For Markets Just One Thing Matters: Did China Go Back To Work Today Or Not?

Submitted by Michael Every of Rabobank

“Hi-Ho!” Or “Uh-Hh!

So, Monday morning. February 10. And rather than worrying about Valentine’s Day plans, most people are still focused on coronavirus. (With the exception of those in America who are talking about the fact that the aptly-named ‘Parasite’ from South Korea won the coveted Best Picture Oscar. And, no, it doesn’t deal with viruses, rather the vast inequality in South Korean society.) Anyway, back to the virus, where the death total is now 910 vs. 3,352 recovered, so still one in four on that measure, which is fortunately going down slowly, albeit too high for comfort and now 40,536 cases.

Crucially for market quants who do not understand fat tail risks–as proven by their behaviour against this global backdrop–that means there is still no clear sign of a rapid drop-off in the total of new cases given that the last seven days reads as follows: 3,239; 3,927; 3,239; 3,163; 3,457; 2,676; 3,001 although in day-to-day percentage terms this does represent a slow-down. (Although also note that at this pace, just two-days’ worth of new cases are enough to fill a brand new hospital.) Not so much of a slowdown in being seen outside China, however, where we now have just shy of 400 cases, vs. virtually zero a few weeks ago. Yes, the numbers are low. Yes, the cases are milder. Yes, preparations are in place in many locations. However, that is close to an exponential trend, with 43 in Singapore, now on orange virus alert, 36 in Hong Kong, where panic buying and working from home are the norm, 15 in Australia, 14 in Germany, .12 in the US, and 11 in France, among others.

Underlining that this week is going to be crucial, Shanghai reported this weekend that they now assume the virus has aerosol transmission, meaning it is airborne, adding to food-borne, touch, and contact, and explain why it might be spreading through buildings in air-conditioning, etc. That remains unconfirmed, however. The WHO boss has also, for once, not been accentuating the positive, stating that what we have seen so far may be “the tip of the iceberg” given that we now have human-to-human transmission outside China. At the same time, the London School of Hygiene and Tropical Medicine, who might just know more about these kind of things than the average market analyst with their expertise on the suffering of “man flu”, models that at its peak later this month in China the coronavirus might infect 500,000 people in Wuhan alone. That is 5% of the population.

We have also seen at least one economist publicly state that China’s GDP growth will be 0% y/y in Q1, which seems optimistic to me if this is not resolved soon; and more concretely, an AmCham Shanghai Coronavirus survey reports the following: 87% of firms see a direct impact on them; 25% see revenues falling by 16% or more; 16% see China’s GDP falling more than 2% in 2020 as a result of the virus; 29% believe their corporate HQ does not sufficiently understand the full economic impact; and 60% are planning work-from-home policies.

Of course, for markets what matters most is one thing: did China go back to work today or not? Commodity markets, where force majeure is being called to cancel Chinese copper trades; bond markets, where we are still close to a Maginot Line of 1.50% in 10-year US Treasuries; equities, where we are obviously still close to (silly) record highs; and FX markets, will all be watching closely.

If it is truly “Hi-ho!” and off to work we go, as officially planned, then “all is well” – even if that means the virus might spread much faster and further. Yet if it doesn’t, then it is “Uh oh!” as the global supply-chain impact of a lack of key Chinese inputs is days or weeks away at most, with the pain varying by industry. So far the evidence is that has been more “Uh oh!” or “so so”. For example, there has been a particular fixation on whether the Foxconn factory that makes iPhones is able to open or not, with flip-flopping headlines. It seems that the latest news is that around 10% of workers returned today, perhaps enough to fool the algos, but not enough to mean much to supply chains.

Meanwhile, it is obviously also worth noting the “Hi-ho!” number from the US payrolls report on Friday, which was once again strong at 225K despite downward revisions to back data, and yet which saw the unemployment rate tick up to a still-low 3.6%. Asia is sneezing but the US is not *yet* catching a cold, even if we still believe it will go down with its own made-in-America flu later this year anyway. (At which point Asia will be relatively even more sickly, of course.)

In other data out today, China saw January PPI up 0.1% y/y, marking a bounce away from deflation just as the rest of the world appears headed for it. Moreover, it saw CPI spike to 5.4% y/y as food prices shot up over 20%. How does one see inflation moving in an economy where much of it is under lock and key, but where those parts that are in demand do not have enough supply? A very mixed, and ugly, picture of biting deflation AND inflation that economic models are not set up to assume. It certainly will not make the PBOC’s job any easier, even if it is clear that it will be throwing money at the economy ahead.