Macro (Re)view (28/2) | Global Equities Hit With Coronavirus

The increasing spread of the coronavirus outside of China, most notably through Italy, Korea and Japan, led to a rout on global equity markets of around 10% this week (see chart of the week, below) as the earlier sense that its impact on economic activity would be transitory gave way to something more uncertain and long-lasting. This risk-averse sentiment saw bond markets rally hard, highlighted by the move in the benchmark US 10-year treasury yield to its lowest on record, while Australia's 10-year yield also plunged to record lows.

Chart of the week

The theme of last week's review was that equity markets would be looking towards central banks across the globe for signs they would remain supportive through this phase of uncertainty, but that faith was stretched this week as the response from monetary authorities left markets underwhelmed, typified by the surprise decision from the Bank of Korea to hold rates steady. In any case, the efficacy of an easing in monetary policy in the prevailing situation has come into question when it can seemingly do little to offset the impacts of disrupted supply chains, travel restrictions and an unwillingness of consumers to venture from home. Nonetheless, the tightening in financial conditions brought on by the plunge in equity markets this week has resulted in rate cuts being priced back into the market, with the US Federal Reserve (Fed) now expected to cut three times in 2020.

For its part, the Fed is taking a measured approach in assessing the impact of the outbreak, with Vice Chair Richard Clarida using a speech during the week to outline that it was "still too soon to even speculate about either the size or the persistence of these effects, or whether they will lead to a material change in the outlook". The Fed's ongoing guidance is that the "current stance of monetary policy will likely remain appropriate" unless developments emerge that prompt a "material reassessment of our outlook". Markets have unequivocally decided that the coronavirus is that material change and appear likely to firm up pricing for further easing in the weeks ahead. On the data flow, the 2nd estimate of US GDP growth was unchanged at 2.1% annualised in Q4, but with its key support of the past year or so in consumer spending moderating, the economy appeared on a slightly less constructive footing heading into a coronavirus-impacted Q1. Meanwhile, durable goods orders ex-transportation posted a stronger-than-expected result rising by 0.9% in January.

In Europe, a cautious approach was also being taken by the European Central Bank (ECB) with President Christine Lagarde in an interview with the Financial Times explaining that while the Bank was monitoring the coronavirus outbreak "very carefully" it was not yet ready to provide a policy response as it was not clear that it would cause a "long-lasting shock" to activity in the bloc. Similar sentiments were expressed by Executive Board member of the ECB Isabel Schnabel in a speech this week on the basis that "very little is yet known about the potential medium-term implications" of the coronavirus outbreak. The main data point from the continent this week was the European Commission's Economic Sentiment Indicator, which at a headline level lifted by 0.9pts to a stronger-than-expected 103.5 in February. This was driven by a more optimistic assessment from consumers of economic conditions, though this comes with the caveat that it is yet to incorporate any coronavirus-related impact.   

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In Australian developments this week, the partial indicators on construction activity and business investment ahead next week's GDP growth outcome for the December quarter (previewed here) came to hand, both of which provided material downside surprises. The downturn in Australia's construction cycle intensified over the final months of 2019 as construction work done pulled back by a sharper-than-expected 3.0% in Q4, whereas consensus was for a modest 1.0% decline, steepening the fall in activity through the year from -5.6% to -7.4% (reviewed here). 

Renewed weakness came through from residential construction, likely accentuated by the summer bushfires and related smoke haze, as private sector activity contracted by its most in a single quarter (-4.6%) since Q2 2003, driving the annual decline from -9.4% to -12.6% to make this the sharpest downturn the sector has encountered in 18 years. New home building saw an accelerated 5.1% decline in the quarter (-13.5%yr) and continues to reflect the deterioration in dwelling approvals through 2018 and much of 2019, while renovation work was also down by 1.2% in Q4 (-5.6%yr). Weakness in private sector non-residential building was also notable in the December quarter (-4.7%), though it remained positive through the year (3.7%) following from an earlier uptrend in approvals for commercial and industrial facilities. Consistent with one of the major themes in the domestic economy over the past year or so, weakness in private sector construction activity was in contrast to relative strength in the public sector in which work done lifted by 0.7% in the quarter and by 0.5% over the year. Within this, infrastructure work appeared to have regained momentum through the second half of 2019, which given the pipeline of work to be done will not only be supportive of the growth outlook but also help the major capital cities to cope with strong population growth.

The dynamics for business investment in Australia remain challenging with confidence in the sector having deteriorated to its weakest since mid 2013 according to recent NAB Business Surveys, soft domestic demand conditions and an uncertain global backdrop. This was reflected by a 2.8% fall in capital expenditure (capex) by private sector firms in Q4, which resulted in the contraction over the year widening from -1.6% to -5.8% (reviewed here). A sharp 5.9% fall in capex on buildings and structures in Q4 confirmed the weakness conveyed in the construction activity data, though spending on equipment, plant and machinery lifted modestly by 0.8% in the quarter. On a sector-by-sector basis, mining sector capex pulled back by 2.7% in Q4 but appeared to have stabilised over the past year (0.9%yr) as the remaining large-scale LNG projects were completed, while non-mining capex showed further weakness in falling by 2.8% in the quarter and by -8.3% in annual terms. In looking ahead, the 5th estimate of investment plans at $120.3bn implied a modest 2.1% rise in total capex in the 2019/20 financial year, with the mining sector remaining on track to end 6 consecutive years of decline (11.4%) against weakness from non-mining (-1.7%) in a challenging environment. On the surface, estimate 1 of 2020/21 investment plans was more constructive than anticipated at $100.2bn, some 8.8% ahead of estimate 1 for 2019/20, but is tinged with considerable uncertainty given the bushfires and coronavirus outbreak.