Coronavirus Outbreak: An Economic Shock?

FOCUS TOPIC

Recent development of the coronavirus outbreak seems to suggest that the virus is more contagious than SARS in 2003. The number of infected individuals has already surpassed SARS in a much shorter period of time and is still rising rapidly, although the fatality rate is lower (currently ~2% vs ~9.7% for SARS).

Does this imply that the economic impact could be larger this time given the broader and faster spread of the virus? Is it a Blackswan event that is going to derail the moderate global growth recovery that we had expected at the beginning of this year?

A SHORT BUT SHARP ECONOMIC SHOCK

We mentioned in our strategy note published before the Lunar New Year that the impact of coronavirus on economy and markets tend to be short-lived (last for a few months) based on the experience of SARS, and digital consumption (e-Commerce, online entertainment and online education) could be beneficaries.

Here we try to assess the potential economic damage in the near term amid the evolving situation of the current outbreak.

(1) Aggressive quarantine measures lead to a sharp economic disruption in China

Lockdown of cities are unprecedented moves by the Chinese authorities. Most provinces suspending business and production until 9 February will also incur economic cost.

Not only offline retail (include catering), transport and hotels (altogether account for 16% of China GDP and 29% of service sector output) are hit due to travel restrictions and heightened uncertainty, the manufacturing sector is also affected given factory closures and logistical disruption.

In addition to a high base in 1Q 2019, year-on-year China’s GDP growth in 1Q 2020 could fall below 5%. 

(2) Demand shock in economies with strong links to China through tourism and trade 

Tourism: The substantial decline in outbound tourism from China hurts the economies that are highly exposed to China visitors. In Asia, Hong Kong and Thailand are the most exposed as Chinese tourism accounts for 8% and 3% of their respective GDP, and share of China tourists are 79% and 28%, respectively.

While visitors from China to Hong Kong were already sharply lower due to the protests, the actual impact may not be as large as shown from the numbers. 

Trade: China is more integrated into global supply chains today than in 2003. Travel restrictions create large uncertainties and supply chains disruptions. For instance, some Taiwan and Korea technology companies and component makers with factories in Hubei and adjacent provinces could be affected.

Furthermore, much slower China growth could have spillover effects across all Asian economies. However, US-China trade war has triggered a partial shifting of supply chains over the past 18 months and growing online consumption nowadays (vs minimal in 2003) could mitigate the overall impact.   

(3) Indirect impact from precautionary behaviors

Indirect impact due to precautionary behaviors from consumers, business owners and investors are hard to quantify. An increasing number of countries and many multinational companies have imposed travel ban to China.

Slowdown in flows of people also significantly limit business and production opportunities. Overall, India and Indonesia, which are more domestic demand driven economies, appear to be more insulated in the region. However, they could also be vulnerable amid their weaker healthcare systems should the virus spread to these countries. 

ECONOMIC IMPACT COULD BE SHARPER BUT UNLIKELY TO DERAIL GLOBAL GROWTH 

The current outbreak, which tends to be more infectious, together with more dramatic and widespread measures to limit further contagion, as well as China’s larger share in the global economy now (~20% vs  ~8% in 2003), suggest that economic impact this time could exceed SARS.

However, we do not expect the economic shock (which we assume to be temporary at this point of time) to derail global growth significantly for the whole year. On the contrary, pent up demand after the outbreak situation is contained and potential policy stimulus could offset the weakness in 1H20, seeing a stronger sequential recovery in 2H20.

The final economic cost of the outbreak is determined by how quickly the epidemic is deemed to be under control and whether it is affecting a much broader part of the world, which are big unknowns now and causing anxiety.

Markets particularly those link closely with China would remain very volatile in the short term. During SARS in 2003, MSCI Asia ex-Japan fell 16% from peak to trough, but rebounded 32% in 2H03 after the outbreak was contained. There will be bottom-fishing opportunities, but it is still early days as the situation is escalating. We may see the peak of outbreak within a couple of months if SARS is any guide.

China central bank’s huge liquidity injection of RMB 1.7 trillion (USD 243 billion) through open market operations after the Lunar New Year holiday shows their determination to stabilize financial market.

In case of a more severe scenario with the duration/magnitude of the epidemic much longer/bigger than expected and economic disruptions much more sizable, we believe central banks globally are ready to ease and many governments are likely to response with acceleration in fiscal spending. 

GDP & CPI FORECASTS

Growth

• Global manufacturing cycle has started to recover in the last few months while political risks have also decreased significantly, particularly after the signing of the “Phase 1” trade deal as well as Brexit developments. Combined with very accommodative central bank policies, conditions are met to see some acceleration in economic growth this year, although uncertainties may likely return from time to time.
• The outbreak of the coronavirus could lead to more economic weakness than compared to previous epidemics. The shock could challenge full year economic outlook as the virus will likely prolong the weakness in the manufacturing sector while adding another downside risk to the outlook. For now, we still stick to our view of a second half rebound in economic growth.
• China started 2020 well as activities showed signs of recovery while a preliminary trade agreement was just signed with the US. Nonetheless, the acceleration of the Coronavirus outbreak will likely act as a headwind to economic growth, although it should prove to be temporary. Beijing is very likely to step up in policy easing along with other fiscal measures to improve optimism and boost economic prospects in the medium term.

Inflation

• Devastation in China’s pork industry pushed consumer-price inflation to an eight-year high in 2019, complicating decisions for policy makers looking to boost a cooling economy. Full year 2019 consumer inflation grew 2.9%, albeit still in line with the government target of 3%. Meanwhile, producer prices fell at a slower pace in December, in signs of a modest recovery in manufacturing activity and suggesting Beijing's stimulus measures might have helped to steady the economy.

GLOBAL EQUITIES

Asian equities started 2020 strong, given the positive momentum from the “Phase 1” trade deal as well as the accommodative stance of most central banks globally. Investors were actively seeking opportunities to participate in the markets.

However, the recent acceleration of the coronavirus outbreak quickly unnerved investors and we saw a sell-off in risk assets. Market impact though, may be temporary, particularly when we look to the previous experience of SARS, where markets bottomed at the first sign of stabilisation.

In light of the coronavirus outbreak, we have downgraded Consumer Discretionary and Industrials in Asia, mainly driven by significant volume drop in tourism, hospitality and general offline activities/services.

The transportation sector is likely to be hit hard as well, while we expect industrial production activities to witness a slowdown due to supply chain disruption. We upgraded Technology in Asia, which will likely benefit from the accelerated migration from offline to online. 

GLOBAL FIXED INCOME

• January saw large inflows into safer assets as investors took flight to safety amid the acceleration of the coronavirus in China. US 10 year treasuries saw huge demand, and yields plunged from a high of 1.9% at the end of December 2019 to 1.5% at the end of January 2020.
• In the US, the Fed held the fed funds target steady at its January meeting, as expected. Several Fed policymakers felt that economy was stable and that the policy rate was in a good place. Even policymaker doves agreed for a pause in rate cuts for the foreseeable future. Leading indicators for January suggest an improvement in manufacturing, and the job market remains strong. The Fed is unlikely to change interest rates until after the US presidential election, although they did voice concern over the persistently low – and below target – inflation.
• We remain neutral on Indian credit. Valuation look fair with the risks on slower economic growth still weighing on investors’ cautious sentiments, despite the 2020 Budget announcement. Overall, valuations of Indian IG and HY corporates look fair compared to rest of its Asian peers. Credit selection will remain key in 2020, while we prefer large public sector banks and remain cautious on non-bank financial corporations (NBFCs) as the ramifications of the stresses among NBFCs remains a key concern. 

GLOBAL FOREX

USD: Near term, we think the expected slowdown of the US economy will be somewhat smooth as employment remain strong and the manufacturing sector bottoms. Economic data will be key in the potential reassessment of the US monetary policy, although the Fed is unlikely to change interest rates until after the US presidential election. However, they did voice concern over the persistently low – and below target – inflation. We are neutral USD short term, given the synchronized monetary easing globally, albeit some weakness can be expected towards the year end.

CAD: We stay neutral on the CAD after its trend reversed in January. Recent economic data showed signs of slowdown especially on investment, housing and spending. Additionally, the central bank became more dovish, after revising 2019 growth forecast downwards. Externally, the USMCA awaits to be ratified by Canada but we expect the agreement to be fully approved over the first semester. The easing US-Sino trade tensions should also have a positive effect on the Canadian business environment while tax cuts should sustain private consumption. 

ALTERNATIVES & COMMODITIES

COMMODITIES

Oil: Oil prices declined sharply due to worries about the global demand in the wake of the coronavirus pandemic in China. Its impact should however be temporary. OPEC+ restraints, possible supply disruptions (Libya, Iraq), a slower US shale supply growth and better economic momentum should help a price recovery in the 2H 2020.

Should weakness persist, we may upgrade our view from neutral to positive, but for now we keep to neutral and we still expect Brent prices to remain in $60-70/b range.

Gold: We remain positive on gold as its key fundamentals remain in place: low/negative real bond yields, ongoing central bank purchases and moderate supply.

Gold jumped to 1590$/oz after the killing of the Iranian general Soleimani, retraced to $1540 and was back at $1580 due to the coronavirus scare. We still like the yellow metal due to its ability to hedge against tail risks, be they inflation, financial instability or geopolitical. Our forecast range is USD 1450 – 1650.

ALTERNATIVES

Global Macro: We stay positive on global macro. It is best placed to trade the shifting environment between restrictive and accommodative monetary policies, as well as possible volatility due to geopolitical risk (trade, US elections, etc.) and even the coronavirus outbreak. There will be opportunities in EMs with several rate cuts expected.  Systematic trend followers (CTAs) also have a structural role to play in a portfolio, given its tail hedge nature.

Event Driven: We upgrade Event Driven to positive. Slow global growth pushes companies towards external growth.  Technological disruption leads to offensive or defensive vertical integration. Low interest rates means cheap financing and increased deal attractiveness. 

Source: BNP Paribas Wealth Management as of 31 Jan 2020

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