The psychology of individual investors will also play a role. The big drop in commodity prices (oil, copper) shows an expectation of a major decline in commodity demand, largely driven by China, but tells us little about what to expect in the rest of the world.US treasury yields have rebounded but have not fully recovered. Bond and equity investors are not exactly aligned in their assessment of the growth outlook, although the expectation that, if necessary, the Federal Reserve will cut rates could also play a role.
As discussed in the previous issue of Ecoweek, the epidemic combines a demand, supply and confidence shock. Assessing the supply shock is particularly difficult because of the lack of data. It depends on the specific organisation of value chains at the individual company level, on the level of inventories, on the (im)possibility to find alternative sources of supply. Anecdotal evidence points towards a considerable impact from supply chain disruption[1]. Concerning the shock to demand in China, the task is hardly easier. The gross regional product of Hubei province, the epicentre of the epidemic, represents 4.2% of the country’s total. Under the realistic assumption of a significant contraction in activity, one ends up with a non-negligible impact on the country as a whole, to which spillover effects should be added: a drop in demand in Hubei will entail fewer purchases of goods and services produced in the rest of the country. Confidence effects should also act as a drag on spending throughout the country.
Turning to the international repercussions, research by the IMF shows that a 1% decline in Chinese growth lowers European growth in the medium run with 0.2%[2]. The number for the US should be even lower[3]. For sub-saharan Africa the impact is -0.7%, for Asia about -0.3% and Latin-America and the Caribbean -0.4%[4]. Then there is the impact from the jump in uncertainty. Analytically this raises two challenges: quantifying the increase in uncertainty and estimating its impact. On the former, a recent analysis by the ECB[5] shows the development of economic uncertainty and trade-related uncertainty since the mid-90s. This allows to gauge the impact of certain events (9/11, Iraq war, eurozone sovereign debt crisis, etc.) on uncertainty. With the exception of the collapse of Lehman Brothers, most shocks correspond to a move of the uncertainty measure of about one standard deviation. Obviously, this does not tell us where the coronavirus ranks but it does allow for a, admittedly very judgmental, comparison. Clearly, the jump in uncertainty will depend on the economic exposure, hence it will be far bigger in China than in Europe. Assuming a temporary one standard deviation uncertainty shock for the eurozone, the peak impact on growth should be about -0.3%[6].
To conclude, on some of the topics we have a satisfactory level of visibility of the order of magnitude: international spillover effects of the demand shock, repercussions of the global increase in uncertainty. The visibility is much lower concerning the effects of the supply disruption. This is even more the case for the impact on China. This means that in the near term, data surprises –the difference between the consensus forecast and the outcome- should be higher than normal, which should be a source of market volatility. It could even push companies to adopt a wait-and-see attitude until a clearer picture emerges. To the extent that the peak of the epidemic is reached quickly, this should improve visibility of how demand and activity evolve and hence support confidence.
On some of the consequences we have a satisfactory level of visibility of the order of magnitude: international spillover effects of the demand shock, repercussions of the global increase in uncertainty. The visibility is much lower concerning the effects of the supply disruption and, even more so, the impact on China.
