Rabobank: Markets Need To Start Pricing For One Of Two Things - One Bad, The Other Terrible

Submitted by Michael Every of Rabobank

It is that rarest of occasions. Not a global pandemic, because: 1) we still aren’t in one yet, officially; and 2) we have had that pandemic declaration made in the relatively recent past (2009-10). Rather, we are being told by well-known voices on Wall Street NOT to buy this particular dip in stocks, which closed down once again in the US (S&P -0.4%) to make it three losing sessions in three. The Nikkei is also down another 2.1% this morning in Asia. Furthermore, those “Kud-LOW” bond yields are also now Kud-LOWER, with the 10-year US Treasury at 1.30%, a new record that I suspect will not hold for long. Aussie 10s also hit a new record low of 0.84%, as once the virus hits housing prices in Sydney and Melbourne, the RBA will of course be forced to act.

Is that equity slump and yield-move justified though? Certainly, when the WHO notes that the spread of COVID-19 is now faster and wider outside China than within it. (Albeit with a further press report alleging that China’s numbers are far higher than being officially recognised). At time of writing we now have the first cases in new locations like Georgia, Greece, Finland, Macedonia, Norway, and Romania, to say nothing of suspicions of what may be happening unrecorded in Africa, as well as what looks like the first case in the US unrelated directly to China, and with 91 reported as under precautionary quarantine in the States too. This virus is indeed now threatening to spread at the pace previously seen in China in many other locations.

Yesterday also saw US President Trump make a public statement on COVID-19, and rather than be as dismissive as his recent tweets, he appointed Vice-President Pence as the “Virus Czar”, who will have direct responsibility for fighting what is now recognised as a real potential crisis – even if Trump again tried to accentuate the positive via talking up the possibility of a vaccine (which experts say is 12-18 months away). He also said he would be willing to take whatever financial virus-fighting package Congress offers, having asked for USD2.5bn and then seeing Democrats up this to USD8.5bn to try to out-bid him.

Australia has also just initiated its official virus emergency plan. Presumably this will not allow some Australian universities to continue doing what they have been doing until now: allegedly paying Chinese students to fly back into Australia via third countries to evade quarantine restrictions. Ah, the wonders of capitalism!

Meanwhile, other travel shutdowns and lockdowns are proceeding apace. Notably, Israel has become the first country to officially recommend, not yet order, that ALL international travel be postponed unless absolutely essential. Is that an over-reaction? The WHO and EU would of course scream “Yes” and “Because markets”. But what is an individual holiday, shopping trip, or business meeting weighed up against the fat tail-risk of catching and spreading a virus that might decimate an economy and kill an untold number? It is also an uncanny parallel with the 2013 movie “World War Z”, which for those who don’t recall saw Israel as the only global hold-out against a zombie plague. Of course, in the same movie religious fervour (loud singing) allows the plague in anyway; and here there is another ironic parallel, as Israel waits to see if South Korean Christian pilgrims who recently tested positive after returning from the Holy Land brought it in with them or picked it up on the flight home.

Regardless, markets now need to start pricing for one of two things. Either COVID-19 is going to spread, making an untold number sick and killing many others, and economies will go into lockdown as supply-chains are badly hit; or governments are going to lockdown anyway, the public are going to rapidly scale back most activities, and supply chains will again be badly hit. In either case, don’t buy the dips.

Tellingly, one Six Nations Rugby game has already been postponed, and there are real questions being asked over the safety of events such as Euro 2020, the Giro D’Italia, the Olympics, and even the annual Muslim Hajj to Saudi Arabia. (Please also see the special report we published yesterday on COVID-19 vs. the Spanish flu and previously-unrecognised “Sick-stematic risk” in the global economy.)

The other key market question is how FX will trade any global pandemic. For now some of the safe-haven shine seems to be coming off of the US Dollar following the dip in stocks and the Virus Czar appointment. However, as we have seen so far in recent years, and during the trade war, this is all a question of who has the least dirty (or virus-y) dirty shirt: the level of USD debt outstanding, and the fact that US imports paid for in USD are likely to crash in a World War Z scenario are both likely to mean that the Dollar gets a very strong bid again at some point – just as US Treasuries are, for example. (Not to say that gold won’t get a bid in a time of panic: it will.)