Global financial markets flinch on virus fears

A quiet week on the Australian data front before next week’s big download, which will bring Q4:2019 GDP, as well as the 3 March RBA meeting. Instead, attention has focused on the sharp financial market reaction to Covid-19 which has seen substantial declines in global markets as well as falls in the ASX and the Australian dollar. This week’s readings include Australia’s China-dependence (again), a look at the changing fortunes of the Australian dollar, an analysis of the global data economy, and several pieces examining the distinctive nature of the Indian economic model along with the challenges it currently faces. 

What I’ve been following in Australia . . . 

What happened:  

According to the ABS, the volume of construction work done in the final quarter of last year was down three per cent over the quarter (seasonally adjusted) and 7.4 per cent lower over the year. In annual terms, residential building work was down 12.8 per cent and engineering work was down eight per cent, although non-residential construction was 3.3 per cent higher relative to the 2018 December quarter. 

Why it matters: 

The broad message here – that falling residential construction in particular continued to be a headwind for the Australian economy into the final quarter of last year – is no surprise, although it’s also worth noting that the actual three per cent fall in work done reported turned out to be quite a bit worse than the consensus forecast for a one per cent drop in Q4:2019.   

What happened:  

The ABS reported that private capital expenditure dropped by 2.8 per cent over the December quarter (seasonally adjusted) to be 5.8 per cent lower over the year.   Spending on building and machinery was down 5.9 per cent in quarterly terms and 9.6 per cent in annual terms, while investment in equipment, plant and machinery rose 0.8 per cent over the quarter but was still down 1.3 per cent relative to the final quarter of 2018. 

By sector, expenditure over the quarter was lower across the board, dropping in mining (declining by 2.7 per cent), manufacturing (a steep 10.1 per cent fall) and other industries (down 1.9 per cent).

The ABS also published the latest estimates for expected new capital expenditure. The fifth estimate for 2019-20 expenditure was $120.3 billion, 2.1 per cent higher than the corresponding estimate for 2018-19. The first estimate for 2020-21 was $100.2 billion, up 8.8 per cent on the first estimate for 2019-20. 

By industry, estimate 5 for 2019-20 for mining expenditure was 11.4 per cent higher than the same estimate for 2018-19, while estimate 1 for 2020-21 was 28 per cent higher than estimate 1 for 2019-20. In the case of manufacturing, estimate 5 for 2019-20 was 2.5 per cent higher over the year and estimate 1 for 2020-21 was up 6.8 per cent relative to the 2019-20 projection. Finally, for other industries, estimate 5 for 2019-20 was 2.3 per cent lower than the 2018-19 number, while estimate 1 for 2020-21 was likewise 1.6 per cent lower than the corresponding estimate for 2019-20. 

Why it matters: 

The near three per cent drop in private capital expenditure in the final quarter of last year was worse than expected – the market consensus had been for a small (0.5 per cent) increase – and confirms that 2019 overall will have been a year of weak private sector investment.  

On a more positive note, the forward-looking elements of the ABS release do paint a somewhat more optimistic picture, with the first estimate for 2020-21 of $100 billion beating market estimates of a $95 billion print. The key driver here was the mining sector, with the projected increase in spending plans consistent with the RBA’s oft-repeated view that mining investment is set to transition from an economic headwind to a tailwind over the coming years. Set against that, however, the first estimate for other industries in 2020-21 was for a decline in spending. 

 . . . and what I’ve been following in the global economy 

What happened:  

The past week has seen financial markets sell off in response to growing fears about the likely impact of Covid-19 and the expectation that the outbreak would soon be declared a global pandemic. Global stock market indices dropped as investors fretted that the hit to the world economy could turn out to be significantly larger than initial estimates based on the assumption of only short-lived and relatively limited disruption.

Unsurprisingly, market volatility also spiked: 

And government bond yields fell as investors sought safety, with yields on the benchmark US 10-year dropping to a record low. 

Australia was far from immune from this sudden spike in global risk aversion. The ASX tumbled, erasing all the gains made since the start of the year, while the Australian dollar slumped to an 11-year low against the US greenback. 

Why it matters: 

Until this week, financial markets had seemed reasonably sanguine about the likely economic consequences of the coronavirus.  While global share markets did stage a modest retreat late last month, for example, they then quite quickly resumed their previous upward march, apparently based on the prevailing assumption that Covid-19 would turn out to have a limited impact.   

Likewise, official economic forecasts have been understandably cautious to date, conditional as they are in part on still uncertain parameters regarding the virus and in part on hard to predict reactions by individuals and policymakers. 

Last weekend, for example, the IMF said that it was trimming its growth forecast for China by 0.4 percentage points for this year (bringing projected real GDP growth down to 5.6 per cent) and noting that this would only lower global growth by about 0.1 percentage points. Not insignificant, but not the stuff of market meltdowns, either. The fund also conceded, however, that it was looking at ‘more dire scenarios where the spread of the virus continues for longer and more globally, and the growth consequences are more protracted.’ This week’s market action suggests that many participants are no longer feeling quite as sanguine as they were and are now considering some of those ‘dire scenarios.’ 

One implication of this re-assessment of risk is the emergence of another economic channel through which outbreak will hit global growth.  Initial estimates that looked beyond the direct hit to China’s economy tended to focus on the consequences for travel, tourism and international education, along with the impact on exporters exposed to a weaker Chinese consumption, and softer commodity prices, particularly oil. Subsequently, estimates of the potential economic costs also started to consider the impact on businesses transmitted via global supply chains and the resultant disruption to downstream production in connected producing and consuming economies. 

So, now these assessments are expanding again, this time to include the implications of falling financial markets and increased volatility. At each stage of this process, the estimated magnitude of the likely economic shock to the global economy has increased, although markets are also starting to pay more attention to the potential for offsetting policy initiatives to prop up growth, including the possibility of central bank action. 

What I’ve been reading 

Bloomberg says that Covid-19 has ‘exposed the extraordinary depth of Australia’s economic dependence on China and fuelled questions over whether the nation is too reliant on the Asian behemoth.’

Bloomberg analyses the changing fortunes of the Australian dollar, which is seen as transitioning from a ‘high-yield darling’ to a cheap funding currency. The FT has a similar take. 

Infrastructure Australia (IA) has published its 2020 Priority List. The list identifies six high priority projects, 17 priority projects, 36 high priority initiatives and 88 priority initiatives (projects are advanced proposals that have a full business case and which have been assessed as being capable of addressing a nationally significant problem or opportunity and delivering robust economic, social or environmental outcomes, while initiatives are proposals that have the potential to address a nationally significant problem or opportunity). The six high priority projects include three in NSW (the M4 motorway upgrade, Sydney Metro, and Western Sydney Airport), two in Victoria (the M80 Ring Road upgrade and the North East Link) and one in Queensland (the Brisbane Metro). The Chair’s Forward notes that ‘our infrastructure networks face unprecedented risks’ and argues that in the face of ‘higher temperatures, unpredictable seasonal rainfall and water availability, more extreme winds, more extreme weather events and bushfire seasons the likes of which Australia has never seen’, we need to plan for resilience.  

This focus is visible in the eight new high priority initiatives included on the 2020 list. Five of these are national (town and city water security; national water strategy; coastal inundation protection strategy; national waste and recycling management; national road maintenance strategy), one is in Queensland (Queensland National Land Transport Network maintenance) and two in Western Australia (regional and rural WA road network safety improvements and Perth water security). 

Nicholas Gruen makes the case that by focusing on the debate over how to inject greater competition into the Australian economy, we’re falling for a ‘competition delusion’, which means we are failing to think hard enough about the terms on which competition takes place. One potential solution he advocates is a greater advisory role for citizen juries.   

Raghuram Rajan provides a critical review of Thomas Piketty’s latest magnum opus, Capital and Ideology.  Rajan likes the underlying research on inequality but is unconvinced by the proposed policy solutions Piketty offers. 

The Economist magazine has a special report on the data economy which covers a broad set of issues ranging from the economic nature of data itself, the trials around AI adoption in business, the rise of virtual nationalism and challenges around distributing associated gains. 

An attempt to measure internet fragmentation. 

FT Alphaville on the importance of non-woven markets – specifically, the production of disposable face masks – in keeping global supply chains running.  

The Conversable Economist plugs the latest issue of the Journal of Economics Perspectives, and in particular, its discussion of the Indian development experience. See in particular Lama and Subramanian on the distinctive nature of the Indian economic model. Related, see also the FT’s Martin Wolf on India’s twin economic and political crises which draws on a recent paper by Subramanian and Felman looking at India’s great slowdown.

Tyler Cowen provides his sceptical take on social impact investing. 

Nicholas Bloom et al track the fall in Brexit uncertainty since the UK general election. 

An interesting graphical tour of the changing US economic landscape between 1990 and 2018. Laurence Kotlikoff thinks that the United States is running ‘a massive and ever-growing Ponzi scheme that takes from the young and gives to the old’.