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The Weekly Bottom Line: Rate Cut Odds Surge As Covid-19 Spreads

U.S. Highlights

  • Fears about the widening spread of Covid-19 lead to the worst week for equity markets since 2008. The 10-Year Treasury yield continued to find new all-time lows on Friday, and the Brent price of oil was down 15% on the week midday Friday.
  • News on outbreaks in Italy and Iran several days ago confirmed that the spread is not likely to be contained to China and its closest neighbors. As containment efforts and fears increase, the hit to the global economy worsens.
  • Fed speakers pointed out that rate cuts are a possibility if a global pandemic develops. But, the U.S. is still being affected by the stimulus from last year’s rate cuts, which will help it navigate the current situation of uncertainty.

Canadian Highlights

  • Canada joined the selloffs in global financial markets this week, with the S&P/TSX plunging by roughly 10% relative to a week ago (as of writing).
  • Covid-19 adds to the headwinds already blowing against the Canadian economy, which came to a virtual standstill at year end. Real GDP eked out a 0.3% (annualized) gain in Q4, held back by a decline in exports and investment.
  • Market implied odds of the Bank of Canada rate cut in March have risen considerably. A rate cut next Wednesday seems unlikely (though not impossible), but we expect Governor Poloz to use this opportunity to open the door even wider to monetary easing later this Spring.

U.S. – Pandemic Panic

It has been a horrible week for financial markets as fears of coronavirus spread. Bond and commodity markets had been factoring in greater economic weakness for a few weeks already, but the yield on the 10-Year Treasury continued to plumb new lows on Friday, and oil prices are down around 15% on the week at time of writing. Equity markets had remained defiantly optimistic until news of larger outbreaks in Italy and Iran showed that the spread is not likely to be contained to China and its closest neighbors (Chart 1). Equity investors were further rattled by companies warning that the virus would impact earnings this quarter. All told, global stock markets entered correction territory in what is shaping up to be the worst week for the S&P 500 since the fall of 2008 (Chart 2).

Adding to market fears, the Center for Disease Control warned Americans to prepare for containment measures and community spread of the virus. Even if quarantines do not become widespread in the United States, fear will likely lead consumers to spend less, weighing on economic activity.

Globally, containment measures will hold back economic activity. In Japan, schools have been urged to close until April 8th, and Prime Minister Abe also called for cancellation of large-scale public events and sports matches. Switzerland has banned large gatherings, and various conferences are being cancelled as businesses shy away from non-essential travel. All told, our upcoming quarterly forecast will feature a downgrade to global economic growth.

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As the economic hit worsens, governments have started to announce spending packages designed to help cushion the blow. Hong Kong has announced the largest fiscal stimulus so far, amounting to 4.2% of GDP. That includes $1,280 of one-time cash to all permanent residents. In Hong Kong’s case, the stimulus comes after months of protests had already pushed the economy into recession.

South Korea, which is the hardest-hit country outside of China, plans to spend more than $13 bn to combat the economic impact of the virus (about 0.8% of GDP), with potentially more money to come. Malaysia and Singapore have also announced stimulus packages of 1.3% and 1.1% of GDP respectively.

Back stateside, all eyes will be on the ISM indexes for February released next week, for early signs on how business sentiment held up in the face of early news on Covid-19. We expect some weakness in both manufacturing and services sentiment, and we may also get some sense how factories are dealing with disruptions to their Asian supply chains. There is unlikely to be much impact on Friday’s job numbers for February, although you could see some weakness in leisure and hospitality hiring as tourism takes a hit.

The Fed’s Bullard said on Friday that further rate cuts are a possibility if a global pandemic actually develops, but this is not the Fed’s base case. He also pointed out that the stimulus from last year’s rate cuts are still aiding the economy, and this will help it navigate the current uncertain situation.

Canada – Rate Cut Odds Surge As Covid-19 Spreads

Fear gripped financial markets thi