Covid-19 fears shock markets as global ‘recovery’ hopes thwarted

Now that Coronavirus fears have infiltrated Italy, concerns about the global economy have come back with a bang. Risk assets are suffering, find out Minerva Analysis thinks could happen going forward. 

The big shocker at the end of last week was the contraction in the US service sector ISM survey, which fell to a 76-month low. This was way short of expectations, and was not replicated by Europe, where the service sector remains in recovery mode. This caused US stocks to fall sharply at the end of last week, and for safe havens to surge. This theme has dominated at the start of a new week, as US economic fears have been combined with concerns about the growing threat of Coronavirus outside of China, especially after large swathes of northern Italy have been put into quarantine due to an outbreak of new cases that are not directly linked to China. 

Coronavirus dents economic growth forecasts 

This time last week there was some hope that coronavirus cases had peaked, and the virus was on its way out, now that seems premature. Mass quarantine orders in China, South Korea and now Italy are likely to dent Asian and European economic growth in the first quarter of this year. Considering the US services sector contracted before the worst of the coronavirus had struck, fears are also growing for the strength of the US economy. At the end of last week, the US 30-year yield hit a record low of 1.89%, while the ten-year yield has fallen for 5-weeks in a row. This is a clear sign that financial markets are worried about the world’s largest economy. The fears are linked to China’s coronavirus, but they are also due to domestic factors as fears rise that the US consumer may not be as willing to prop up the US economy as first thought. 

Will European stocks play catch up with their Asian peers?

The magnitude of these fears on financial markets is clear at the start of this week: European indices are down more than 3% in some cases; the Dax is the biggest decliner so far due to its correlation with the health of the global economy. Stocks in Asia fared better overnight, Chinese share prices actually rose, potentially as the focus shifts away from Asia now that Covid-19 has taken hold in Europe. We mentioned last week that major stock indices in Europe and the US had held up remarkably well in the face of the coronavirus, however, that was before this widespread outbreak in Italy, now the largest outbreak outside of China. This could lead to some catch up, with Asian indices outperforming their European and US counterparts in the short to medium term, especially if the outbreak in Italy cannot be contained. 

What increased fears about the coronavirus means for risky assets 

As it turns out, it was far too early to call an end to coronavirus fears, while we believe that the stock market sell off at the start of this week may be an overreaction, we do believe that safe havens will remain in demand: gold, treasuries and the dollar, and risky assets will remain volatile. The oil price is likely to remain capped at $59.50 – last week’s high. Brent crude is down more than 3.5% so far on Monday, and key support lies at $53.50, the low from earlier this month. We cannot see a prolonged period of recovery for the oil price, and for commodities more generally, until Covid-19 has been contained. With no end in sight, and with fears for the global economy growing now that the outbreak has taken hold in Europe, a breach of $50 per barrel is a possibility, especially if the outbreak spreads beyond Italy’s boarders. 

Coronavirus and FX 

In the FX space, the dollar is still king, even though USD/JPY has pulled back, the euro made an attempt at recovery after a better than expected IFO survey for Germany, however, the general risk averse sentiment that is gripping financial markets today has cut short its recovery, and EUR/USD is back below $1.0850 and trading below $1.0820 at the time of writing. $1.08 remains a key support level, and if we see Covid-19 spread beyond Italy then we believe that this level could be tested, and potentially breached. AUD/USD has fallen to another 11-year low, as fear grips risky elements of the FX space. Unsurprisingly, the pound is also lower today, it is falling alongside the FTSE 100 and GBP/USD has lost the $1.29 handle for now. $1.2855 is the bottom of GBP/USD’s 2020 range. If stock markets do recover, then we believe that the pound could also get some uplift. EU/ UK trade deal talks resume this week, and while we expect some pound reaction to any negative headlines that emerge from these talks, we believe that the coronavirus and general market sentiment are more important for the pound this week. 

Ahead this week it is worth watching out for more Democratic primaries; if Bernie Sanders’ wins the Democratic nomination could his socialist agenda weigh on US stocks? Also, US GDP data, US personal consumption and Chinese PMI readings for February will dominate the economic calendar. Until then, we expect the fallout from the coronavirus to dominate markets in the short term.