The last time the Year of the Rat
Was with us, the markets fell flat
In two thousand eight
The crisis was great
Let’s hope this year’s better than that
Alas as the New Year commences
The Chinese can’t offer pretenses
That virus is spreading
And fears are it’s heading
Worldwide, with insane consequences
Markets this morning are on alert as fears increase regarding a more rapid spread of the coronavirus first identified last week in China. Late yesterday afternoon, Wuhan, the epicenter of the virus’ outbreak was shut down by Chinese authorities. This means that all air and long distance train travel out of the city has been halted. The thing is Wuhan has 11 million residents, larger than NYC, and keeping tabs on all of them is impossible. Then just hours ago, two other cities with a combined population of 8.5 million, Huanggang and Ezhou, announced they, too, were restricting all long distance travel out as well as closing public spaces like movie theaters and internet cafes. The death toll attributed to this virus is up to 17 now, and more than 500 confirmed cases have been recorded.
The timing of all this is extraordinarily poor. China is about to embark on a week-long holiday celebration of the New Year, this year being the Year of the Rat. Typically, this is a time of active travel within and out of China, as well as a time of significant consumer activity. But clearly, locking down major cities with a population approaching 20 million is not instilling confidence anywhere. Chinese equity markets, which historically have always rallied in the last session prior to the New Year holiday, fell sharply last night, with Shanghai falling 2.75% and the Hang Seng down 1.5%. While this fear has not filtered into European equity markets, they remain essentially flat, we have seen increasing demand for Treasuries with the yield on the 10-year falling to 1.75% and German bund yields falling to -0.275%. The last piece of this puzzle is the yuan, which fell 0.4% in its last on-shore session ahead of the holiday. However, CNH continues to trade so do not be surprised to see further weakness there if we continue to hear more negative stories regarding the health situation in China.
But, back to the Year of the Rat. What does it mean in economic and financial terms? The Chinese have a twelve year cycle within their calendar, so the last Year of the Rat was in 2008. I’m sure you all remember how 2008 finished, with the financial crisis unfolding in the wake of Lehman Brothers’ bankruptcy that September. Clearly, nobody wants to see that happen again! But there are certainly anecdotal indicators that might give one pause. The latest anecdote comes from Bob Prince, CIO of Bridgewater Associates, the giant hedge fund, who explained that “…we’ve probably seen the end of the boom-bust cycle.” This is disturbingly similar to a different Prince, Chuck, the former CEO of Citibank, when he defended loosening lending standards in 2008 by remarking, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Perhaps an even more famous comment of this nature was made by Irving Fisher, the renowned economist whose work on debt-deflation and in monetary economics earned him wide acclaim, but who just nine days before the stock market crash of 1929 declared that stocks had “reached what looks like a permanently high plateau.” Now granted, 1929 was not the Year of the Rat, but pronouncements of this nature do have a habit of coming back to bite the speaker in the butt. Given the remarkably long tenure of the current economic and stock market gains, caution that things might change is in order. I’m not predicting an imminent collapse of anything, just highlighting that many market prices seem somewhat excessive and reliant upon a continued perfect outcome of moderate growth and easy money.
Looking at this morning’s activity, the major news will be made in Frankfurt, where the ECB has left policy unchanged (Deposit rate -0.5%, QE €20 billion/month) and now all eyes and ears will turn to Madame Lagarde’s press conference at 8:30 NY time. She is expected to announce the results of the ECB’s internal review of their inflation target, with the ongoing “close to but below 2.0%” likely to be changed to a more precise 2.0%, with an emphasis on the symmetry of that target, implying that slightly higher inflation will be acceptable as well. Alas for the ECB, higher inflation is just not in the cards, at least as long as they maintain interest rates at -0.5%. They can push on that string as much as they like and still will not achieve their goals. As to the single currency, this morning it is unchanged, continuing to hover just below 1.11, right in the middle of its effective 1.10/1.12 range that has been in place since October. We will need something really significant to change this mindset, and my sense is it will not come from within the Eurozone, but rather be driven by the US.
Other than that story, the UK Parliament approved the Brexit bill, which now needs to be ratified by the rest of the EU and is due to be addressed next Wednesday. Then Brexit will well and truly be done, a scant forty-two months after the initial vote. Of course, the next step is the trade negotiations, but even Boris would not risk blowing things up, now that he is in power, so look for an approved delay and an eventual deal next year. Meanwhile, the pound, which has been the best performing G10 currency this week, has stopped its run higher for now, and is actually lower by a modest 0.15% this morning. The other G10 currency movement of note was the Aussie dollar, rallying 0.4% after Unemployment surprisingly fell to 5.1%, thus offering some good news for a change.
In the emerging markets, while CNY is the biggest loser, the rest of the space has been pretty uneventful. On the positive side, CLP is higher by 0.5% after the central bank there indicated they would start to intervene if the peso started to decline too rapidly on the back of weakening commodity prices.
Aside from the ECB press conference, there are two pieces of data today; Initial Claims (exp 214K) and Leading Indicators (-0.2%). But at this point, unless Lagarde says something very surprising, it is shaping up as a very quiet session.