The spread of the coronavirus globally has continued unabated in recent weeks. The combination of “business as usual” in Europe and the U.S. and limited testing has exacerbated the issue and increased uncertainty regarding the extent of the outbreak and the ultimate path the outbreak will take. As policymakers take more aggressive measures to control the spread of the virus, we will likely see a large impact on global growth. As the extent of the outbreak has expanded, investors have had to price in a larger impact on growth over a longer period.
Invesco Fixed Income expects Q1 growth in the U.S. and Europe to be weaker than expected and Q2 growth to be significantly negative, as these economies are hit by fear and the impact of measures implemented to contain the virus. The path forward also remains very uncertain, which is a headwind for markets.
China provides a model for us to think about what lies ahead. China implemented strong measures to control the virus, which has hit the economy badly in Q1. China has now controlled the outbreak and is in the process of returning to work. Once the level of daily infection peaked, the process of returning to work started. Infections in the U.S. and Europe are still rising, and it is likely the epidemic will take a while to peak in these regions. It is the impact on growth and uncertainty around the virus propagation that is causing current market action.
It is very important to acknowledge that we believe this is a fundamentals-driven correction, which makes it very different than a financial crisis. The resolution of this situation will likely take time as we watch the epidemic play out in the U.S. and Europe. Financial conditions-driven crises, such as the one in Q4 2018 and the Global Financial Crisis can be resolved quickly by central banks. In the case of fundamentals-driven crises, central banks can only ameliorate, not solve, them. We expect this market to follow a U pattern rather than a V.
We expect risk assets to continue to be volatile, and markets will likely take a while to bottom. U.S. interest rates have been the shock absorber, but there is little room for bonds to rally further, in our view, as we do not expect the U.S. Federal Reserve (Fed) to embrace negative interest rates. The Fed will likely cut rates close to zero, but we expect the yield curve to remain positively sloped. Lower U.S. interest rates will likely erode the interest rate advantage of the dollar versus other developed market currencies, which will likely weigh on the dollar going forward versus other developed market currencies.
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