10 Jun What has been the impact of Coronavirus on capital markets?
It is hard to summarize succinctly what has happened in the financial markets and various stock exchanges around the world since Covid19 became a worldwide pandemic. Even six months on from the first death the disease caused, we are still in the thick of troubles the virus can provoke on all parts of our lives. It is difficult to see therefore what the lasting effects of the Coronavirus will be on capital markets as people try to adapt to the ever-changing turmoils the disease wreaks.
However, it has been long enough now that we can at least look back and see what has happened in the financial markets in 2020 and see if we can at least learn something from them to help us inform our investment decisions in the future. Here, in this blog post, we look to explain how the markets reacted to the spread of the Coronavirus around the world, and what governments have done to try to curb the havoc that the illness can induce. By understanding what has happened this year, it may enable investors to look ahead and see if there is a way forward while the Coronavirus is still at large without a usable vaccine being estimated until the end of the year, at the earliest.
What has been the impact of Coronavirus since the beginning of 2020?
One of the reasons it is so hard to summarise the impact of the coronavirus on capital markets is that not only has it impacted every single market out there, in every single country and currency, the markets have been so volatile that it has made the financial crisis of 2008 seem like a daydream.
Back in January, while the virus was still seemingly contained in Wuhan, investors were already moving money out of riskier asset classes and were fleeing to safety in government bonds. However, when the Italian government announced its own quarantine in the North region of Lombardy due to the Coronavirus, the markets reacted more strongly still.
The reason for this was two-fold – not only does quarantine simply inhibit large parts of a country’s economy to be productive, this quarantine was also happening in a debt-stricken country that is part of the Eurozone. The fear that another Eurozone crisis could happen therefore was undoubtedly on every bond trader’s mind. Additionally, questions abounded as to whether the ECB would be able to withstand the political tensions between the zone’s countries – particularly in a post-Brexit Europe and a Europe where strains were rife between the stronger economies of the North and the weaker economies like Italy, Spain and Greece.
The result of these fears led to record lows on US Treasuries as investors fled to the safest of all government bonds. However, the dollar surged in strength against all other currencies and the impact of this drove up debt costs for all those that did not hold dollar-denominated debt. The result of this mass flight to safety meant that, come the middle of March – two weeks after Italy’s quarantine, shares in blue-chip companies plunged, wiping $26tn off the value of the global equity markets. From this point, government traded debt continued to rise and fall in value with unprecedented levels of volatility.
Additionally, one of the world’s largest sectors, the energy sector, was grappling with the sudden lack of demand for oil. While people stopped flying or travelling anywhere in all corners of the globe, the tensions between Russia and Saudi Arabia also caused trouble for oil prices. The tensions between the two countries meant that they continued to fill more barrels of oil, whilst getting dangerously close to the limits of storage. The price war meant that while the countries were maximising their production, they were heavily discounting its prices.
And, as oil prices continued to fall throughout March, the sector acted as an example of what would happen in all manner of industries and sectors as they felt the force of the Coronavirus. The impact of the global quarantines and social distancing measures around the globe meant that demand all but dried up for anything but the bare essentials.
What has been done to stop the impact of Coronavirus on capital markets?
In the face of all this, governments around the world sought to soften the blow of the impact of the Coronavirus as quickly as they could. This meant implementing both fiscal and monetary policy to try to flatten the curve of the deteriorating markets and calming trading sentiment. The markets were perilously close to grinding to a complete halt. To get them moving again, government after government unveiled a series of measures that were unprecedented in times of peace. The UK government, for example, offered to pay 80% of all furloughed workers’ wages while embarking on a stimulus package that made the financial decisions made during the financial crisis look like mere pocket money negotiations.
However, given that the world’s fund managers were trying their best to position their portfolios in dollars, the US took huge strides to show its influence over the entire global economy – realising that without doing so debt repayments everywhere would spiral out of control. The Federal Reserve, as a consequence, slashed interest rates to zero in the middle of March 2020 which is something they have only ever done once before – during the financial crisis in 2008. Additionally, to ease volatility, the Fed announced that it would enter into quantitative easing that equated to them buying $700bn worth of US Treasuries. However, unlike in 2008, when they did this in a slow, drip-feed way, the Fed bought a massive $80bn of those Treasuries within 48 hours of their announcement.
Yet, this still wasn’t enough. Post their announcement, circuit breakers came into effect in the first morning of trading. In fact, market sentiment was so bad that the fall in value on the S&P 500 managed to drop by over 8% before trading ceased completely – circuit breakers are meant to limit falls to 7%. The reason they didn’t manage it in March 2020 was that the fall was that quick and fast.
The continued problem in the US was not only doing the markets not stabilise in reaction to the Fed’s swift action, but the politics of the country got in the way. The ever warring Republicans and Democrats simply could not agree on a way to help fund the healthcare system battling with the virus, and the rising unemployment that was occurring because of the virus too. When it was announced that no bill had been passed to help alleviate the troubles within the US, the futures markets dropped so quickly that circuit breakers came into effect again. In fact, by this point in the last week of March, circuit breakers had come into effect 5 times in just 14 days.
Arguably, the reason that the Fed’s efforts had not stabilised the markets was simply because the measures taken were not a cure for the virus itself – the real root of the problem. Additionally, with the rising cost of debt around the world, corporations were finding it more and more difficult to borrow which was having wider implications on other elements of the economy.
However, the Fed had never before entered the world of corporate debt as it was too widely seen as a process likely to be tainted with political gain. What made this situation worse was the fact that the country’s two parties were yet to agree on their stimulus bill. Bearing this in mind, and foreseeing mass shutdowns by huge companies that would result in yet more job losses and total loss in revenue, the Fed decided it finally had to dip its toe into the world of corporate debt. To do so, it announced that it would back or guarantee corporate debt through newly set up legal entities that were off the Fed’s books, yet would still manage to prop up the corporate bond market.
As a result, on the 23rd March with markets around the world trading 30% lower than where they started the year, they started to climb again. Even complex economies that enjoy the highest of credit ratings, are helped and supported by the Fed in some way. By supporting its own markets, the Fed also helped the likes of Japan, the Eurozone, and the United Kingdom. Without unveiling their measures to support the economy through interest rate cuts, quantitative easing and backing the corporate debt market, the Fed may have made the credit squeeze around the world far worse too.
What will be the impact of Coronavirus on capital markets now?
In March, governments in the US and Europe managed to reduce the impact of the Coronavirus on markets as well as the impact on the day to day running of businesses. However, the shocks were still deep, albeit blunted in their power of what could have been. What will happen in the rest of the world is now only just starting to unfold. Sadly, a huge amount of countries have already applied to the IMF for financial aid to help in the aftermath of the disease.
More sadly still is that this all looks set only to be the start of one of the biggest shocks to the global economy the world has ever seen. So what will the impact of Coronavirus on capital markets be from now on? As ever with investing, knowing anything with any certainty is difficult. But while volatility has characterised the first few months of 2020, unprecedented levels of government intervention has also been seen. It is important to remember for the future therefore that those governments will continue to do whatever it takes to minimise the impact of the coronavirus on capital markets as well as individuals.