I have been a bit under the radar lately. Largely due to an excess of University-related work and partly because conditions had turned somewhat boring, being neither boom nor bust. Fairly unexciting near trend growth.
Conditions are no longer boring.
Still, I hesitate to comment. I am not an epidemiologist. I am also not prone to panic, a trait which doesn’t match well with the current mood. I am not inclined to play the game of ramping up the hysteria. Moreover, this is a low-information environment, making any comment risky and vulnerable to being overtaken by events.
All that said, this is how I am thinking about the current state of play:
The basic situation can be quickly summarized. Efforts to contain the virus have substantially disrupted the Chinese economy. This disruption quickly spills into the global economy due to the reliance on Chinese manufacturing in the global supply chain. Containment efforts also severely impacts the travel and tourism industry. The longer the containment continues, the more damage the global economy will suffer.
In theory that damage should be largely temporary. Once containment ends – presumably with the threat of contagion ebbs – we would expect a substantial push to rebuild inventories. That gives rise to the V-shaped recovery scenarios.
This story works reasonably well if the virus can be contained. Worrisomely, this may not be the case. Outbreaks in Italy, Iran, and South Korea, for example, reveal it spreading; the Italian situation is especially worrisome given they authorities reportedly can’t track down the original source of the local infection. The World Health Organization already worries that the virus can no longer be contained.
If containment fails, that failure would likely be attributed to an initially slow response in China and the nature of the disease. According to reports, for many the virus has mild symptoms or the carrier may be asymptomatic. The virus could already be spread much farther than we realize. On the upside though, the mortality rate might then be much lower.
I am happy to be wrong on this (remember, not an epidemiologist), but I am working on the assumption that this virus is now out in the wild and can no longer be contained. If so, we will need to adapt to it as we have to other seasonal illnesses.
While that may be my base case, that isn’t necessarily yet the base case of public health authorities. As long as the focus remains on containment, and the virus continues to spread, we should expect further disruptions to the global economy. Containment – travel restrictions, closure of public spaces and factories, etc. – is costly. More containment efforts will yield greater economic and social costs.
The extended and rolling nature of containment efforts appears to be the greatest concern of market participants.That concern was likely the proximate cause of Monday’s market action. I think we should keep in mind though that, at some point, the economic and social costs of containment become too much to bear. There is only so long authorities will be able to hold the global economy hostage for a virus that can no longer be contained and has a potentially fairly low death rate. At some point, the focus shifts from containment to mitigation (good thread here), supply chains come back to life, and the inventory correction begins.
If containment is still possible, but takes longer than expected, then the V-recovery becomes a U-recovery.The longer it takes to shift from containment to mitigation, the wider the base of the “U” and the higher the chance that the bottom of the “U” is a recession. In any scenario, I would expect persistent weakness in travel and tourism activity. It seems reasonable to expect international travel, particularly to Asia, to be depressed until people become more familiar with the nature of the virus (I am still assuming it is out in the wild).
In either case then – containment or mitigation – what this comes down to is a waiting game.How long until the virus is contained? How long until authorities shift to mitigation? I would assume that one of these two outcomes happen by the end of the second quarter. Either the warmer weather helps reduce the pace of new infections, or the ongoing containment efforts become too costly, or some combination of the two.
To be sure though, this is all guesswork. Clearly, we have limited information to work with. I don’t know how an admission that mitigation is the option will be met by a public already fed a daily death rate. Will they panic? Or take it in stride? The risk in either containment or mitigation in the U.S. is that the process is completely botched by the Trump administration. Early signs are not encouraging.
Federal Reserve officials are likely asking many of the same questions. Until the last few weeks, it was evident that the economy was on the mend. They were comfortable holding rates at current levels for the foreseeable future. They are not prone to rapid policy shifts and the equity decline has yet to be of a magnitude to justify concern. Indeed, I suspect that many will believe equities were a bit frothy and set for decline anyways. A credit event, however, would likely get the attention of policy makers. They won’t want to cut rates too soon and then immediately see the pace of new infections quickly diminish and an inventory correction occur suddenly. Some officials may even question the usefulness of a rate cut in the face of a supply side shock.
Bottom Line: This is a low information environment. We don’t know how long this virus issue will be with us. The uncertainty will leave us susceptible to panic. Best case scenario is obviously that the virus subsides soon. If it doesn’t subside soon and instead the spread widens, the next best scenario is that the shift from containment to mitigation happens sooner than later. My baseline scenario lies on the mitigation part of the continuum (does this make me an optimist or a pessimist?). I don’t see that authorities will let the global economy collapse with ongoing containment efforts if the virus is already out in the wild. That said, I also cannot ignore the possibility of a more pessimistic outcome. Fed will bide its time absent a credit event or signs the economic foundation is weakening.