Coronavirus (labelled 2019-nCoV by the World Health Organisation) fears have sent shockwaves through global communities and financial markets in recent days. When the SARS outbreak occurred, China’s economy represented 4% of the global economy, today that number is over 16%. If the virus follows a simple progression model (i.e., assume a 53% increase in cases as reported, where each infected person transfers the virus to 2 to 2.5 people) then by 20 February 2020 we can expect to have over 100 million cases of Coronavirus worldwide, according to China National Health Commission Daily Reports (chart below). 

This assumes the virus continues to follow the actual growth rates seen over the last 12 days. A successful quarantine/isolation of infected communities or a development of a vaccine/cure can clearly have a large impact on projected infections, but notwithstanding the situation is changing quickly and has vast human and economic impacts at a time when the global economy is only just showing tentative signs of recovery from a weak 2019. The ability to quarantine the virus will be more problematic and comparisons to the SARS epidemic are difficult given the increase in global travel numbers over the last decade.

Source: China National Health Commission Daily Reports and Bianco Research.

Trying to break the infection cycle

For now Chinese cities are closed. Chinese New Year holidays have been extended across the country until 2 February 2020, with some cities and provinces, such as the major provinces of Guangdong, Zhejiang, Jiangsu, not to resume work and school before 9 February 2020. These three provinces are numbers 1, 2 and 4 in China in terms of GDP. Whilst the reported mortality rate is low, at around 3%, the long incubation period of two weeks is making identifying infected cases difficult during the peak travel period of Chinese New Year. This makes the virus harder to isolate.

The impact on the Chinese economy

The outbreak began in Wuhan in December, home to 11 million residents. Wuhan is at the centre of China geographically and connected to all major Chinese cities by road and high speed rail (one of 4 national rail hubs) and is an important engine of the Chinese economy. Putting aside the human tragedy for a moment, let’s look at the economics. Exact modelling of the impact on the Chinese economy is very difficult, however a two week shutdown is likely equivalent to >1% of Chinese GDP, a three week impact is likely equivalent to >2% GDP. The overall impact of the SARS virus in 2003 resulted in over 2% of GDP, but the GDP base was much higher at 11% growth. It is likely that Chinese businesses will halt for a prolonged period, travel will cease which will lead to a plunge in the demand for oil on an already oversupplied market (this can have material implications for high yield bonds – very energy heavy complex).

Risk mounting on global markets

Although mainland media quoted Chinese infectious diseases expert Li Lanjuan on Monday as saying a vaccine targeting the coronavirus was being developed, this will take up to a month to manufacture and will require testing before it could be deployed.

Trying to connect the dots is incredibly complicated, as markets are also concerned that China is withholding the true state of the outbreak. As with any thematic that is gripping markets and causing risk aversion, the circuit breaker can only be a cure or a plateau in the number of cases of people around the world contracting the virus.

The economic impact is very likely to already be material for global growth – which will be another body blow for the fragile domestic economy. Given the asymmetry we have noted in most Central Banks (ease on bad news, do nothing on better news), we think this can bring policy makers to the rate cutting table faster than otherwise predicted in 2020. Overall, pressure on bond yields, while it may ebb and flow, will mostly be downwards and the foreign exchange markets will be torn between seeking haven currencies and seeking yield, but the US dollar, Japanese Yen and Swiss Franc are likely winners, whilst we expect the Euro and China-sensitive emerging market currencies may be losers.

Safe haven currencies at a time of uncertainty

In our December 2019 post − Tail risk hedging your portfolio using currency, we highlight any interesting paper authored by staff from the Bank of England (and co-authored by staff at the European Central Bank) on currency risks and looking into the idea of safe-havens in FX markets. As the authors note, their results largely match 'market talk' but they can quantify the effects.

"The Australian dollar remains top of ranking in terms of an increased likelihood of a sharp depreciation (large downside entropy), while at the opposite end of the spectrum there are a series of currencies with large upside entropies that join the yen as ‘safe havens’, notably the Swiss franc and the US dollar."

As to why a certain currency attracts a safe-haven assessment, the paper concludes that current account deficits and positive interest rate differentials as the most robust indicators of increased chances of seeing a sharp depreciation in the event of a tightening in global financial conditions.

To follow the progress of the virus closely we found this link useful to get a current read on the chart below. 

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Jerome Lander

Great article Charlie. The equity market really appears to be dismissing the risk related to this issue and the potential requirement for greater mitigation (now that the bat is out of the bag, so to speak..). This seems strange given the characteristics of the virus have not been fully identified and hence there is a real risk this could get a lot worse and become a big problem globally, and not just for China and Chinese growth. It is unclear for instance currently whether transmission can occur while someone is asymptomatic, and for how long this might be the case. The death rate could increase as many cases are relatively new. Draconian measures would likely have to be implemented in other economies if the virus proves to have adverse characteristics. It is unlikely an effective vaccine or treatment will be implemented soon, so we really do appear now to be at the mercy of the characteristics of the virus as to whether this proves a really big issue or not.

Tony Ellis

I feel the need to call out the nonsense data and false attribution. "we can expect to have over 100 million cases of Coronavirus worldwide, according to China National Health Commission Daily Reports".... That's not what they say, that is you completely misunderstanding the data. For a start, the rate at which diagnosed cases has increased across the daily reports is not a proxy for the speed at which infection is spreading. New confirmed cases means that existing sick people, who were infected when there was little awareness, have now been have been tested and confirmed. A ten-fold increase in the confirmed cases does not equate to a ten-fold increase in infected people (The China National Health Commission were very explicit about this in their briefings). Also, if we ignore for a moment your timescale, your 'simple progression model' is also fundamentally flawed. It predicts about one trilion infected people by the start of April... In reality, an R0 rate of 2 to 2.5 might be a valid starting point, but is not a constant. It will start to fall now that the virus has our attention, partly because of steps to isolate and quarantine potential cases, but also because a panicked Chinese population is taking steps to protect themselves (avoiding public places, wearing masks, etc), that they were not 7 days ago. And also, at the grand epidemic scale you predict, the rate of increase will slow simply because the more people that have been infected, the fewer the opportunities that an infected person has to transmit to.

Hugh Johnson

I agree with Tony Ellis, it's always bonds vs equities is what's really going on here is it not?

Charlie Jamieson

Hi Tony, thanks for your comment and I somewhat agree. The model is interesting because at the time of writing the virus had definitely jumped continents and is undetectable for 2 weeks meaning that containment will be very challenging indeed as carriers are now everywhere - as we are seeing in the last few days since the article was published. In my defence the very next paragraph of the article states that projected infection rates will be altered by..... “A successful quarantine/isolation of infected communities or a development of a vaccine/cure can clearly have a large impact on projected infections, but notwithstanding the situation is changing quickly” Let’s hope things calm down for humanities sake. We note a slight dip in Friday’s numbers vs model so we could be seeing the rate of change slowing which is a good thing and markets will take comfort in that.