Blog

COVID‑19: Repercussions Could Worsen Before They Improve

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 U.S. 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.

Policy responses

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 U.S. 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.

History lessons

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.

This blog was published on 28 February 2020.

For more on PIMCO’s outlook for markets and how investors can prepare for volatility, please see our “Investing in Uncertain Markets” page.

READ NOW

Tiffany Wilding is a PIMCO economist focusing on the U.S., and Nicola Mai is a portfolio manager and leads sovereign credit research in Europe. Both are regular contributors to the PIMCO Blog

The authors would like to thank Stephen Chang and Isaac Meng for their contributions to this post.

The Author

Tiffany Wilding

North American Economist

Nicola Mai

Portfolio Manager, Sovereign Credit Analyst

Related

Disclosures

London
PIMCO Europe Ltd
11 Baker Street
London W1U 3AH, England
+44 (0) 20 3640 1000

Dublin
PIMCO Europe GmbH Irish Branch,
PIMCO Global Advisors (Ireland)
Limited
3rd Floor, Harcourt Building 57B Harcourt Street
Dublin D02 F721, Ireland
+353 (0) 1592 2000

Munich
PIMCO Europe GmbH
Seidlstraße 24-24a
80335 Munich, Germany
+49 (0) 89 26209 6000

Milan
PIMCO Europe GmbH - Italy
Corso Matteotti 8
20121 Milan, Italy
+39 02 9475 5400

Zurich
PIMCO (Schweiz) GmbH
Brandschenkestrasse 41
8002 Zurich, Switzerland
Tel: + 41 44 512 49 10

PIMCO Europe Ltd (Company No. 2604517) is authorised and regulated by the Financial Conduct Authority (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963), PIMCO Europe GmbH Irish Branch (Company No. 909462), PIMCO Europe GmbH UK Branch (Company No. BR022803) and PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 32 of the German Banking Act (KWG). The Italian Branch, Irish Branch, UK Branch and Spanish Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority; and (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication.| PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2) . The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser.

All investments contain risk and may lose value. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.

The Fed's New Guidance: Surprising Is Not Convincing
XDismiss Next Article