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If there wasn’t any Covid-19 problem, financial markets would have probably invented it. Interestingly enough, virus did little to bother European and US market players until the very last week of February, as if they did not know that it would soon become global. The Asian stock exchanges also largely ignored the news, losing only a few percentage points. Let us be a little cynical – no pandemic in history has ever led to the collapse of the financial markets.
On the other hand, statistics from China became much more pleasant in mid-February – the numbers of infected (both detected and suspected) began to decline rapidly and the number of recoveries was rising – the crisis in this part of the world could be considered contained. And if it was overcome in China, in other places one could expect an identical picture with a few weeks lag. Market participants also knew that the virus would still be likely to affect the economy. We will see figures for GDP and other economic indicators in a few weeks, but the first numbers from China were not very encouraging. Manufacturing PMI posted a historical low of 35.7 points versus the expected 45.1 and 50 points last month, while the Non-Manufacturing PMI showed 29.6 versus the expected 51.4 and 54.1 points in January. These numbers are likely to be a one-off event and markets are well aware of that, waiting for “much more valuable” March data.
Meanwhile, the European macro data for February was quite encouraging. Germany’s private sector expanded steadily in February as growth in services activity slowed but still made up for a small recession in manufacturing. Flash composite Purchasing Managers’ Index (PMI), which tracks the manufacturing and services sectors that together account for more than two-thirds of the economy held the levels of the previous month. The signs from the data are that domestic demand remained in good health, with service sector activity continuing to rise despite reports of lower tourist numbers. French business activity expanded faster than expected in February as a rebound in the service sector following transport strikes at the end of last year helped offset a slump in manufacturing.
Overall, Euro-zone economic activity unexpectedly accelerated to its fastest pace in six months in February, with services proving resilient as factories battled the known challenges. The reading comes after ECB Vice President Luis de Guindos said the bloc’s relatively strong labor market and ultra-low interest rates are supporting growth. Still, European Central Bank policy makers warned against too much of the economic optimism. Reports have shown the Euro area can still be stuck in a deep slump as coronavirus is hitting supply chains. The ECB also warned of potential trade issues, saying the U.S.-China deal could cost the European Union some exports as a result of “trade diversion” and noting that U.S. and EU still have unresolved tariff issues. Christine Lagarde has warned that a decade of crisis fighting has left ECB arsenal “significantly” depleted and urged governments to step up spending.
On the other side of the Atlantics U.S. consumer confidence edged up in February, suggesting a steady pace of consumer spending that could support the economy despite fears over the spreading virus. Strong consumer confidence suggests the longest economic expansion on record, now in its 11th year, could withstand exogenous disruptions although it is probably too early to draw any conclusions as U.S. manufacturing and services sectors activity stalled in February. The flash services sector Purchasing Managers’ Index dropped to 49.4 this month, the lowest since October 2013,signaling that the sector accounting for roughly two-thirds of the U.S. economy was in contraction for the first time since 2016.
As many parts of China ease coronavirus travel curbs, main manufacturing hubs in the east and south are seeing hundreds of thousands of migrant workers returning to work and more traffic on the roads during rush hours. Several provinces have lowered their coronavirus emergency response measures, allowing more flexibility on transportation and helping firms resume production. Even as companies return to work, production levels remain behind what they would normally be due to supply chain disruptions, curbed demand, and spotty labor shortages. The effects of the coronavirus outbreak are likely to reverberate beyond China as most major economies in the region are expected to either slow down significantly, halt or shrink outright in the current quarter. Proximity to the region’s economic powerhouse and trade relations mean any impact from a slowdown in the world’s second-largest economy is likely to be felt across the region.
China’s top leaders signaled their plans to be more “proactive” in using fiscal policy and exercise “more flexibility” in monetary easing. People’s Bank of China will free up part of the reserves of some commercial lenders to unleash long-term funding to the economy, and consider adjusting the benchmark deposit rate at an appropriate time.
The last 10 days of the month witnessed a stock market sell-off in magnitude and speed not seen for years, thus erasing four months of gains in a single week. High yield bond markets followed suit, but the drop was somewhat muted. Both Bloomberg Barclays US Corporate and Pan-European High Yield indices lost about 3% top to bottom, ending the month 1.41% and 1.86% in the red. High yield bond risk premiums widened by 125 basis points, but that negative effect was offset by falling benchmark bond yields exacerbated by a desperate flight to safety. 2-year USD yields finally did what they normally do when markets are in panic mode – passed all our «conservative» targets and landed as low as 0.73%.
Gold managed to jump in panic environment to XAU/USD 1650 (one of the target levels we mentioned a few times) and peak at 1689. Metal was overbought before and could not sustain that condition, giving back some gains, dropping to its lows of USD 1563 per ounce. Technically this may signal some pause in the uptrend. With large long positions on its hands, market could off-load more of the metal if it starts to push lower. We mentioned last month that stops are clearly in XAU/USD 1440 region. It would be very healthy if market takes those stops out and reduces its long position, then it will offer better odds for the next move higher.
Finally, we see some volatility in the FX markets with, still, no solution on the direction of the next important move. We saw EUR/USD level of 1.0970 being broken with 1.0785 level tested almost immediately but then came the reverse to the familiar trading range. Clearly, EUR/USD of 1.1250 is very important level now to confirm much bigger upside potential.
In early March the Central Banks have been tumbling over each other to offer reassurances to market participants of emergency measures to counter the damage of the virus. Fed cut rates by half a percentage point in its emergency meeting to combat coronavirus slowdown. So did (or most likely will do) other central banks around the world. This fact and the words of comfort seem to have an effect as financial markets are rebounding. The endgame is harder to predict. Caution would be advised for the upcoming quarters, as volatility seems to reassert itself going forward.