After more than a month of horrible news on the Covid-19 coronavirus outbreak, first in China and then globally, the markets have finally abdicated.
For the whole of February, markets had managed to endure the first ups and downs, especially outside China. To begin with, the area of contagion was expected to remain limited to China or, at best, to the rest of Asia. In addition, once it was understood that the impact on the Chinese economy was going to be very negative, the markets came up with the hope of a great stimulus plan to be carried out by Beijing, which filled them with bliss, to the point of recovering all of the losses that had accumulated since the epidemic began in Wuhan.
For too long, investors continued to turn a deaf ear to the announcements by a large number of companies that their sourcing from China would suffer delays and disruptions. Investors had to wait for a company as big as Apple to announce a profit warning due to disruptions in its supply chain to realize what was happening and experience a market correction, although still moderate compared with what we have experienced during the past week.
The trigger for the most recent market nightmare was the sudden increase in the number of infections in Europe and the US, which convinced investors we are now dealing with a global shock. The 50-basis-point interest-rate cut by the US Federal Reserve only proved the point.
There were good reasons for a cut, from fear that the dollar would become a true safe-haven currency during President Donald Trump’s pre-election campaign to possible liquidity problems in some financial institutions, to the fear of a coronavirus-induced recession in the US economy. What is clear by now is that the market considered the Fed’s cut more as a snack than a dessert, as expectations of further cuts have been built all the way to 75 basis points or more.
The carnage that took place in financial markets on Monday, starting with oil and energy companies and followed by a sharp stock-market correction and the rally in US Treasury yields, is explained not only by the Covid-19 epidemic but by what is behind it. The interesting thing is that “what’s behind” the epidemic is not the same as what led to the market collapse in 2008.
In 2008, the origin was the strong indebtedness of American households promoted by permissive banks that lacked the capital needed to take on so much risk. Today, American households are not as leveraged and banks are better capitalized. So why this collapse?
The reality is that since Trump came to power, isolated problems have become global but solutions are more local than ever. Policy coordination at the international level has never been more difficult even for problems for which coordination is essential, like a pandemic. This is obviously also true for oil, whose supply has been coordinated through the Organization of the Petroleum Exporting Countries (OPEC) for decades.
In short, the market has broken down because it fears a world that cannot achieve coordination even when facing big challenges. We should take note that this is not only China’s fault.
If we are lucky, the Fed might manage to coordinate its next cuts with the European Central Bank and the Bank of Japan, but for now it is clearly being pushed by the market and falling behind the curve.
Not the best way to boost confidence.
Alicia Garcia Herrero is chief economist for Asia-Pacific at Natixis and senior research Fellow at Bruegel.