has brought global equities off highs. But world markets also have to face up to possible changes in US monetary policy.

by
John Redwood

in Features

29.01.2020

The spread of the coronavirus has upset the bullish markets that started 2020. There will be an immediate impact on the Chinese economy. Three more days have been added to the New Year holiday. Consumer confidence is likely to fall, and in the worst affected cities people are not going to the shops or out on the streets.

The Chinese market is likely to take the biggest hit, but as confirmed cases are found in the US, Japan, France and in other countries all equity markets have fallen, worrying about how far this may spread and for how long this new threat may endure.

Past outbreaks of serious illness worldwide have knocked markets temporarily, but have often been followed by market recovery as and when the authorities turn the tide on the spread of the disease. It is difficult to forecast when this outbreak will peak, as we are still in the early stages of it spreading around the world.

No isolation

No country is going to quarantine anyone coming in from an affected area, so there remain risks of it spreading as travellers turn up in new countries, often unaware themselves that they are carrying the virus. The Chinese have made travel very difficult into and out of Wuhan, where it started, but it is now spreading from many locations well beyond the epicentre of the outbreak. There is debate over whether it originated in an animal market or elsewhere. The more that the Chinese can disclose about how they think it came about, the better. More than 100 people have died so far, though most contracting the disease are expected to get over it.

So far, Asian markets have suffered the most, with the US falling the least. Shares most exposed to the trouble include airline stocks and luxury brands, as people anticipate less travel and less discretionary shopping by the rich on the back of their reduced travel plans. There are also effects on oil and other commodities, as investors assess the likely impact on the Chinese industrial economy.

The extended holiday and the interruptions to normal travel and activity are likely to slow the already slowing Chinese economy further. China is co-operating with World organisations, but it is another blow to China’s standing in the world, dented by the issues in Hong Kong and the treatment of Muslims and Christians in mainland China.

Meanwhile, world markets also have to face up to possible changes in US monetary policy. The Fed has been boosting bond and equity markets by spending more on the purchase of Treasury Bills. As its balance sheet expands to intervene in these trades, so there has been spill over into other financial assets, taking prices higher. It is quite likely this process will slow or even end soon. This will be a challenge to markets, used to supportive central cank action to keep asset prices high and increasing.

China has more scope now to take action to expand its economy, with plenty of options in monetary policy where the authorities could lower interest rates, relax bank capital requirements, expand the budget deficit, bring forward more public sector borrowing and offer a bigger boost to small business amongst a variety of options.

We expect some further turbulence on the back of news of the progress of the virus, and as the economic consequences for China are thought through. The worst effects could be offset by more Chinese official action to boost their economy. The advanced world too needs to consider whether this unwanted disaster means the possible gentle recovery from last year's slowdown needs a further boost.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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