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Global Economic Disruptions

Globalization, automation, and inequality—oh my!

What’s up? Well, not much. Traders are selling anything they think is risky as Covid-19, the disease caused by a novel coronavirus, spreads. There are too many unknowns to calculate how much the virus will knock off corporate profits and economic growth, which means investors are looking for safety.

The US stock market was gaining earlier this year even as concerns about the epidemic intensified. That went into reverse on February 20, when the S&P 500 began five-straight days of declines, according to FactSet data. Since then things like oil and copper, which tend to be linked to economic growth, have tumbled. Other risky assets like junk bonds and, well, bitcoin have also taken a spill. Gold and top-shelf government bonds are among the few assets that are rallying.

To put the stock market’s drop into context, it’s worth noting that US equities were trading at record highs this year.

“The crisis is hitting growth expectations particularly in Asia and Germany, fears of a pandemic spreading, a supply chain leading to disruption and some inflation at a time when some equity markets were very expensive,” Sebastien Galy, senior macro strategist at Nordea Asset Management, wrote in an email. “Fears of a pandemic are likely overblown in Europe and the US, but it is leading business to re-adjust.”

High grade government bond yields, which move inversely to prices, have steadily dropped. Ten-year US Treasuries yield about 1.3%, a record low, compared with about 2.7% a year ago. Investors are agreeing to lose money by owning similar-maturity German and Swiss government bonds, which yield -0.5% and -0.8% respectively, according to FactSet data.

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Traders are increasing their bets that the US Federal Reserve will cut interest rates in the coming months to keep the economy from stalling. The problem is that the central bank doesn’t have much ammunition to fight a coronavirus-induced slowdown. Policy makers are targeting a rate of 1.50% to 1.75%, leaving little leeway before rates hit zero. The ability of the Fed and other central banks to stimulate the economy when interest rates are already so low is debated among economists.

Perhaps one of the biggest worries for investors and regulators is a massive build up of corporate debt. Regulators in the US and Europe have been sounding the alarm about $3 trillion in leveraged loans—a loose term that refers to junk bonds and loans that have a higher risk of default.

If coronavirus concerns stall economic growth, it could set off a series of defaults among these companies, driving up unemployment and further weakening the economy. Investors yanked $1.6 billion from a popular exchange-traded fund for junk bonds—the iShares iBoxx USD High Yield Corporate Bond ETF—during the week that ended Feb. 25, according to ETF.com.

“In a super-low rate world, the threat will not be that great for highly-rated, well-capitalised borrowers, but there are plenty of others who have increased leverage in recent years,” Kit Juckes of Societe Generale wrote in an email. “As the virus spreads to more countries and more companies report supply chain problems, more companies are going to struggle.”



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