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The 2003 SARS outbreak did not affect currency markets. However, the main reason for this was that China and Hong Kong accounted for a smaller proportion of global GDP: in 2003, they together accounted for around 4% of global GDP; in 2019, the figure was closer to 18%. This time, the effect on global demand was likely to be substantial and markets have already taken notice. Coming out of the 2001 recession, markets were more focused on the general economic improvement. This time around, markets are cautiously monitoring the late-cycle slowdown (with China’s 4Q GDP growth balancing on the 6.0% threshold), and reflationary expectations, for any demand disturbance. In addition, both in the Asia region and globally, services were expected to be the catalyst for slight economic improvements. Growth and inflation expectations have been stabilizing and investors are less pessimistic about market conditions. This is what is being damaged.
As global news flow around the escalating coronavirus outbreak increases and fundamentals worsen, currencies will further react. The first observed currency impact was the strengthening of CHF. As usual, safe-haven flows were attracted to CHF in particular because of its distance from “ground zero” (not true of JPY). CHF should continue to appreciate as the virus spreads, despite SNB Chairman Jordan’s view that CHF is “highly valued.” Expectations of SMB intervention have receded after the US put Switzerland on its Treasury Department watchlist. Other vulnerable currencies are the Singapore dollar and the Thai baht. The two countries’ proximity to China, reliance on tourism and room for a policy response (with their central banks currently open to currency deprecation) are all signals that further FX selling is likely. In addition, the Monetary Authority of Singapore’s reaction to SARS in 2003 was to let SGD weaken, which gives us an indication of its likely strategy. Finally, EUR is unlikely to be affected given the broader theme of Brexit. That said, the faint improvement in sentiment in the euro area and potential problems with tourism and manufacturing linked to Asian supply chains could become an issue. However, the threshold for additional ECB easing remains high. Looking beyond currencies, gold and bitcoin should remain well bid as the media bombard us with graphic images of the global pandemic.
It is critical to mention that over 300 of the Global Top 500 companies have a presence in Wuhan, in the Hubei Province. Wuhan has 10 car factories, such as those Honda, Renault and General Motors. The car industry represents around 20% of the city’s economy and employs 200k people directly and more than a million indirectly. Factories generally factor in two weeks of downtime for the Lunar New Year but this time will be significantly more. Downtime at these critical supply chain hubs will have global reminfications. Not just reducing global demand but eroding corporate sales / earnings.
In equities, coronavirus will clearly generate significant headwinds (starting in China/Hong Kong and spreading to the Asian Tigers). While volumes are likely to remain subdued, western countries should be seen as an opportunity since central bank policy remains supportive. At last week’s FOMC meeting, Powell was generally positive on the economic outlook while acknowledging that “uncertainties about the outlook remain, including those posed by the new coronavirus.” The current committee has a reputation of reacting before hard data materializes. The committee has taken note of the rapid spread of the virus and the resultant risk to the global economy. Should the situation worsen, watch for the Fed to quickly begin cutting rates and for US indices to move back to being bullish.
Crude prices are the most vulnerable to a deep pullback. Recent price appreciation has been driven purely by expectations of potential supply disruption. But coronavirus has put the spotlight back on demand. Fears of the virus spreading increase the likelihood of a potential demand shock. Brent prices have dipped below $60 a barrel for the first time since November 2019. Even deeper supply-side discretion and expectations of an extension to the OPEC+ production deal are not enough to shake investors’ concern over a significant oil imbalance (driven by the continual supply glut). Weak oil demand from China and already softer than expected PMI prints would put pressure on global oil demand growth. Unseasonably warm weather in Europe and North America has limited demand for heating fuel, further increasing the scope of demand weakness. With nowhere to hide, watch for the outlook for integrated oil companies to dim.