Teetering on the edge?

Affected by the spread of the Novel Coronavirus (COVID-19), stock markets in various countries ushered in a slump across the board, which was comparable to the global financial crisis in 2008. From February 24 to 29, statistics show that, of the major indexes in 133 countries or regions worldwide, 115 fell more than five percent, accounting for 86 percent, of which 64 indexes fell more than 10 percent. As the global stock market weathervane, the three major US stock indexes last week showed the worst result since the 2008 global financial crisis.

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The Dow Jones Industrial Index, the Nasdaq Index and the S&P 500 Index (in terms of percentages) fell by 12.36, 10.54 and 11.49 respectively. Standard & Poor’s (S&P) estimates that global markets wiped out six trillion US dollars in wealth and the US market lost four trillion US dollars. The market worries that the turmoil in the capital market caused by the Novel Coronavirus pandemic may drag the global economy into a new round of crisis.

The main reason why the US-led global capital markets are panicking is because investors are wary that if the pandemic continues in this trend, the global economy may be brought down. As the epidemic began to erupt globally, investors realised that the impact of the epidemic was beyond expectation. The effect brought about by investors’ panic has caused a collective plunge in global capital markets. Many people are beginning to think that the 10-year bull market in the United States may eventually be halted due to the epidemic outbreak. As the US stock market plummeted, investors began to buy US Treasury bonds as a hedge and the yield on US 10-year Treasury bonds fell rapidly, falling to a record low of 1.116 percent on February 28. This is the first time that the interest rate has fallen below 1.2 percent and the 1.4 percent warning line. The two-year Treasury yield fell to 0.874%; the lowest level since November 2016.

This means that capital markets are sending a strong signal that the economy is about to decline. In fact, the fall in the US stock market was not just a result of the virus outbreak. In particular, after nearly 10 years of continuous rise, US stocks have repeatedly broken historical highs and can no longer stay at the peak values. Anbound noted that the Dow has faced an unsustainable situation at the top of 30,000 points and the current outbreak is just one of the contributing factors that crushed the US stock market.

Therefore, the real reason for the continuous slide in US stocks is that they are too high, especially the high valuation of US technology stocks. As the impact of the epidemic on the economy begins to emerge, corporate performance cannot assume that they can stabilise their stock at this high value. Goldman Sachs projected that the profit growth rate of American companies will be zero in 2020 and the decline in economic growth in emerging markets alone will cause the S&P 500’s profit growth rate to decline by about two percent in 2020. Its ripple effect will further reduce earnings growth in other economies. At the same time, the impact of the Federal Reserve’s monetary policy on the yield curve is also one of the internal reasons for the market correction. For some time, the large-scale purchase of US Treasury bonds by the Federal Reserve is distorting the currency market. At first, the Federal Reserve tried to ease the pressure on the currency market, but as a result, it had an unexpected impact on some of the world’s most important benchmarks for borrowing and it has repeatedly caused interest-rate inversions on US debt.

Federal Reserve Board Chairman Jerome Powell speaks during a press conference following the January 28-29 Federal Open Market Committee meeting, in Washington, DC on January 29, 2020. (Photo by MANDEL NGAN / AFP)

This policy can pose a distortion of the interest rate for market and may eventually overwhelm the stock market. Researchers at Anbound believe that actually Federal Reserve is at a key point of choice and they believe that limiting yields on short-term and medium-term bonds may be an effective way to expand the toolbox. The purpose is to reduce the cost of borrowing and to promote more borrowing, which can devalue the US dollar and thus reduce the debt burden relatively. This process means that a major adjustment may be forthcoming. Federal Reserve Chairman Jerome Powell said on February 28 that the Fed is closely monitoring the developments and its impact on the economic outlook and will use its own “tools” and take appropriate action to support the economy. This led investors to expect the Fed to start cutting interest rates again in March to restore the normal yield curve.

Judging from the current situation, the spread of the COVID-19 pandemic will inevitably affect the global economy. Moody’s believes that if the novel coronavirus epidemic develops into a pandemic, it may cause the United States and the global economy to fall into recession in the first half of 2020 and its probability of developing into a pandemic has increased from 20% to 40%. PNC Financial Services Group predicts that the US economy may slow down to 1.2% in the first half of this year. Although the US economy is likely to rebound later this year, the outlook is not clear. Considering the high degree of uncertainty in the spread of the epidemic, economic losses may be much greater than currently expected. Bank of America economists warned that the global economy will grow by 2.8% this year; the lowest level since 2009.

Anbound believes that changes in the global economy depend on the development of the pandemic. This will impact demand and supply. Short-term demand will be suppressed. At the same time, the epidemic will disrupt global supply chain and cause short-term supply problems. This could bring about crisis for the global enterprises. Unlike the financial crisis of 2008, it was an internal collapse of the financial market followed by its proliferation that affected the global economy. In the case of COVID-19, the pandemic has impacted the entire supply chain and the global economic system from the outside. Once the economy is severely affected, it will bring more serious consequences.

In this case, the market generally expects the Federal Reserve and other major central banks to adopt further monetary easing policies to deal with the impact of the epidemic crisis. Then, its impact on the economy will be short-term and temporary. Only after the epidemic is under control, production and consumption will gradually recover. However, many analysts also mentioned that interest rate cuts are not a panacea to deal with the impact of the epidemic. At present, the global economy is closely connected and the industrial chain is distributed across different countries. The impact of the epidemic on the economy is more reflected in the supply area than in the demand area. Therefore, it is more important to ensure the smooth flow of supply and global trade cycles. It is particularly vigilant that if the United States and other major countries adopt more drastic prevention and control measures and trade protectionism policies, it will cause restructuring of global supply chains and market fragmentation in various countries. Under such circumstance, the impact of the COVID-19 pandemic on the global economy will be catastrophic and may cause fluctuations in global trade, financial markets and the real economy.

In conclusion, the outbreak of the virus has triggered a sharp adjustment in the global capital market and the turbulence in the capital market will hold back the global economy. Changes in the pandemic and policy uncertainty will have a lasting impact on various countries’ economies. If prevention and control measures and macro policies are further intensified, this will lead to continuous turbulence and restructuring of the global economy.

This analysis is from Anbound, a China-based think tank. Founder and chief researcher Chan Kung worked with Wei Hongxu, who holds a PhD in Economics.


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