Macro matters: coronavirus forcing central banks’ hand as domestic demand shock climbs

In a note by Candriam, an affiliate of New York Life which manages more than €500 billion in global assets, analysts wrote that domestic shocks within both the US and the Euro area – including inability of domestic workforce to attend work for a couple of weeks (or months?) – will severely impact demand.

Federal Reserve chairman Jerome Powell took swift action and lowered its fed funds target range by 50 basis points to 1.00 / 1.25%. This unanimous decision was the first-rate cut of more than 25 bps since December 2008 and the first inter-meeting rate cut since October 2008. Robust action, but as Powell himself noted, “the ultimate solution to this challenge will come from others, most notably health professionals.” An accompanying statement last Friday claimed, “the fundamentals of the US economy remain strong, the coronavirus poses a risk to economic activity”.

Bastien Drut, senior strategist senior at CPR AM, explains:

“One of the possible interpretations is that the Fed is aware that during this election year, the support for the economy coming from fiscal policy will necessarily be limited and that it will be left alone to be able to do something. Nevertheless, there is some doubt about the effectiveness of such a decision and Jerome Powell himself suggested that this action would not have much impact: ‘We do recognize a rate cut will not reduce the rate of infection; it won’t fix a broken supply chain. We get that’.

Australian and Malaysian central banks have also lowered their key rates. Capital Economics forecasts that ECB will respond with a 10bps deposit rate cut at its scheduled meeting this week and that the Fed will sanction an additional 25bp rate cut at the FOMC meeting scheduled for the middle of this month. In addition, Capital Economics forecasts the economic effects of the coronavirus will result in GDP growth slowing to just 0.7% this year and will soon prompt the Bank of England to cut interest rates from 0.75% to 0.50%.

Paul Dales, chief UK economist at Capital Economics, explains:

“We have become more convinced that the coronavirus will eventually hamper domestic activity as well as demand from overseas. It is extremely uncertain what that would mean for the economy as it depends on how the government, households and policymakers respond. After all, the lesson from the experience of China is that it is not the virus itself that causes most of the reduction in economic activity, but the measures put in place by the government to contain it and to delay the spread.”

The impending UK Budget, on 11th March, will include a package of “coronavirus” measures worth up to £5 billion (0.2% of GDP), which could include more spending on the NHS and temporary tax breaks for companies, predicts Capital Economics.

Pascal Blanqué, group chief investment officer, and Vincent Mortier, deputy group chief investment officer at Amundi, wrote.

The spread of Covid-19 outside China has rattled risk assets. Investors triggered some profit-taking in markets, which reached historical highs and even broke psychological thresholds in previous weeks. Our central scenario is for a temporary deterioration of the global economic picture in Q1 of this year, with some possible spillover into Q2. Overall, we have downgraded global growth to 3.0% from 3.2%. Clearly, the main risk now is the unwinding of recent market complacency and the reaction of ‘animal spirits’. The good run in risky assets has been driven by investors who believe (1) the Covid-19 episode will be temporary (our central scenario); (2) a worsening situation will trigger more Central Bank (CB) action; (3) they have no alternative, given the moves of safe-haven assets. Therefore, we can expect to see some profit-taking, short-term market volatility and overreaction.”

james.wallace@realassetmedia.com