Safe Haven Rally as Volatility Rises

Intermediate
  • The market has begun to show genuine concern about coronavirus
  • Is it really contained in China? It appears to be spreading elsewhere!
  • There are calls for extra fiscal stimulus to take up economic slack
  • The price trends of late last week will continue

On Friday, February 21 global investors adopted a serious sense of concern with regard the coronavirus outbreak after the markets had been “whippy” during the week, rotating between profits and losses.

The U.S. Treasury “Long Bond” i.e. the 30-year saw its yield decline to an all-time low on Friday as it was deemed an attractive safe-haven instrument. The long bond closed at a yield of 1.917% from 2.135% just a month ago. The more popular 10-year note also made gains as the yield closed at 1.473% from 1.686% four weeks back.

Virus Spread

The epidemic has now entered a new phase. What to make of reported cases slowing inside China? Is that genuine, or is just a result of the reclassification of the disease incidence? Of concern is the way the spread is growing outside of the People’s Republic as there are now more than 500 cases in South Korea, 85 in Singapore, 135 in Japan, with fresh cases recorded in the Middle East and Europe.

For example, in Italy “extraordinary measures” have been introduced to tackle the spread of the biggest outbreak of coronavirus in Europe. Prime Minister Giuseppe Conte announced the emergency plan as the number of cases rose to more than 100. Twelve towns in the northern regions of Lombardy and Veneto are now quarantined under the plan and approximately 50,000 people from towns in two northern regions have been asked to stay at home by authorities.

Economic Impact

Over the weekend at the G-20 summit in Riyadh, finance ministers discussed the biggest challenges confronting the global economic outlook. Be ibn no doubt one key issue that was the need to cooperate against Covid-19, to use the scientific classification of the virus.

The IMF has downgraded its GDP growth outlook for China to 5.6%; it’s previous estimate, before the pandemic, was 6.0%. The virus will not just hurt China. The global economy is going to slow as supply chains are disrupted and tourism numbers will fall. More negatives on market sentiment.

As if to fanfare the economic worries U.S. data displayed evidence of a slowdown. The Markit Composite PMI for February retreated 3.7 points to 49.4 i.e. in the sub-50 space which implies a contraction. It’s the lowest point for the measure since October 2013, when the U.S. government shut down.

IHS Markit U.S. Composit Graph

Figure 1: IHS U.S. Markit Services over 10-Years  Source: HIS Markit

A similar picture emerged in Asia as data reported at the end of the week showed that Australian and Japanese manufacturing also took a hit.

The Ai Group Australian Performance of Manufacturing Index dropped to 45.4 in January 2020 from 48.3 in the previous month. The reading pointed to the third consecutive month of contraction in the factory activity and marked the lowest monthly result since June 2015.

The Jibun Bank Japan Manufacturing PMI dropped to 47.6 in February 2020 from 48.8 in the previous month and well below market expectations of 49.0, a preliminary estimate showed. The latest reading pointed to the steepest pace of contraction in the manufacturing sector since December 2012 amid the coronavirus outbreak, while activity was already under pressure following the sales tax hike and devastating typhoon in October.

Motor manufacturers from South Korean endured a devastating collapse in demand from China; sales plummeted 92%. The only bright spot came from an unexpected source as the Euro Zone saw economic activity rise to a six-month high and German manufacturing picking up to 47.8 in February of 2020 from 45.3 in January, beating market forecasts of 44.8.

Markets Reconsider The Viral Impact

As yields fall there has been a call for additional government spending to be unleashed as a means of overcoming the economic impact of the virus. The Organization of Economic Cooperation and Development (OECD) has advocated increasing fiscal stimulus through infrastructure projects and other spending.

There was a sense that as the year began the market felt the selloff driven by coronavirus was overdone. The thinking was clearly reflecting on how the markets had fared during other outbreaks such as SARS or bird flu, (H5N2).

No less a figure than UBS Chairman Axel Weber thinks the economic impact of the virus is being underestimated. Speaking to Bloomberg at the G-20 Summit in Riyadh he said:

“…There is going to be quite a bit of impact that is going to go beyond the first quarter and that is where fiscal response, providing businesses with some tax relievers, some emergency funding, that is going to be very important for putting businesses through…”

Webber said that his estimates, global growth will experience a massive drop from 3.5% to 0.5% and China will post a negative growth rate in Q1 2020, something not seen since 1990.

The new week will begin with a continuation of the trends that became established at the end of last week. March has not even begun; however, trading desks and fund managers will be feeling some concern about their Q1 returns.

Multiple graphs

Macroeconomic Strategist

Stephen Pope is the Managing Partner of Spotlight Group. He has worked in the world of finance since 1982 and has performed d... Continued

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