Submitted by Rabobank's Michael Every
The beginning of 2020 starts to look alarmingly similar to 2018. Back then the US stocks extended their impressive 2017 gains in the first few weeks of trading only to plunge at the end of January and sustain heavy losses in the first half of February. In that period the S&P 500 Index plunged almost 12% from the peak to trough on the back of rising concerns that inflation may rise much faster than initially anticipated forcing the Fed to accelerate the pace of monetary policy tightening. It was just a taste of what was to come as 2018 proved to be a tumultuous year for the US equities which set record highs in September only to end the year deep in the red.
Back to 2020, global stocks are in a risk off mode amid escalating concerns about the coronavirus. The S&P 500 Index plunged 1.57% on Monday trimming its year-to-date gains to just 0.40%. One could argue that this is just a correction from seriously stretched levels that will ultimately prove as an opportunity to buy stocks on the back of an assumption that the Chinese officials will, eventually, get on top of the coronavirus.
However, it is extremely difficult to estimate the negative impact on the Chinese economy at a time when the death toll is rising sharply (106 so far) and the number of confirmed cases is soaring (4,515 as of today). More than 50 million people in China are now in a lockdown.
It is also worth considering the following: what if we are on the brink of an exponential increase in the number of people affected by the deadly virus? One could argue that we have already reached this stage given that confirmed cases reportedly increased by 65% over the past few days.
There is more evidence that the coronavirus has an incubation period of about two weeks before those infected start to show signs of the illness in a country where half a billion people travel at this time of the year. While travel restrictions have been put in place, it could be too late. The worst may yet to come despite the best efforts by the Chinese authorities to contain the virus.
Market concerns about severe impact on China and the global economy are reflected in rising demand for safe haven assets. The yield on the 10-year US Treasury plunged below the trendline support from the September low. The October low at 1.5051% is the next level to watch ahead of 1.4272% (2019 low).
The US dollar is the beneficiary of growing demand for Treasuries. The Bloomberg Dollar Index is on the cusp of breaking above the trendline resistance at 1200. A bullish breakout in the USD Index would provide USD/EM crosses with even strong upside momentum. Commodity currencies have been the most impacted so far. The plunge in oil prices to the lowest level so far this year provided USD/RUB with sufficient upside traction to revisit the December 23 high at 63.1057. USD/RUB was leaning lower this morning, but the upside bias is likely to prevail in the coming days with 64.49 as the next potential target for USD/RUB.
Looking more broadly at the EM space, the pace of capital inflows into risky assets slowed down last week when concerns about the coronavirus increased. Exchange-traded funds focused on emerging markets attracted USD 311.7mn in the week ending January 14 – this was significantly lower than USD 3.16bn in the previous week, Bloomberg reported. The impressive run of 16 consecutive weeks of inflows may come to an end if risk aversion continues to rise.