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January saw the markets bedeviled by macro risks, with inflamed U.S.-Iran tensions followed by revelations regarding the spread and nature of the Wuhan coronavirus (also known as 2019-nCoV). The Federal Reserve committed to supporting “inflation returning to the Committee’s 2% target” (emphasis added), a pivot from previous statements that merely committed to supporting inflation “near” the 2% target. This was interpreted by the markets as a dovish tilt in the Fed’s policy stance.
A challenge that’s been seen before?
With the Wuhan coronavirus showing little sign of abating, we chose this month to analyze the impact of emerging market epidemics. We assume trends in Google searches for specific terms (e.g., “avian flu”, “ebola”, “zika”, and “coronavirus”) are indicative of media coverage and market anxiety. To that end, we use Google Trends, which indexes the number of Google searches for a particular term over time. Under the index, the value 100 is the all-time high for a given term. In the chart below, we align the peaks for the listed terms.
Source. Orthogonal, Google.
The week ending 1/31/2020 saw the greatest number of Google searches for “coronavirus” historically. For the purposes of our analysis, we assume that the 1/31/2020 peak for “coronavirus” will remain the peak and that coverage and interest will decline. Of course, coverage and interest may rise further in the coming weeks as new developments emerge in China and around the world.
For our analysis, we take the dates extracted from Google Trends and calculate the average market impact from SARS (2003), avian flu (2005), ebola (2014), and zika (2016) on crude oil, gold, equities, and bonds. In the charts below, we concurrently plot the average impact of these prior epidemics and the current impact of the Wuhan coronavirus.
Source. Orthogonal, Reuters.
In general, recent market behavior has been consistent with historical movements:
- Crude oil takes a steep dive, falling 15% on average in the 5 weeks leading up to peak search.
- Gold rallies 4% on average, only to dip briefly coming out of peak search before rising again in the weeks following.
- Emerging markets underperform U.S. equities, falling on average 6% as compared to 4%, only to resume an uptrend thereafter.
- The yield on U.S. 10-year Treasuries falls 15 basis points on average into peak search, bounces back, and then resumes its trend lower. This is almost a mirror image to gold.
In the long run, market impact tapers out, although in some cases there is a small aftershock of a risk-off episode.
For the most part, market impact from the Wuhan coronavirus has followed script. Crude oil is on track, equities have held up slightly better than expected, and the movement in gold and interest rates is a bit more extreme than the previous average. Assuming that we have reached peak search for 2019-nCoV, we should expect equities to resume trend, crude oil to find a base, and gold/bonds to see a short-term bounce before resuming higher. Again, we caution that peak search may not yet have occurred.
While historical averages provide insight into general patterns, there are a few reasons to believe that the Wuhan coronavirus will have a larger impact than past epidemics. First, while 2019-nCoV is less deadly than SARS and other viruses, to date it has proven to be much more infectious, making its spread much more difficult to control. Economics research has shown that low-virulence, high-infectiousness outbreaks tend to have a greater economic impact. Second, China’s share of global GDP has grown since prior epidemics that occurred in China, from 8.7% in 2003 to 18.7% in 2019. Similarly, China’s share of global manufacturing output has risen from 8.6% in 2004 to 28.2% in 2018.
In sum, because China has grown to be a major player in the global economy that is far more integrated than in years past, the impact of the 2019-nCoV epidemic on markets could be more sustained than historical averages suggest. Wall Street has forecasted a minor impact to global GDP (approximately 0.5 basis points), assuming that the shocks to consumption and travel will bounce sharply come summer and Chinese factories in affected areas will resume production by March. To the extent that these assumptions prove too rosy, a supply shock to the global economy may result in greater medium-term consequences.