Source:
https://scmp.com/comment/opinion/article/3074604/coronavirus-outbreak-advances-expect-more-rate-cuts-and-more
Comment/ Opinion

As the coronavirus outbreak advances, expect more rate cuts and more economic turbulence

  • Fears about the global economic outlook are intensifying, with the release of a set of weak Chinese data. These numbers could be a harbinger of more pain to come for other economies, if the spread of the virus is not contained quickly
A traveller wearing a full-body protective suit walks through Pudong International Airport in Shanghai on March 10. Traffic, power consumption and economic data reveal the impact of the coronavirus on China’s economy. Photo: Bloomberg

The coronavirus outbreak has entered a new stage. As Covid-19 spreads across the world, the centre of the crisis appears to have shifted from China to other countries.

Within China, the number of new cases stood at 24 on Wednesday, from over 400 two weeks ago. While the battle in Wuhan continues – new infections are still being reported, albeit at a slower pace – the spread of the virus outside Wuhan seems to be under control.

In contrast, there are worrying signs of accelerating outbreaks elsewhere in the world. Infections are increasing faster outside China than inside. In Asia, South Korea is the worst-hit country outside China, with more than 7,700 confirmed cases and new infections jumping by the hundreds every day.

Italy has become the centre of Europe’s epidemic, while growing infections in Iran are causing fears of a widening outbreak across the Middle East, where relatively poor health care coverage could see the death toll rise significantly. The WHO raised the alert for the coronavirus to the highest level on February 28, moving a step closer to calling the epidemic a global pandemic.

Fears about the global economic outlook have also entered a new phase, with the release of a set of awful-looking Chinese data.

Not only do daily traffic and power consumption data reflect the slow resumption of business after the Lunar New Year holiday, February’s purchasing managers’ indexes (PMIs) also reveal the devastating impact of the coronavirus on China’s manufacturing and service sectors.

Both the official and Caixin PMIs plunged to the lowest levels on record, worse than during the height of the global financial crisis. With hindsight, these dire readings aren’t surprising given that the economy was practically paralysed by the viral outbreak in the first half of February and was only slowly getting back on its feet in the second half of the month.

Looking ahead, the continued return to normal business operations – even at a slow pace – should lead to a solid rebound in March, since the PMI measures sequential growth momentum.

However, even if the PMI rises above the 50-point margin that separates contraction from growth, it does not necessarily signal a return to full economic normality, as many firms will still be struggling with labour shortages, supply chain disruption and weak demand in absolute terms.

Assuming that the historical relationship between the PMI and the economy holds, the average PMI should be around 46 for the first quarter, which implies real economic growth not much higher than zero, on a year-on-year basis, and a substantial contraction on a quarter-on-quarter basis. These numbers from China could be a harbinger of more pain to come for other economies, if the spread of the virus is not contained quickly.

Finally, investors and policymakers appear to have changed their assessment of the coronavirus as the epidemic wreaks havoc across the world. The precipitous decline in global equities at the end of February suggests many investors are reconsidering their options after realising that Covid-19 could not be confined to China.

The same is happening in the policy circle. After G7 central bankers and finance ministers issued a statement of solidarity, the US Federal Reserve spearheaded the action by delivering an unscheduled 50-basis-point interest rate cut. A response of this speed and on this scale has not been seen since the global financial crisis, and suggests that the US central bank is taking the virus threat very seriously.

By this logic, it makes little sense for the Fed to move aggressively now, between regular scheduled meetings, and then sit on its hands for nearly two months. The experience of 2008 suggests that an inter-meeting cut is a complement to, and not a substitute for, an easing decision at a scheduled meeting.

Hence, the market is right to be pricing in two more reductions that will take the rate down to 0.5-0.75 per cent by the end of April.

Other central banks and fiscal authorities are likely to follow suit. The issue is that with policy tool kits emptying in most parts of the developed world, many will be scraping the bottom of the barrel for stimulus options. And, even if such options exist, they may not be the most suitable way to offset the current economic shock.

All this, including the acute uncertainty surrounding the coronavirus itself, foreshadows a turbulent ride for the global economy and markets in the year ahead.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers