While a slowing global economy due to the impacts of the coronavirus and its containment is a well known narrative, markets have still grappled with how to price it.
Volatility in Friday’s session stemming from fixed income markets compounded the previous bout of wild FX price action coming ensuing from the US and eurozone flash PMI reports.
Investors are screaming out for more data to accurately measure the economic impacts of the pandemic after China’s January PMIs failed to capture the beginnings of the virus due to early cut-off dates.
The US and eurozone soft survey data highlighted part of the impact China’s containment programme had on developed market economies.
Supply-chain disruptions led to increased order times and when coupled with reduced external demand, both production levels and business sentiment plummeted. Fixed income markets pro-actively braced for the impact of the coronavirus, especially on developed market economies, but such aggressive price action leaves plenty of scope for miscalculation and therefore prolonged volatility in markets.
While initial US and eurozone data added to the markets information set, it did little to address the elephant in the room; what is the true damage to China’s economy?
Chart: Economist estimates of the official manufacturing PMI are broad as uncertainty lingers in markets
Official PMI release
Released over the weekend, the official PMI measures are likely to paint the rosier picture of the two measures due to their composition.
The survey of 3,000 businesses, many of which are state-owned, are likely to under-report the true economic impact of the containment program.
Bloomberg’s economists forecast the official manufacturing reading for February at 40.7, based on the downturn in the Sales Managers Index produced by World Economics, used as a reliable proxy. The SMI was released back on the 23rd of February and highlighted a 50-60% drop in business activity YoY.
If this were to be correct, it would mark the deepest contraction in manufacturing activity since November 2008, when the global financial crisis began to hit.
The non-manufacturing index is more concerning due to restructuring of China’s economy away from export-intensive production. Any reading below the 50 level would mark the first contraction in the non-manufacturing PMI since the survey began in 2007.
IHS Markit (Caixin) PMI
The private PMI measure not only differs from the official survey due to business size, but also geographical positioning.
The Caixin survey sends out questionnaires to 500, mainly small, businesses which tend to be concentrated on the bustling east coast, the region of China hit hardest by the virus and the resulting containment programmes.
Notable areas such as Hubei and Suzhou have been subject to the longest containment programmes. This is likely to taint the reading somewhat and suggest the economic contraction is deeper than the true effect, especially considering the monetary injections struggle to reach SME’s due to problems with the transmission mechanism.
Chart: John Hopkins University graphic on the distribution of confirmed cases cumulatively in China, highlighting the virus’ increased prevalence in the east coast
So while the PMIs themselves will give markets the clearest indication to date of the shock to Chinese growth, quirks to the individual data readings will still leave some grey areas for markets to jostle with, as the dollar may begin to find out as rate cut bets build.
Author: Simon Harvey, FX Market Analyst at Monex Europe.