The Impact of the COVID-19 Epidemic on the Economy and Markets

Qualifying further, there will likely be a dead weight loss to Chinese GDP, and therefore to global GDP, for the first quarter. The degree of propagation to other economies will depend on the degree of openness to virus infected countries, particularly China. (Another significant epidemic centre is Iran which isn’t as integrated in global supply chains; Italy and South Korea are more so). On that basis, the economy of Germany is at risk while that of the United States is relatively shielded given that total goods imports account for close to 15% of GDP. Not insignificant, but nowhere near household spending’s close to 70% share.

To gauge if the supply shock is morphing into a demand shock which could therefore impact household spending, we are keeping a close eye on labour market indicators. Aside from the monthly non-farm payrolls and labour force surveys, which for January were not showing signs of weakness, there is weekly unemployment insurance claims data released every Thursday. Released on February 27th, initial claims (see chart), still hadn’t revealed contamination from the virus to the US labour market.

Financial markets are interpreting the information differently though. To be sure, one could argue that the more-than-fairly-valued equity markets are assuming a close to worst case scenario. Equity markets, given their high valuations, seemed ripe for a correction whatever the trigger. The correction led to investors seeking shelter into the perceived safety of government bonds; corporate and provincial credit spreads increased.

In spite of recent much easier financial conditions resulting from the decline in bond yields and the drop in oil prices, market participants still seem to be looking to central banks to step in even if central bank tools are designed to address cyclical, i.e. demand shocks, rather than supply-side shocks. Sure enough, the US Federal Reserve answered the markets’ call by lowering its Fed Funds target range by 50 basis points on March 3rd, soon after G7 finance ministers and central bankers had issued a non-committal statement that they would be intervening to cushion the blow from the virus. The Fed moved a few weeks ahead of its regularly scheduled meeting in an effort to soothe markets’ fears. Equity markets seemed to demand more from the central bank as major US stock indices closed lower by around 3%. (Markets seemed to reassess their reaction at the open of the March 4th session as they were up more than 1% in early trading.)

Turning back to the real economy, US personal income data released for January, though somewhat dated, show that consumers’ purchasing power is expanding. In addition,thereportprovidedmoreinsightoninflationasthepriceindexforpersonal consumption expenditures, the Fed’s inflation target measure, inched up to 1.7%, getting closer to its 2% target. Consumer price inflation for January in the United States runs at 2.5% while it stands 2.4% in Canada. The Bank of Canada disregarded the overshoot of its inflation target and chose to follow the Fed down the path of lower rates by lowering the bank rate by 50 points today. Hopefully, these measures will prove enough to eradicate the virus and its economic impact.