Covid-19 risks to our core scenario
The further spread of the coronavirus (Covid-19) beyond China, and in particular to Europe, highlights the risk that global travel and global supply chains could be hit harder than in our current global scenario, which assumes successful containment and resumption of supply chains, including China-based ones, in Q2 2020.
From a macro point of view, ammunition to fight a riskier scenario has become increasingly scarce with lack of room for manoeuvre (or political will) for fiscal stimulus, and an erosion in the effectiveness of monetary policy. At this stage, our core scenario of no recession in 2020 remains unchanged, but the V-shaped recovery in global growth is at risk of becoming "U-shaped", i.e. with coronavirus-related difficulties persisting into Q2 2020.
The transmission channels of the virus to economies differ according to region:
- China: manufacturing supply chains disrupted;
- US: the shale oil sector harmed by steep fall in oil prices;
- Europe: the auto sector hurt, with Italian and German exports hit particularly hard by events in Asia.
The recent rise in cases of infection in Italy is increasing the downside risks to our European growth forecast. The US economy could also be exposed to a fall in oil prices below USD 40/bbl, which would undermine the large US shale oil industry and even risk triggering a US recession. The Federal Reserve is likely to wait for signs such as a decline in payrolls or the ISM index before it considers acting, but the heat from an inverted yield curve could pressure it to move sooner. There is therefore a downside risk of a Fed rate cut in April (versus our current scenario of a first rate cut in September).
From an asset allocation point of view, the main safe-haven assets that can help mitigate current portfolio risk are:
- Physical gold;
- Defensive currencies (USD and CHF); and
- US Treasuries.
A further spread of Covid-19 could continue to boost safe-haven currencies: gold could continue to shine despite already heavy market positioning. As for equities, yesterday’s sharp correction in equities realigns markets, as protective assets and equities were paradoxically both trending up in recent weeks. Before the spread of the virus to Europe, the S&P 500 had been pricing in a V-shaped recovery in the global economy, but this is now in doubt. Emerging-market equities, given their high-beta nature, are still at risk of underperforming developed-market equivalents in a worst-case scenario.