Just as the dust began to settle and the coronavirus outbreak in China slowly came under control, a marked increase in new infections outside China, notably in South Korea, Italy and Japan, caused market gyrations this week. More new cases of COVID-19 are now being reported outside China than within. In particular, the sudden jump in infections in Italy and (to a lesser degrees) in a number of neighbouring European countries sent markets into a tailspin, amid fears that a global recession is dawning. Sentiment soured across equity, credit and fixed income markets globally and the oil price dipped to USD50.6/bbl, the lowest since end-2018. US and German 10Y yields hit new lows of 1.21% and -0.58%, respectively, and Italian yields, in particular, came under pressure amid building expectations that the economy will head into recession in Q1. European equities had their worst week since the eurozone crisis in 2011 and the S&P 500 has declined 12% since the peak in mid-February. As long as the verdict is still out whether western countries are able to contain the virus spreading and markets continue to price in rate cuts, it might be too early to declare a bottom in the equity sell-off/rates rally (see also Replay of conference call on the spreading of the coronavirus and the implications for the global economy and financial markets , 27 February).
With the spreading of the virus, calls for a co-ordinated fiscal and monetary response globally have grown louder. In Italy a number of banks have announced liquidity support measures for retail and corporate clients in the affected regions and the government is preparing decrees on tax relief and financial support measures. Hong Kong and Singapore have also introduced fiscal easing measures and cash handouts. However, with a co-ordinated European fiscal response not yet in sight, expectations of further central bank easing have increased. Markets are now pricing in aggressive easing from the Fed, sending EUR/USD above 1.10 this week (see also Fed Monitor – Why the Fed may soon move in a dovish direction , 27 February). A 25bp cut at the March meeting is now fully priced and on a one-year horizon, three Fed cuts are priced. However, markets’ hopes rest not only on the Fed but also on the ECB cutting rates by 10bp by end-2020.
In our view, coronavirus developments will continue to be the market theme for now, especially the pace at which it spreads to the rest of Europe and whether China can contain new infections as people return to work. We also have some interesting releases on the agenda. Chinese PMI figures for February are due out over the weekend and are likely to show a sharp fall in manufacturing activity due to the production shutdowns. In the US, ‘Super Tuesday’ will be crucial in the Democratic presidential candidate race when 16 states vote on one-third of the delegates (see Research US – Democratic Party primaries and caucuses – an overview , 27 February). Friday’s US jobs report should still paint a decent picture but in light of the PMI disappointment last week, it will be interesting to see whether the February ISM figures paint a similarly weak picture about services activity. We will also keep a close eye on Fed communication during the week, as the blackout period starts on 7 March. In addition, the EU and UK are set to start their trade negotiations. Judging from the already-published negotiating objectives, a rocky path lies ahead, as the UK rejects following EU rules, while the EU sees this as a precondition for granting the UK quota and tariff free access to the single market. We believe tensions will increase over coming months ahead of the first deadlines in June, which is the main reason we are still negative on GBP.