Policy rate-cut, supply chain links to lessen economic stress of COVID-19

February 28, 2020 (MLN): The concerns over coronavirus spread have spread deeper into the markets and affecting global economic activity.

Rather than predicting the final outcome, the main concern is what measures can be done to minimize this economic stress. The research report by JPMorgan provided a framework for tracking infection rates globally, monitoring the impact on economic activity using daily data, and assessing the economic linkages that could serve to transmit the economic stress.

The report highlighted a well-diversified portfolio approach which not only includes diversification by region but also by asset class given the uncertain nature of the outbreak.  

As far as the latest virus statistics, the daily rate of infection has shown some initial signs of slowing in China, though it has taken significant restrictions on travel to reduce this spread of infection. Yet quarantine policy and travel restrictions mean workers are struggling to return to work. This is impacting national and regional supply chains, the report added.

It’s difficult to monitor and access the ultimate impact of the coronavirus on the Chinese activity in real-time, however, the research used the purchasing managers’ index (PMI) surveys to monitor the Chinese activity through daily coal consumption and migrant flows of two of the main cities.

According to the study, here, daily coal consumption reflects electricity and energy demand for broader economic activity. Clearly, the rebound that is usually seen after the New Year holiday has yet to materialize. Whereas, again, the flow of workers back to the cities after the New Year celebrations has been delayed, with only tentative signs of a recent pickup.

The question arises here; how might economic weakness spread to other regions? To answer this, the study underscored three channels which assess economic contagion.

• The impact on the growth of those countries reliant on crisis-hit areas for demand
• The supply chain disruption
• There is the risk of financial contagion if a country’s stock market is reliant on other regions for corporate earnings

It is prudent to mention that the Asian countries like Hong Kong, Singapore, South Korea and Malaysia are most exposed to a Chinese slowdown, considering the importance of their exports as a per cent of their total output. The transmission differs by country.

As per research note by JPMorgan, China is the top exporter of intermediate goods (9.4% of global exports of intermediate goods). While US economic growth tends to be domestically generated, the supply lines of many of its largest firms are reliant on Asian economies. In such a critical economic disruption where supply chain links are much harder to evaluate, there may be some impact to valuations in the short term as investors seek safer assets; however, over the medium term, investors should remain focused on any disruption to earnings growth in the coming quarters.

In Asia, the worst affected regions have so far focused their policy efforts on supporting businesses with targeted relief measures. To recover from this economic crisis, Emerging market and Asian central banks have more room to cut interest rates and this would benefit the emerging market and Asian fixed income.

Since stock markets appeared relatively resilient, there has been a meaningful increase in both short- and long-dated government bond prices since the fears emerged in mid-January. Therefore, a low yield environment would benefit developed market corporate debt, despite tight corporate credit spreads indicating rich valuations. Potential growth concerns from the outbreak could harm high yield corporate debt more than high-grade papers.

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