What does the Coronavirus mean for finance?
The Coronavirus has dominated headlines for the past few weeks, with global reported cases topping 90,000. Alongside the human costs to the virus, its spread has also caused significant disruption to financial markets. The Dow Jones alone saw its biggest one day drop since 2008 on Friday 28thFebruary, falling by 1,192 points, though this was swiftly followed by its largest gain since 2009 on Monday 2nd March, rising by 1,294 points.
The virus is also causing disruption to the wider economy. The OECD said it could cut its global growth forecast from 2.9% to 1.5% in the event of “a longer-lasting and more intensive coronavirus outbreak”. In economic terms, the range of possible outcomes is vast. In this article, I’ll outline how the coronavirus is affecting the global economy, how governments and central banks are responding and what this means for investors.
How the coronavirus is affecting financial markets
The coronavirus has created a shock on both the supply side of the economy as well as the demand side. This is unlike the global recession of 12 years ago, which makes that recession an unreliable guide to the current shock.
From a supply-side perspective, closed factories and travel bans have heavy short-term economic costs. When people working for companies producing goods and services (especially in China) can no longer go to work, the supply chain breaks down. For instance, we have seen warnings from companies that are directly implicated such as Apple, which manufactures iPhones in China.
From the demand side, airlines and global tourism have already been affected. Hotel company shares have fallen, anticipating a decline in tourism and business travel. Furthermore, a widespread halt in economic activity could cause insolvencies and defaults on bank loans, putting the viability of banks in question, and spreading financial disruption even further.
As a countermeasure, central banks arehelping to stabilise financial markets by promising to ease the economic impact, which has caused a smaller rebound in the stock markets this week. However, lowering interest rates are of limited use in tackling an economic shock caused by the spread of a virus. Central banks have few other tools at their disposal and lower interest rates probably won’t perform their traditional role of encouraging investment and consumption. The last programmes of Quantitative Easing already increased bank balance sheets and it is not clear whether further asset purchases would make a significant difference.
The response will need to be provided by governments worldwide, using fiscal policies on taxation and spending plans, though we do not know if this will have any noticeable effect on consumer confidence.
So, what next?
Share prices have rebounded somewhat since last Friday, but we cannot say that the market’s mood has improved definitively. In the medium-term, we don’t know how governments will try to re-boost the economy once the outbreak is under control.
Mark Carney, the governor of the Bank of England has already told the Commons Treasury Committee that the economic effects could last up to six months. However, he said the Bank was ready to help businesses and households adjust to the impacts of the deadly virus. And he said the prospects were that "we will have disruption, not destruction".
The Group of Seven (G-7) finance chiefs said they’re ready to act, though they stopped short of spelling out what specific measures they would put into place. Their statement read:
“We, G-7 Finance Ministers and Central Bank Governors, are closely monitoring the spread of the coronavirus disease 2019 (COVID-19) and its impact on markets and economic conditions. We reaffirm our commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.”
The US Federal Reserve yesterday announced a reduction of 50 basis points to its benchmark rate, in order to support the economy.
The stock market will be unpredictable given the nature of current events. However, there is still good medium-to-long-term potential for stocks. Given the volatility of the markets, investors should be careful of making rash decisions as a result of disruption to stock markets.
Any longer-term rebound is likely to happen when more is known about the potential impact of the virus. In the meantime, central banks and governments will be doing all they can to stimulate the economy. Progress is reportedly being made on a vaccine, though it is likely that we will continue to see disruption from the coronavirus in the short term at least.