Key insights from the week that was.
Heightened volatility has again been seen in financial markets this week as participants attempted to assess the economic and financial implications of the ongoing spread of COVID-19. What was initially seen as a China-centric shock is now certainly a global concern.
Highlighting this, of the 2241 new cases on March 5 (as reported by WHO), only 143 were located in China. 438 were in South Korea; 587 in Italy; and, in total, around 350 additional cases were reported elsewhere in Europe and the UK. Notably, 21 new cases were also reported in the US for a total of 129. As we look ahead, it seems likely that March and the June quarter will see China’s economy recover while much of the rest of the world confronts the virus.
Outside of Asia, European countries seem likely to prove the most exposed developed nations to COVID-19. Hit in 2019 by US/China trade tariffs then by China’s February disruptions, the Euro Area’s manufacturing sector is presently highly susceptible to further shocks which will inevitably come as the virus grows as a domestic concern. Further, not only is Europe’s service sector set to experience reduced demand from Asian tourists and students, but also as tourists from other nations reconsider their travel plans. This is particularly the case for Italy where the majority of European cases have been reported. We now expect Euro Area growth to be well below trend in 2020, circa 0.6% in year-average terms.
Moving to the US, the FOMC cut the federal funds rate by 50bps this week at an unscheduled meeting to a mid-point of 1.125%. They also signalled a willingness to ease further in coming months.
Why did the FOMC take such a dramatic step? In part it is because of continuing market volatility. But chiefly it is because the “risks [to the US’ real economy] associated with the Coronavirus” are evolving. An impact may not have been apparent in the data for February, but growth will weaken materially as a result of the outbreak from now until mid-year.
The US certainly has exposure to global service trade but, for as long as the US’ outbreak remains limited in scale, the shock on this front is likely to remain modest – at least relative to Asia and Europe. Domestic demand is instead the key risk for the US economy.
Our revised call for three further FOMC rate cuts by June 2020 is founded on the belief that: business investment will continue to contract and employment growth slow amid persistent uncertainty; and further that, following a long-period of outperformance, the US consumer will materially reduce discretionary consumption across both goods and services in coming months. To the extent that goods can easily be purchased on line and delivered while services typically cannot, the effect on discretionary services consumption is likely to be much greater.
From 2.3%yr in 2019, we see US growth slowing to 1.0%yr in 2020 with an outright contraction in activity likely in the June quarter. As is the case globally, risks are arguably skewed to the downside. A significant increase in US testing for COVID-19 in coming weeks will help quantify the scale of the downward skew to the risk profile.
Coming back to Australia, the RBA cut the cash rate by 25bps at their March meeting to 0.50%. The commentary following the meeting made clear that the “Board is prepared to ease monetary policy further to support the Australian economy”. As outlined at the beginning of this week, we expect this to take the form of another 25bp cut in April (to Australia’s lower bound for rates of 0.25%) and thereafter the introduction of QE by mid-year. To do otherwise would risk domestic confidence and chance the Australian dollar rising at a time when the economy can ill afford a loss of competitiveness.
The Q4 national accounts made clear this week that Australia’s economy was struggling for momentum ahead of the coming COVID-19 shock. While Q4 GDP growth came in above expectations at 0.5%, domestic demand grew by just 0.1% (1.3%yr). More worrying still, private demand only increased by 0.1% over the full year to December 2019.
Key here is declining business investment and residential construction as well as very weak household consumption growth (1.2%yr) – note, consumption contracted in per capita terms over 2019. Retail sales for January point to this weak trend continuing into Q1, with sales down 0.3% in the month. This is ahead of COVID-19’s impact but, at least in part, due to disruptions associated with summer’s bushfire emergency
Ahead, apart from the effect of COVID-19, consumption growth will be held back by weak income growth, decelerating job creation, high household debt and weak confidence. Dwelling approvals point to residential construction remaining a negative for growth throughout 2020. Weak business investment growth is also likely. Full detail on our view of the outlook will be provided in our March Market Outlook – to be released next Wednesday.
