InvestmentEurope is providing ongoing coverage of responses from the fund industry to developments linked to the spread of Coronavirus.
29/02 1400 UMT - Covid‑19: Repercussions could worsen before they improve
Nicola Mai, portfolio manager and head of sovereign credit research in Europe and Tiffany Wilding, US economist at Pimco have commented:
"History teaches that epidemics tend to have short-term effects on economies and markets, but great uncertainty remains about the coronavirus.
"Fear of the fallout from the coronavirus has roiled markets, but while economies are likely to slow - dramatically in some regions - growth should rebound after the outbreak abates.
"Still, at this stage there is great uncertainty. There remains the possibility of a sharper-than-expected contraction in China, and the potential for quarantines and other measures to directly disrupt economic activity outside of China. Indeed, disease experts widely predict the spread of the virus could get worse before it gets better.
"China - where the first case of the coronavirus disease was reported in early December - is suffering the most.
"Authorities have imposed quarantines across various provinces, including those along the east coast that contribute the lion's share of the country's GDP, manufacturing and trade activity. Despite reports that factories and businesses are reopening after the extended Chinese New Year holiday, high frequency data on traffic congestion and port shipments suggest activity remains severely depressed.
"The longer quarantines depress Chinese economic activity, the more economic costs will rise. Weaker businesses that can't withstand cash flow disruptions will start to feel stress, which could spill over into financial markets, tighten financial conditions and exacerbate economic weakness.
"Because China now accounts for an estimated 25% of global manufacturing activity, the ramifications will be felt worldwide.
"It's both a supply and demand shock. For most countries, there will be a direct hit as exports to China slow. Already, falling Chinese demand for commodities has led to lower prices for industrial metals and oil.
"On the supply side, a key concern is that reduced production of components made in China could lead to price hikes and force manufacturers outside China to find new sources of supply, or at worst, halt production. However, moving supply chains is a complex process that would likely take three to five years to play out - so near-term supply disruptions to economic activity could be significant.
"In China, we estimate growth in first quarter real GDP could contract by 6% (at a quarterly annualized rate), which is a dip to 3% year-over-year growth. Last year, China averaged 6% growth.
"The next-hardest-hit economies will likely be in Asia, especially Singapore, Malaysia and Vietnam in Southeast Asia, and Japan and South Korea in Northeast Asia. We expect economies in Europe and the US will also be affected, with Europe likely hit harder than the U.S. given the region's higher exposure to exports to China and the greater openness of its economy to global trade.
"The sectors most vulnerable to the shock include energy and autos, followed by gaming, cruise lines, hospitality and airlines.
"Although the People's Bank of China has cut rates, injected liquidity and enacted targeted measures to smooth cash flow disruptions of business and consumers, central banks in developed markets have done little more than acknowledge that risks are growing.
"As of 28 February, most Fed officials were continuing to say it's too early to assess the impact of the pathogen. They appear reluctant to ease monetary policy because US economic momentum had been improving and they believe that policy is already easy. Furthermore, there is some doubt on the effectiveness of lowering rates in counteracting a supply-side shock.
"However, the decline in global equity markets - a real-time indicator - suggests that economic fundamentals may be deteriorating faster than previously thought. As a result, preemptive policy is needed to stabilize financial conditions and thwart a larger hit to the economy.
"Just before the market closed, Fed Chairman Jerome Powell said the central bank would act as appropriate, if necessary. We believe the Fed will announce an interest rate cut as a preemptive step at the Federal Open Market Committee's next gathering on 18 March, and keep the door open for further cuts as needed. If things deteriorate further, we believe a 50-basis-point cut is possible. Policymakers want to avoid a more disorderly tightening of financial conditions that could further exacerbate the economic shock. After the pronounced weakening in equity and credit markets, we will be monitoring the extent to which banks begin to withdraw credit, which is the lifeline of the economy.
"European central banks (and the ECB specifically) are monitoring the situation closely, and have said it is too early to assess the impact of COVID-19 on economic activity and policy. However, similar to the Fed, the ECB may need to act, as the longer financial market turmoil persists, the more downside risks may build.
"Overall, most coronaviruses are like the flu - they usually stop spreading by summer. As such, if past is prologue, activity and growth should normalize over time. Still, the situation is fluid and it's too soon to know with confidence the ultimate impact of the coronavirus - on global health, economies, and markets.
"As such, we favor remaining cautious in portfolio positioning and are mindful of liquidity and market dislocations. Recent market moves could create buying opportunities, but we would caution against rushing to take risk at this stage."