Coronavirus roils global markets, putting rate cuts back on the radar

Mounting concerns over the spread of coronavirus outside China sent global markets into a panic Monday and some economists are warning the prospect of a pandemic could push the Bank of Canada and the U.S. Federal Reserve to consider cutting interest rates sooner rather than later.

“It is reasonable to assume that coronavirus is going to last longer given the infection rate is higher than SARS and is still climbing. That itself, might convince the Bank of Canada and even the U.S. Fed to cut interest rates. I wouldn’t be surprised,” said Benjamin Tal, deputy chief economist at CIBC Capital Markets. “This is just the beginning of coronavirus, and there is a consensus starting to be generated that maybe, it will last longer than expected.”

Stock markets began the week in turmoil as a surge in the number of coronavirus cases was reported outside China — specifically in South Korea, Iran and Italy — just days after G20 officials warned that the ongoing outbreak would have a detrimental effect on global growth if not contained soon.

The Dow Jones Industrial Average plunged 1,031 points, or 3.56 per cent on Monday, while the S&P 500 fell by 3.3 per cent, the steepest drop since August. The tech-heavy Nasdaq was hit even harder, losing 3.71 per cent to close Monday at just over 9,200 points.

Canadian markets felt the pinch too, with the TSX dropping by 1.5 per cent or approximately 280 points, ending the trading day at 17,562 points. The VIX, a measure of stock market volatility surged by 35 per cent.

The price of gold, meanwhile, soared by 2.6 per cent, reaching a seven-year high while the 10-year Treasury yield plunged to its lowest level in almost four years as investors sought out traditional safe havens to weather the uncertainty.

Oil prices tumbled by as much as four per cent on concerns over stalling global demand, as energy traders began to price in the notion that the virus could last longer than previously thought.

“The virus spread comes at a time when companies are already facing significant inventory restocking and a stalling in global manufacturing following the application of tariffs and overall trade tension,” said Frances Donald, chief economist at Manulife Investment Management. “Coronavirus is adding salt to the wound.”

Like Tal, Donald believes that the Bank of Canada will seriously contemplate a rate cut.

“I have a lot of trouble believing that the central bank is not very concerned at this point about what the first half of 2020’s economy looks like for Canada,” she said.

Worries over coronavirus morphing into a global pandemic began to flare up late last week, as the number of infections in South Korea surged fivefold to over 800 while authorities in both Italy and Iran reported tens of new cases and almost 20 deaths. Italy is now the epicenter of the biggest coronavirus outbreak outside Asia, as officials still struggle to track down how the virus first entered the country.

The number of cases in North America, however, remains much lower, with just nine in Canada and 53 in the U.S. — 18 of which were discovered on Monday.

Markets reacted negatively to the virus when it first came to light almost a month ago, but then recovered, signalling a dismissal of the potential for a wider economic impact.

“What I find fascinating is that up until last week, the U.S. consensus had not changed one iota on coronavirus concerns,” said Douglas Porter, chief economist at BMO Financial Group. “I wonder if that might start to shift a little bit in the next few weeks,” he added.

Porter remained cautious on the idea that the U.S. Fed would ease rates, saying that it would take a “major shock like a massive, wide outbreak of the virus” to get them to shift gears.

“I can see a scenario where the Bank of Canada cuts rates, and the Fed doesn’t because the Bank has basically told us they are biased to ease, if need be, but the Fed hasn’t indicated that,” he said.

Because of how large the Chinese economy is, the impact of a coronavirus-related slowdown on Canada would come from both the supply side (Canadian companies depending on Chinese goods) and the demand side (exports of our commodities to the Chinese market), says Donald.

“But the supply side component of this is so much worse than in 2003, with SARS, because global supply chains are significantly more complex. In today’s environment, we are relying on China for intermediary goods — for example automakers rely on parts made in China,” she said.

“So the biggest challenge from a policymaker’s point of view is how much of the loss we might experience over the next few months is going to be recouped over the next year,” Donald added.

On Sunday, China confirmed 150 new deaths, pushing its national death toll to almost 2,600.

The outbreak has also caused widespread travel chaos, with Turkey, Pakistan, Armenia and Oman closing their borders with Iran on Monday, citing the surge in the number of cases there. Hong Kong too, closed its doors to all arrivals from South Korea over the weekend.

Airline stocks in particular took a hit on Monday, with American Airlines dropping just over eight per cent and Air Canada’s stock declining five per cent, as the company continued to restrict the number of flights between Canada and China.

“The direct damage to global economies is still limited, but there’s potential for much more which is basically what the market is reacting to,” said Porter.

”But frankly, no one can really know at this point, because if you think about it, it has really only been a month (since) this first emerged as an issue.”