Global markets are reeling as the novel coronavirus continues to spread around the world and the extent of its economic, geopolitical and social impact begins to be felt. The outbreak, which occurred in Wuhan, China and was first publicised at the end of 2019, has now spread to over 100 countries worldwide. At present there appear to be four regional epicentres; China, South Korea, Iran and Italy, with new cases growing at an exponential rate.
Initially markets seemed to discount the virus’s effects, but now the economic contagion appears to be spreading rapidly – even the most conservative estimates of the likely fallout are quite sobering. Not only has this virus already infected more people than both SARS and MERS combined, its economic impact thus far has also been greater.
According to the World Economic Forum, the 2003 SARS and 2015 MERS outbreaks cost the global economy an estimated $58.5 billion combined. According to the United Nations, Covid-19 has cost the global economy $50 billion in just exports in February alone. A recent Bloomberg estimate sees the cumulative damage to the entire global economy coming in at around $2.7 trillion.
China at the Epicentre
China remains at the heart of this crisis. It’s the country where this virus originated and it has experienced the greatest number of infections, recoveries and deaths. It’s also the country that much of the world is taking its lead from regarding both what to do and what not to do in response.
Beyond this, China is inextricably connected to the global economy and greatly responsible for driving many key areas of it. China finds itself in a radically different situation today than it did in 2003 during the SARS outbreak. Back then it accounted for less than a twentieth of global trade, today it accounts for around a seventh.
Also, twenty years ago, China’s middle class barely registered as a driver of global demand. In 2000 the number of Chinese urbanites earning between $9000 – $34,000 per year was around 4%. By 2012 this figure had risen to 68%. So, not only is China a manufacturing hub for the entire planet, it’s also an enormous market for Western goods. Car sales in China were down a staggering 80% in February, to take just one important metric of consumer demand.
Last month Chinese manufacturing activity dropped to all-time lows. Its official manufacturing PMI fell from 50 in January to 37.5 in February. This abrupt drop in Chinese production is certain to affect the nations that China imports intermediate goods from and exports intermediate goods to.
Intermediate goods are goods that are used in the production of other finished products and can range from hard and soft commodities such as metals and soy beans, through to plastics used in manufacturing and active pharmaceutical ingredients (APIs) used in the production of drugs, all the way to finished car engines and LED screens.
According to the World Bank, China imports the greatest amount of its intermediate goods from South Korea, Japan, the United States and “other” Asian states. Additionally, it exports its greatest volume of intermediate goods to the United States, Vietnam, South Korea and India. The coronavirus is already affecting these deeply intertwined trade relationships and is almost certain to have a far-reaching influence on entire supply chains and final markets of a plethora of finished goods.
South Korea, which has also been hit particularly hard by the virus, is highly dependent on exporting its intermediate goods to countries around the world. 90% of South Korea’s exports comprise of intermediate rather than finished goods. India is also very dependent on intermediate goods from China. The trade relationship between the two nations, which include active pharmaceutical ingredients, electronics, textiles and chemicals is worth around $30 billion per year.
India is the world’s leading manufacturer of generic drugs. The disruption to its supply of Chinese APIs prompted its government to recently restrict the export of 26 medicines including paracetamol, Vitamin B12, several antibiotics and progesterone.
The Oil Narrative Worsens
It was widely expected that coronavirus would cause a big shock to global oil markets. At the end of February this initial speculation gave way to photographic evidence provided by NASA and European Space Agency pollution monitoring satellites. The images released in a joint effort show nitrogen dioxide density over China having fallen by between 10-30%.
Oil price volatility picked up sharply in that same week. The CBOE’s crude oil volatility index (OVX) shot up from around 32 on February 20, to just under 52 by February 28. China is the world’s largest oil importer, with many of its factories at a standstill and eerie images emerging of deserted streets and empty motorways, it was only a matter of time before the world’s most oil thirsty nation affected the price. Last week Morgan Stanley (NYSE:MS) updated its oil forecast for 2020, expecting Chinese oil demand growth for the year to be “close to zero.”
At the beginning of March, OPEC+ members met to try and hash out further production cuts to the tune of 1.5 million barrels per day in order to try and counteract the detrimental effects the virus is having on global demand. Russia pushed back at these talks, stating that it was willing to continue the existing agreed upon cuts for a further three months but would not be willing to cut any further.
Over this past weekend Saudi Arabia seems to have initiated a price war, having slashed its official selling prices for April by $6-8 per barrel. Oil markets have been in panic mode since their open this morning. West Texas Intermediate is in the midst of its largest price crash since the first Gulf War in 1991, having dropped by some 28% to $29.80 at the time of writing. Brent Crude has also taken a big hit – it gapped down from its close of $45.50 on Friday and is currently trading at $33.30.
A pandemic such as the one that we’re currently experiencing places enormous strain on all areas of government. Leaders are caught between the rock and hard place of shutting things down or alternatively allowing the virus to spread. Shutting everything down will lead to our very fragile and interconnected global economy juddering to a halt. Shooting for business as usual will lead to rapid community spread, which will then overwhelm health services and eventually cause the economic crisis that was being avoided in the first place. In both scenarios you have the prospect of great human misery to contend with. No leader wants to be in such a position.
We’ve now seen historic drops in both the stock and energy markets in the space of a couple of weeks. At best this is a pronounced correction, but we could be witnessing the beginning of something worse. It’s often said that volatility is exactly what traders are looking for. However, this massive increase in volatility, both in stock and oil markets, makes it an enormously risky trading environment. Dip buyers ought to beware.
We’re also seeing the first signs of nations hunkering down to protect their own best interests. India’s restriction of pharmaceutical exports is a perfect example of this. Tasked with the protection of its own populace, and not knowing when its supply of APIs from China will resume, it would be ill advised for it to send much needed medicines abroad.
The latest turn of events between the Saudis and Russians is another example of this and will potentially have immense consequences that are not limited to their two nations. It seems as though a race to the bottom has just been initiated. This will certainly hurt many areas of the global petroleum industry but there are also likely to be far broader geopolitical effects. For one, this could be the event that breaks US shale oil. It’s widely known that US shale firms are highly over-leveraged and unable to maintain profitability at oil prices below $50 per barrel. We could be looking at the end of this recent period of American energy self-sufficiency, which is problematic to say the least. These price levels may also wreak havoc on the best laid plans of the green energy industry as fossil fuels are likely to outcompete renewable alternatives in the short term.
As you can see, the interconnections and possible implications are seemingly endless. It has just been reported that limit down “circuit breakers” will come into effect today to prevent US equities from crashing even further at their open. The only certainty is that almost all certainties have just flown the nest.
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