Chief Economist’s Weekly Brief – Meltdown

Coronavirus has now spread to 104 countries. The Italian government took exceptional measures to put in quarantine 16 million people living in 14 provinces in North Italy, it also announced restrictive measures covering the whole country. The Fed made an emergency 50bp rate cut, but this failed to put a floor under the falling stock market. Oil prices have plunged following OPEC’s failure to cut output, resulting in a price war between Russia and Saudi Arabia.

Keep calm and cut.  Amidst growing concern over the disruptive impact of coronavirus, the US Federal Reserve last week unveiled an emergency 50bp rate cut, slashing the federal funds rate to 1%-1.25%. Meant to guard against risks to the outlook and provide reassurance, the move followed a joint statement by G7 finance ministers and central bankers pledging to use both monetary and fiscal tools to support the global economy. Is it enough? Probably not. A sustained period of monetary easing is expected to follow, and financial markets are pricing in another 75bp of cuts this Spring.

Shrug. Such central bank action might have had the effect of shoring up confidence. That wasn’t the case this time with equity markets falling. Did it, in fact, create fresh jitters, coming as it did unannounced? Perhaps. But there may be other concerns. That interest rate cuts alone are too blunt a tool when it comes to the nature of the problem posed by coronavirus. The effectiveness of interest rate cuts was already under question prior to the outbreak. The past week reinforces that view.

When the tide retreats. And there might just be wider concerns still. When markets sell off sharply longstanding fragilities in the financial system often get exposed. In this case it might be fears over the US corporate bond market. An area that’s grown hugely in recent years. Weaker economic activity means reduced corporate earnings, potentially exposing the fragile balance sheets of heavily indebted firms. That points to policy needing to be more targeted than cuts in rates, addressing areas of potential market malfunction, so as to prevent a bleed into the real economy. Indeed, China has resisted from big traditional stimulus so far, instead focusing on providing relief to firms facing financial stresses.

Hit home. Most of us may delight in the thought of being asked to stay away from work. Yet many UK households would face financial hardship. The good news is Statutory Sick Pay (SSP) is now payable from Day 1 (usually from Day 4) as part of government plans to stem the spread of coronavirus. Yet roughly four in ten employees, or potentially 12 million people, would only receive SSP of £94.24 a week. As median gross weekly pay was £585 in 2019, that’s a £490-sized hole in the household budget. Meanwhile, most of the 3½ million full-time self-employed would get nothing. Ouch.

All rise. Services, construction and manufacturing all posted output growth last month, the first time in ten months. Construction joined its sector peers which recorded their second month of expansion. The UK composite PMI (all sectors) saw business activity accelerate to 53 – a 17-month high. Firms are also the most optimistic since June 2015. Will this last? Receding political uncertainty has been replaced by new concerns, namely COVID-19. The service sector witnessed a slowdown in output, orders and hiring in February. Service providers cited the impact from the coronavirus outbreak with cancellations to bookings and delays in new projects. This economic headwind looks set to intensify in coming months.

Brace! Brace!  Northern Ireland’s private sector has been unable to pull its nose up above the 50 mark that defines the PMI expansion / contraction threshold. Last month’s 46.5 marks the twelfth successive month of contraction. Export orders headed south for the thirteenth month running. NI remains an outlier as the only UK region still contracting. But firms continued to increase their staffing levels and remain confident about the year ahead. Since the survey was conducted, the economic headwinds have intensified. The accelerated spread of the Coronavirus coupled with the collapse of Flybe airline will impact negatively on the economy in the months to come.  

Let’s get moving. The UK housing market put its best foot forward in January with Bank of England lending data confirming that over 70,000 mortgages were approved for house purchases. Activity hasn’t been that high since back in 2016 and it shows that many households do seem to have started the year on a more optimistic note. There were already signs that house price growth had stopped falling, so this should help solidify that position.

Pulling. Inflation remains subdued across the Eurozone. Consumer prices rose 1.2%y/y in February, a three-month low as energy prices fell. There’s more where that came from given that oil is down 30% so far in March, plunging to a 4yr low. Not only is weaker economic activity brought on by the coronavirus outbreak exerting downward pressure on prices, but also the fall-out amongst OPEC members particularly Saudi Arabia and Russia has fuelled increased concerns about excess supply in the oil market. A double whammy for oil prices.  

The last hurrah. Another blockbuster US employment report in February, but does anyone care as it predates the coronavirus. Non-farm payrolls jumped 273K in February, well above market expectations. The unemployment rate nudged down to 3.5% last month, returning to a 50yr lows. Average hourly earnings edged down to 3.0%yoy in February (3.1%yoy Jan), continuing the recent softening. The resilient US household sector faces significant downside risks from the coronavirus. US growth is slowly but surely losing momentum. Not a good omen for the world economy.

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