China’s deadly virus has delivered a lesson in humility to the prognosticators on Wall Street, as hard-to-price market risks challenge projections for 2020.
With fears growing over the economic impact of the spreading illness, investor nerves were on full display in Tuesday’s choppy trading. The announcement of further curbs on travel between China and Hong Kong derailed an equity rebound and sparked another dash into bonds -- before a risk-on reversal.
Here are some of the latest thoughts from market watchers as they rush to work out what’s next:
Jim Reid, global head of thematic research and team.
- “Without downplaying the very tragic human effects, a confirmed death toll of 106 so far (vs. 80 yesterday) is but a fraction of the hundreds of thousands of people who die each year globally from seasonal flu.
- “Many experts suggest that by far the biggest issue in this episode is the long contagious period where there are no symptoms which makes the virus much harder to isolate and different from SARS. SARS had a higher mortality rate of 9.6% though against c.2.8% for Coronavirus so far. For reference the famous 1918 flu outbreak had a fatality rate of 2.5% with normal flu often no more than 0.1%.
- “China’s reaction has been a lot more rapid than for SARS so a different template and this makes analyzing it hard.
- “As a minimum Chinese data is going to take a notable hit for many weeks and getting a true read of underlying momentum is going to be hard.”
Nordea Investment Funds
Sebastien Galy, senior macro strategist.
- “China is slowing, we may be the only one making that point, but it most likely is and there is no coordinated rebound, only the end of a passthrough of the EM shock in DM. The shock of this health crisis is likely around 1 to 1.5% in a Chinese economy likely growing 4.7%. While we are very optimistic for H2, it is the type of cocktail that is unhelpful for the global carry trade.
- “Consequently, we suspect that enough strategies will be selling on rallies to cap these limited equity gains and that humans will reduce their exposure in part forced by a tad higher volatility (VIX is not in the stressed 20-30 regime). Expectations that the Fed will react to this is a testament to late comers in the carry trade. We expect them to stay on hold.
- “Till then we continue recommending a diversified portfolio which could include covered bonds, listed infrastructure and listed real estate.”
Kit Juckes, chief FX strategist.
- “The belief that low rates can and will smooth over in the deepest potholes in the road ahead for financial markets, is deeply-ingrained. But there will be an economic impact from the virus outbreak, even if we don’t yet know how long it will last and therefore how big the economic hit will be. Whatever else happens, there will be more pressure for easier policy in China, and further reason for other central bankers to remain dovish.
- “Most already have a skewed reaction function to news now (ease on bad news, do nothing on good news) though Yves Mersch yesterday was the latest ECB grandee to warn of that dangers of elevated asset prices. Overall, pressure on bond yields, while it may ebb and flow, will mostly be downwards and the FX market will be torn between seeking havens and seeking yield, but the dollar and yen are winners, the euro and China-sensitive EM currencies are losers.
- “Today, investors are threatening to go yield-hunting again. I doubt that this mood will last for long, but it won’t do much for the euro.”
Pepperstone Group Ltd.
Chris Weston, head of research.
- “What we are trying to understand is the economic impact shutting transport links and imposing strict travel controls in Beijing and Shanghai, as well as effectively quarantining 14 cities and millions of people will have.
- “With so few in markets holding any formal training in virology, trying to connect the dots is incredibly complicated, and, as with any thematic that is gripping markets and causing risk aversion, we need to understand the circuit breaker. Obviously, that comes from a cure or a plateau in the number of cases of people around the world getting the virus. But the fact is that the incubation period is up to 14 days, where the virus can be contagious during this period, even if the host has no symptoms and this makes this situation very hard to comprehend just how bad it is, or how much worse it can get.
- “How do we fully price risk, if we have such limited visibility on bad this could get, not just in terms of contagion, but the impact this will have on economics and we may have to wait for weeks until this is portrayed in the formal data releases?
- “It’s no surprise to see rates markets moving up a gear as traders start to anticipate a future central bank response. In the U.S., for example, we see a full 25 basis point cut priced by November (from December), with two- and five-year Treasury yields lower by 5 and 6 basis points.”
Priya Misra, head of global rates strategy and team.
- “There remains substantial uncertainty about the virulence and transmission of the virus, and incoming news should keep markets on edge.
- “We took off our long 10 year Treasury position at 1.6% as the risk-reward is no longer attractive given an uncertain headline-driven world. However, Treasuries remain a risk-off hedge and should benefit from more convexity receiving flows. We think that any further risk-off moves should be accompanied by a steeper 5s30s curve as the market should reprice for more Fed rate cuts.”
Richard McGuire, head of rates strategy and team.
- “The immeasurable threat (so-called “Knightian risk”) inherent in the coronavirus outbreak sees us loathe to jump aboard a growing bandwagon of analysts recommending investors fade the pronounced moves above. As far as we can tell, these recommendations are derived from comparing the economic fallout/market reaction from the SARS outbreak in 2002/2003 to the current episode.
- “However, China’s stellar growth in the intervening years means that such comparisons are on shaky ground.
- “The apparent safe haven status of peripheral bonds feeds into our argument that these assets offer investors the benefit of asymmetric risk and, in so doing, arguably offer considerable appeal given the unknowable implications of the coronavirus. To reiterate, a rapid containment of this virus is likely to prompt a very sharp reversal of market sentiment which we would expect to support higher-beta EZ sovereigns as these markets are buoyed by the resultant “risk-on” move. Conversely, ongoing concern is only likely to see safe haven yields fall further into negative territory which stands to force investors, through financial repression, to seek out higher yielding alternatives of which peripherals are clear examples.”
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