In China, it’s gotten much worse
This virus that’s truly a curse
How fast will it spread?
And how many dead?
Ere treatment helps it to disperse.

Despite the fact that we have two important central bank meetings this week, the Fed and the BOE, the market is focused on one thing only, 2019-nCoV, aka the coronavirus. The weekend saw the number of confirmed infections rise to more than 2800, with 81 deaths as of this moment. In the US, there are 5 confirmed cases, but the key concern is the news that prior to the city of Wuhan (the epicenter of the outbreak) #fom locked down, more than 5 million people left town at the beginning of the Lunar New Year holiday. While I am not an epidemiologist, I feel confident in saying that this will seem worse before things finally settle down.

And it’s important to remember that the reason the markets are responding has nothing to do with the human tragedy, per se, but rather that the economic impact has the potential to be quite significant. At this point, risk is decidedly off with every haven asset well bid (JPY +0.35%, 10-year Treasury yields -7bps, gold +0.8%) while risk assets have been quickly repriced lower (Nikkei -2.0%, DAX -2.0%, CAC -2.1%, FTSE 100 -2.1%, DJIA futures -1.4%, SPX futures -1.4%, WTI -3.0%).

Economists and analysts are feverishly trying to model the size of the impact to economic activity. However, that is a Sisyphean task at this point given the combination of the recency of the onset of the disease as well as the timing, at the very beginning of the Lunar New year, one of the most active commercial times in China. The Chinese government has extended the holiday to February 2nd (it had been slated to end on January 30th), and they are advising businesses in China not to reopen until February 9th. And remember, China was struggling to overcome a serious slowdown before all this happened.

It should be no surprise that one of the worst performing currencies this morning is the off-shore renminbi, which has fallen 0.8% as of 7:00am. In fact, I think this will be a key indicator of what is happening in China as it is the closest thing to a real time barometer of sentiment there given the fact that the rest of the Chinese financial system is closed. CNH is typically a very low volatility currency, so a movement of this magnitude is quite significant. In fact, if it continues to fall sharply, I would not be surprised if the PBOC decided to intervene in order to prevent what it is likely to believe is a short-term problem. There has been no sign yet, but we will watch carefully.

And in truth, this is today’s story, the potential ramifications to the global economy of the spreading infection. With that in mind, though, we should not forget some other featured news. The weekend brought a modestly surprising outcome from Italian regional elections, where Matteo Salvini, the populist leader of the League, could not overcome the history of center-left strength in Emilia-Romagna and so the current coalition government got a reprieve from potential collapse. Salvini leads in the national polls there, and the belief was if his party could win the weekend, it would force the governing coalition to collapse and new elections to be held ushering in Salvini as the new PM. However, that was not to be. The market response has been for Italian BTP’s (their government bonds) to rally sharply, with 10-year yields tumbling 18bps. This has not been enough to offset the risk-off mentality in equity markets there, but still a ray of hope.

We also saw German IFO data significantly underperform expectations (Business Climate 95.9, Expectations 92.9) with both readings lower than the December data. This is merely a reminder that things in Germany, while perhaps not accelerating lower, are certainly not accelerating higher. The euro, however, is unchanged on the day, as market participants are having a difficult time determining which currency they want to hold as a haven, the dollar or the euro. Elsewhere in the G10, it should be no surprise that AUD and NZD are the laggards (-0.85% and -0.65% respectively) as both are reliant on the Chinese economy for economic activity. Remember, China is the largest export destination for both nations, as well as the source of a significant amount of inbound tourism. But the dollar remains strong throughout the space.

Emerging markets are showing similar activity with weakness throughout the space led by the South African rand (-1.0%) on the back of concerns over the disposition of state-owned Eskom Holdings, the troubled utility, as well as the general macroeconomic concerns over the coronavirus outbreak and its ultimate impact on the South African economy. Meanwhile, the sharp decline in the price of oil has weighed on the Russian ruble, -0.9%.

As I mentioned above, we do have two key central bank meetings this week, as well as a significant amount of data as follows:

Source: Bloomberg
Regarding the BOE meeting, the futures market is back to pricing in a 60% probability of a rate cut, up from 47% on Friday, which seems to be based on the idea that the coronavirus is going to have a significant enough impact to require further monetary easing by central banks. As to the Fed, there is far more discussion about what they may be able to do in the future as they continue to review their policies, rather than what they will do on Wednesday. Looking at the spread of data this week, we should get a pretty good idea as to whether the pace of economic activity in the US has changed, although forecasts continue to be for 2.0%-2.5% GDP growth this year.

And that’s really it for the day. Until further notice, the growing epidemic in China remains the number one story for all players, and risk assets are likely to remain under pressure until there is some clarity as to when it may stop spreading.

Good luck
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