The Impact of Coronavirus on the Global Economy
Covid-19 was ignored to a large extent when it was spreading across China. However, it is when the virus spread to Europe and the Middle East that a strong reaction was evoked in global financial markets in early March. As per the Harvard Business Review, it was during this time that the fear of a worldwide endemic became apparent. Since then, the virus has been hyped quite aggressively across various platforms to the extent that it appears a recession in the global economy is inevitable.
If the massive drawdown in global financial markets is considered, it does seem highly likely that the world economy is speeding towards recession. There has been a significant rise in valuations of safe assets, whereas term premium on U.S. government bonds has also fallen drastically at negative 116 basis points. This indicates how much investors are willing to do their share in safe harboring the debt of the U.S. government. All this has resulted in an increased risk of recession.
However, if one takes a close look at the situation, it is revealed that a recession should not be considered imminent.
Let us first focus on valuations or risk assets. The impact of the virus is not consistent in this case. There has been a little rise in the credit spreads on the benign end. This indicates that as far as credit markets are concerned, they do not see any problems related to funding and financing in the near future. Equity valuations have indeed fallen from their highs recently, but the noteworthy point is that they are still relatively elevated compared to their longer-term history. The opposite end of the spectrum witnesses the most considerable strain wherein volatility is seen to be severely impacted. It appears that the implied next-month fluctuations are on the same level as other significant dislocations in the past years outside of the circle of crisis in global finances.
Another vital point to consider is that while there is no denying that financial markets are regarded as reliable recession indicators owing to their impact, there is more to it. If you analyze history, it is seen that recessions and bear markets are not always conflated. The overlap is really seen in around two of every three bear markets of the U.S. To put it in simpler terms, there is one bear market out of every three that does not show the effects of the recession. Harvard Business Review studied details of the past 100 years and found seven instances wherein there was no coinciding of bear markets with the recession.
It cannot be denied that financial markets are susceptible to significant disruption due to Covid-19, and the risks are indeed high. However, there are inconsistencies in asset valuations, which indicate that there is quite a bit of uncertainty around the epidemic. If there is anything we have learned from history, it is that a line needs to be drawn between the real economy and financial market sell-offs.
There might be some misconceptions in the market, but the risk of recession cannot be negated entirely. Major economies, including that of the U.S., are now vulnerable owing to the slowing of growth and expansions of various countries. Thus, shocks might not be well absorbed by the world economy. Indeed, the U.S. economy being hit by an exogenous shock when it is vulnerable is something that has been considered a possible cause of recession for quite some time.
In fact, an exogenous shock hitting the U.S. economy at a time of vulnerability has been the most plausible recessionary scenario for some time.
Read the full report by Harvard Business Review in the following link: