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COVID-19 triggers policy action

Cov 19

In spells of economic slowdowns, policymakers, through both fiscal and monetary policy tools, intervene.

With markets fearing the possibility of another economic fallout, deepened by the fast-spreading COVID-19 and consequent disruptions, pressure on policymakers is now mounting to act and take preventive measures to stimulate the economy, thus cushioning the economic hit set to ensue.

Albeit the disruptions brought about are viewed to be temporary, and thus short lived, predicting the extent of contagion and duration of such phenomenon is no easy task to undertake. The wider the virus spreads and the longer the outbreak lasts, the more likely it is for the pneumonia-like virus to leave a more enduring drag on the global economy.

Recently published economic data have indeed supported the view that although short-term, the impact from COVID-19 shall be significant. For instance, China’s Caixin General Manufacturing PMI plunged to 40.3 in February 2020, the lowest level since the survey began in 2004, from 51.1 in January and missing market estimates of 45.7.

To clarify thoughts, PMI readings above 50 indicate expansion, while those below that level signal a contraction.

With Chinese authorities imposing restrictions on movement and businesses extending Lunar New Year shutdowns, China’s output supply chain came to a standstill. New orders and employment fell at the steepest rates on record. Exports shrank sharply on the back of shipping restrictions and order cancellations.

Although business operations have now entered into a recovery phase and the number of new cases in China, the epicentre of such epidemic, seemingly appear to be on a slowing trend, the virus is now accelerating elsewhere. This meaning, when the impact starts to fade for China, it will emerge for other countries. Undoubtedly, growing the risk of a protracted downturn in foreign demand, and decreasing the likelihood of a quick V-shaped recovery.

In addition to the above, the OECD warned that the pneumonia-like virus may halve global economic growth this year from its previous forecast. The Paris-based group lowered its central growth forecast from 2.9 per cent to 2.4 per cent, but stated that a “longer lasting and more intensive coronavirus outbreak” may slash global growth to 1.5 per cent in 2020.

Albeit expected, the downward revision to growth expectations for the global economy, proved to be quite alarming, leaving policy makers no choice, but to act promptly.

Notably, the US Federal Reserve held an urgent meeting on Tuesday in which it cut its benchmark interest rate by half a percentage point, to a range of 1 to 1.25 per cent, to stave off the long-term economic impact from the spread of the coronavirus epidemic. Following the Fed’s first emergency rate cut since the financial crisis, the US 10-year treasury yield, which moves inversely to price, dropped below 1 per cent for the first time.

To further mitigate the negative impacts COVID-19 poses, monetary authorities in both Europe and Emerging Markets are expected to follow suit, and implement the highly-desired interest rate cuts.

Although the benefits, the desired rate cuts may indeed reap, one question looms large; is the implemented monetary policy sufficient to tackle current issues?

Probably not. Despite the fact that monetary policy tends to stimulate demand for goods, spurring businesses and homeowners to borrow, it is indeed rather challenging to repair the existing disruptions to the supply chain, unless normality is reinstated.

On that note, in this rather gloomy scenario, we reiterate that a bottom-up approach is indeed imperative, to ensure that, from a credit perspective, the selected investment ultimately generates sufficient cash to both, service its debt and weather challenging market conditions.

At this juncture, it might be wise to take the opportunity of wider spreads and re-position in more solid credit stories.

This article was issued by Christopher Cutajar, Credit Analyst at Calamatta Cuschieri. For more information visit, https://cc.com.mt/ . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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