Coronavirus: what happens next?

The immediate impact of the coronavirus outbreak is bad enough, writes John Stepek. But the real risk is that it could change our financial system forever.

If we weren’t already convinced that the coronavirus was a serious threat, we know it for sure now. The Federal Reserve on Tuesday announced an emergency interest-rate cut, slashing the key Fed Funds target range by 0.5 percentage points, to 1%-1.25%. The US central bank will be meeting officially in less than a fortnight, but it decided that it simply couldn’t wait. That’s the first time the Fed has done that since 2008. On every other occasion that we’ve seen an emergency cut (certainly in the last 20 years), we’ve either been in the midst, or on the verge of a major panic in markets. So it’s not an encouraging precedent.

On the one hand, it’s easy to see why the Fed felt nervous. In the last week of February, the S&P 500 fell by 11%, its worst showing since 2008. Meanwhile, the yield on US government bonds (Treasuries) plunged to record lows as investors sought out “safe havens” and bet on a decline in interest rates, which indicates that investors fear a recession is nigh. In some ways the Fed was merely playing “catch up” with markets. On the other hand, the move came as a shock to many – markets fell in the aftermath and, as Jeremy Warner put it in The Daily Telegraph, the instinctive question is: “Does the Fed know something the rest of us do not?” So the question is: is the Fed right to be this worried and what does it mean for investors?

History is of little use here

You might be tempted to look to history for a guide as to what happens now, but as Oliver Jones of Capital Economics points out, it’s not terribly helpful. Bond yields rose (ie, bond prices fell) in the wake of the three previous global pandemics (Spanish flu in 1918, Asian flu in 1957 and Hong Kong flu in 1968). However, that was more to do with incipient inflation than the impact of the outbreaks.

Meanwhile, equities rose after 1918 and fell in the other two instances, but that was mostly about the starting valuations (markets were cheap following World War I and not so cheap on the other occasions). Today, equities are expensive in the US and less expensive everywhere else, while bonds are arguably expensive everywhere, but inflation is low and not showing much sign of perking up. So the financial backdrop is very different.

You can say the same for the “real world” backdrop. When Spanish flu went global in 1918, we didn’t have antibiotics or the degree of medical specialisation we do now. Scientists couldn’t even confirm what was behind the outbreak until many years after it happened. So medical science is far more advanced. As The Atlantic puts it, “we have options that were simply undreamed of a century ago”.

On the other hand, the world is far more globalised, which means the economy is much more vulnerable to disruption in any given part of the supply chain, be it physical or financial. In short, looking at past pandemics is – to put it bluntly – a waste of time.

The good news

It’s clear that the coronavirus has had a massive impact on the Chinese economy. At the weekend we learned that activity in both the services and manufacturing industries hit an all-time low in February and there have been similar figures for Hong Kong. That said, there are signs that China is getting back to work. Satellite imagery – more reliable than official Chinese statistics – shows that pollution levels are rising, indicating that business is picking up again. The amount of nitrogen dioxide in China’s atmosphere at the end of February was still down 20% on the same time last year, but up by around 50% on the middle of the month.

As for corporations themselves, according to The Transcript (which collates information from corporate earnings conversations), companies have also indicated that activity is improving. Warren East, chief executive of engineering giant Rolls-Royce, said that “operations in China are getting back to normal… our key suppliers… are all back at work”. Apple CEO Tim Cook talked about factories reopening and Chinese internet group Baidu noted that “when you’re going on the freeway now, you’re actually seeing traffic jams versus, say, two, three weeks ago, where the roads were pretty empty”.

To read the whole of this article, subscribe to MoneyWeek magazine

Subscribers can see the whole article in the digital edition available here

Recommended

The coronavirus is scary – but it's irrelevant to your investments
Investment strategy

The coronavirus is scary – but it's irrelevant to your investments

The spread of the coronavirus is causing alarm around the world. And, while it could be a serious short-term threat to human health, it’s not somethin…
24 Jan 2020
The British equity market is shrinking
Stockmarkets

The British equity market is shrinking

British startups are abandoning public stockmarkets and turning to deep-pocketed Silicon Valley venture capitalists for their investment needs.
8 Nov 2019
Will a second wave of Covid lead to another stockmarket crash?
Stockmarkets

Will a second wave of Covid lead to another stockmarket crash?

Can we expect to see another lockdown like in March, and what will that mean for your money? John Stepek explains.
18 Sep 2020
Great frauds in history: Martin Grass’s debt binge
Investment strategy

Great frauds in history: Martin Grass’s debt binge

AS CEO of pharmacy chain Rite Aid. Martin Grass borrowed heavily to fund a string of acquisitions, then cooked the books to manage the debt, inflating…
16 Sep 2020

Most Popular

Here’s why you really should own at least some bitcoin
Bitcoin

Here’s why you really should own at least some bitcoin

While bitcoin is having a quiet year – at least in relative terms – its potential to become the default cash system for the internet is undiminished, …
16 Sep 2020
Will a second wave of Covid lead to another stockmarket crash?
Stockmarkets

Will a second wave of Covid lead to another stockmarket crash?

Can we expect to see another lockdown like in March, and what will that mean for your money? John Stepek explains.
18 Sep 2020
Central banks want politicians to take charge – but what will they do?
US Economy

Central banks want politicians to take charge – but what will they do?

The US Federal Reserve has come to the end of the road in terms of what it can do to accelerate any recovery, says John Stepek. It's over to the polit…
17 Sep 2020