Risk evaporates on Italian virus spread

Emily Nicol
Chris Scicluna

With the spread of the coronavirus beyond China unabated – with Italy and the Middle East now key focusses beyond Asia – stock markets have continued to retreat at the start of the week. Losses have been most acute in South Korea, where a further 161 cases were recorded to take the total to 763, having been little more than 30 a week ago. So, the KOSPI closed down a steep 3.9% today, with the KOSDAQ down by more than that. Elsewhere in Asia, the main indices in Hong Kong and Taiwan fell more than 1%. But with China’s authorities on Friday having committed to be more ‘proactive’ in its fiscal policy and use ‘more flexibility’ in monetary policy, and today also having relaxed somewhat restrictions on movement in Wuhan, the CSI300 closed down a more moderate 0.4%.

While Japan’s markets were closed for the national holiday, the yen was broadly stable close to ¥111.5 while China’s yuan was little changed above ¥7.0/$. But with other major Asian currencies weaker, e.g. the Korean won started the week down almost 1.0%, and the euro down ½ cent too, the trade-weighted dollar reversed some of Friday’s slide with DXY now back to 99.6. In the oil markets, Brent crude fell almost $2 to below $57 for the first time in six days.

Due to Japan’s holiday, there was no trading in USTs in Asian time. But coronavirus fears have extended their rally upon opening in European time, with yields down 4-5bp across the curve. So, having moved to a record low on Friday, 30Y yields have plunged new depths this morning, down to about 1.875%. 10Y yields are down to about 1.42%, the lowest since July 2016. And with the markets pricing in two cuts to the Fed Funds Rate by year-end, 2Y yields are also down another 5bps to close to 1.30%, the lowest since 2017.

With Italy now home to the world’s third-largest concentration of coronavirus cases (more than 130), controls on the freedom of movement and economic activity in the north of the country might well be followed this morning with the announcement of the reimposition of the country’s border with Austria. Of course, Italy’s economy is also the most vulnerable to disruption from the coronavirus, being at serious risk of slipping into recession this quarter. So, while most euro govvies have rallied this morning (with yields on 10Y Bunds down more than 3bps to close to -0.47% for the first time since October), BTPs have sold off, with the 10Y spread to Bunds some 8bps wider. And Italian shares have fallen sharply at the opening a few minutes ago (FTSE MIB opening down more than 3½%, the most since end-2018, while the Eurostoxx 600 is down almost 2½%).

Against the gloomy backdrop, perhaps unsurprisingly, the weekend saw certain ECB Governing Council members – including Banca d’Italia Governor Visco – call for extra fiscal stimulus to counter any hit to growth from the virus. We should expect more of that kind of talk this week, perhaps most notable from Christine Lagarde, and would also expect the Italian authorities to ease in due course. But we won’t be holding our breath for a proactive response in Germany. By the same token, while Governor Kuroda suggested the BoJ would be willing to ease policy if the coronavirus took its toll on the economy – and a second successive quarterly contraction in Japan this quarter is now a decent bet – the hurdle to further Japanese monetary easing is very high too.

Euro area:
Following Friday’s better-than-expected flash PMIs, this week brings further survey results for February which might provide a reality check. The flow starts in a little while with the German ifo indices, while the French INSEE business and consumer indicators are due tomorrow and Wednesday respectively. And Thursday will bring the European Commission’s economic sentiment indices, which often provide the most reliable guide to activity. If the PMIs are anything to go by, the national indicators and the Commission’s survey will post improvements in the main industry and services confidence indicators. And after the upside surprise to the Commission’s flash estimate of consumer confidence, the headline Commission economic sentiment indicator is highly likely to have risen further from the seven-month high of 102.8 recorded in January.

The back end of the week will also bring the first indications of inflation in February, with the Spanish flash estimates due on Thursday and the equivalent numbers from Germany, France and Italy due on Friday. The euro area’s preliminary CPI estimate for February, which is not due until 3 March, is eventually likely to show that headline inflation eased on the back of lower energy prices, while core inflation likely edged only very slightly higher to a still subdued 1.2%Y/Y.

Friday will also bring revised French national accounts figures, which are likely to confirm that GDP growth slowed sharply to -0.1%Q/Q in Q4, the first quarterly contraction in 2½ years. Likely of more interest will be updated German GDP figures tomorrow, which will bring the first official expenditure breakdown. This is likely to confirm that the euro area’s largest economy stagnated in the final quarter of last year as household and government spending slowed. Other releases due at the end of the coming week include German unemployment data for February and French consumer spending for January.

In terms of ECB-speak, Governing Council members due to perform in the coming week include President Lagarde (Wednesday) and Executive Board members Lane, de Guindos, Schnabel and Panetta (all Thursday). In the markets, Italy will sell index-linked and zero-coupon bonds on Wednesday, while Germany will sell 5Y OBLs the following day.

All of the most notable Japanese data to be released this week will come on Friday, with the January reports for industrial production, retail sales and the labour market due along with February inflation data from Tokyo. In particular, following an exceptionally weak fourth quarter (down 4.1%Q/Q), industrial production is expected to have been little changed in January. Retail sales are also expected to have started the year with a damp squib, as mild winter weather hit clothes purchases and sales to foreign visitors were down from a year ago over the Lunar New Year and thereafter as the coronavirus started to bite. The labour market are expected to show no change in the unemployment rate (2.2%) and job-to-applicant ratio (1.57x). But Tokyo inflation is expected to have eased back slightly in headline terms (down 0.1ppt to 0.5%Y/Y) and on the core measures too (e.g. down 0.1ppt to 0.8%Y/Y excluding fresh food and energy). In the bond markets, Friday will bring an auction of 2Y JGBs.

This week will be relatively quiet for top-tier economic releases from the UK, with just a couple of surveys providing an update on conditions in the middle of Q1. In particular, tomorrow’s CBI distributive trades survey is expected to show that retail sales growth remained relatively subdued in February having signalled no meaningful growth at the start of the year. This would also be consistent with still relatively underwhelming consumer confidence, which Friday’s GfK survey is likely to confirm – indeed, the headline sentiment index is expected to have fallen very slightly from the seventeen-month high of -9 recorded in January. BoE MPC members scheduled to speak in the coming week include Chief Economist Haldane (today and Friday) and Deputy Governor Cunliffe (Thursday). In the markets, the DMO will sell 10Y Gilts tomorrow.

It’s set to be a quiet start to the week for economic data from the US, with the Chicago Fed national activity index today’s most notable release, followed by the Conference Board’s consumer confidence survey tomorrow. Tuesday will also kick off the week’s housing market indicators with the FHFA and S&P Corelogic home prices indices for December, followed by new and existing home sales figures for January on Wednesday and Thursday respectively. Thursday will also bring revised Q4 GDP numbers – likely to confirm that growth was little changed from the initial estimate of 2.1%Q/Q annualized – as well as the more timely release of durable goods orders data for January. Friday’s release of advance goods trade and inventories figures for January will also provide an update on economic activity at the start of the year, while personal income and spending data, including the monthly deflators, for the same month will also be closely watched. Elsewhere, after Friday saw Brainard make the case for the Fed to be ready to use BoJ-style yield curve control in the face of the next downturn, the FOMC’s Mester, Clarida, Evans and Bullard are due to speak publicly this week, while in the markets the Treasury will sell 2Y notes tomorrow, 5Y notes and 2Y floating-rate notes on Wednesday and 7Y notes on Thursday.

This week will bring a couple of releases to inform the Q4 GDP figures due on 4 March. In particular, construction output figures for the fourth quarter are due on Wednesday while private capex figures are due the following day. The former are expected to post a sixth consecutive quarterly drop, and at a faster pace than the decline of 0.4%Q/Q in Q3, as the housing market adjustment continues to take its toll. However, having declined in each of the prior three quarters, business investment is expected to have risen in Q4, albeit only very modestly. The other notable data due this week will be the January private sector credit numbers, scheduled for release on Friday.

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