People have started to notice the wild price movements in the financial markets. London’s FTSE 100 fell as much as 8% yesterday, before recovering somewhat as the day went on. US markets were also hit hard, and the DJIA fell within a breath of a bear market in afterhours trading.
The biggest narrative that is driving the selling is the novel coronavirus, which is having an impact on the real economy. Many areas in China are still basically shut for business, which means that the heart of the global supply chain is on life support.
In addition to the ongoing spread of coronavirus, the oil markets have become turbulent. OPEC+ has fallen apart, and Saudi Arabia appears to be entering into a three-way price war with Russia, and US shale producers. This might seem like a boon to the global economy, but it isn’t that simple at all.
China Caught a Cold
The West is often thought of as the head of the global economy, but when it comes to manufacturing, Asia is by far the most important region. The global supply chain is very complex, and manufacturing problems in Asia set off a global chain reaction that may cripple the world’s interconnected supply lines.
Unlike financial problems, which can be solved by working out agreements with the interested parties, if a factory has no parts, it can’t operate. We are dealing with a world that may source parts from 30 or more countries for a single finished product, and all of the suppliers may also have complex supply chains.
The problems that emerge from this situation are manifold. As factories shut down, and people stop working due to quarantine, the real economy may grind to a halt. That is exactly what has happened in China, and as the data demonstrates, it is very hard to reignite an economy once it has gone offline.
Oil Woes and Shattered Markets
While it is true that a lower oil price is basically good for economic growth, the oil industry is a major player in the global economy. This has become especially true in the USA, where shale oil is a major borrower of capital. The corporate debt markets are already looking strained, and yet another problem will only serve to spread panic.
There is no way that US shale producers can win any kind of pricing war with Saudi Arabia and Russia, which may create another financial crisis. Loans that have been secured by using fracking land as collateral won’t have much value in the midst of an all-out oil price war, which leaves lots of investors on Wall St. holding the bag.
All of this adds up to falling asset values, and a massive demand for government bonds. The US 30 year bond has fallen below a 1% interest rate for the first time in history, which is likely a sign of things to come. While equity markets seem to be bouncing today, don’t expect it to last without loads of support from the central banks.