By David Curmi
World markets continued to gyrate wildly this week as the spread of COVID-19 gathers pace throughout Western Europe. The WHO is now classifying the virus as a Pandemic. This means that this virus is spreading rapidly throughout many countries. Perhaps this is stating the obvious but its classification as a pandemic is aimed at galvanising countries into greater action over the perceived threat of this virus. In WHO’s opinion, action by governments has been too slow in combating the spread.
The action in financial markets reflects this concern too. Equity markets have been hit the hardest with falls of 20%+ from the highs seen in February not uncommon. We are now in bear market territory after the longest bull run in the history of markets. Bond markets are also not immune. High quality bonds benefitted from the rush to safety whereas the lower quality instruments showed signs of strain with prices falling, sometimes heavily.
Aside from the medical and human aspect, the worry with this virus is the impact it has had on the real economy, both in such a short space of time and at a time when central banks have limited ability to take corrective action. This is different to when the 2007/8 financial crisis erupted. Then central banks held little government debt, and interest rates were significantly higher. With the supply chain broken and consumers facing potential lockdown consumer spending on anything but medical and essential supplies is crumbling. Another recession looks increasingly likely.
Yet, if central banks have limited ammunition to discharge, who will step up to the plate? This time round it must be governments. They must do whatever it takes to firstly stop the spread of the virus and secondly provide the necessary impetus to reverse the downward spiral. This can be done in various ways, some of which we have already started to see in the UK.
Assistance and incentives can be provided to the banking system to increase liquidity thus enabling banks to support those businesses suffering from the fallout. Simultaneously regulators should ensure banks are not restricted or penalised when lending. Locally, similarly to that elsewhere in Europe, it is the travel and leisure industry that is in the front line of the fire bearing all the brunt. Perhaps this is where local government could start. In Europe though, Germany should take the lead and shed its balance budget policy. Angela Merkel has indicated Germany may well do this in her “we will do whatever is necessary” comment, also specifying that “we will not ask ourselves what this means for our deficit. This is an extraordinary situation.” One hopes that her words are reflected in actions, which at the EU level also translate into a relaxation of the Maastricht criteria on debt and budget levels.
Christine Lagarde, the new ECB President, has also sought to stir ECB leaders into action. She knows that any further cut in interest rates will be largely symbolic. No business is going to invest or spend more simply because its cost of financing falls by 0.1%, from an unprecedentedly low level already. Greater infrastructure spend is needed, and a lot of it. Yet the flip side of low rates is that governments can easily finance this, perhaps even get paid for borrowing on bond markets.
If this takes place, and is of sufficient size to achieve the shock and awe required to calm markets, then it is possible that Europe will start to emerge out of the likely recession it is facing by the year end. Even in the midst of a disaster of potentially biblical proportions there is the possibility of a silver lining. We live in hope that EU governments will finally spring into action on this front. Meanwhile, stay safe and think a little how, despite all our technology and advancement, we are being brought to our knees by a little virus.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.