Economy Faces ‘Tornado-Like Headwind’ as Financial Markets Spiral
NewsColony
The fast-spreading coronavirus and a plunge in oil prices set off a chain reaction in financial markets on Monday, a self-perpetuating downward cycle that could inflict serious harm on the global economy.
What started last month as unease about a potential economic slowdown in China has evolved into a borderline panic, with the S&P 500 on Monday crashing nearly 8 percent. The mayhem is threatening to roil the underlying global financial system and the abilities of companies large and small to survive a potential economic monsoon — a downward spiral that is fed and intensified by these destructive forces.
The odds of such a storm grew after an unexpected fight between Russia and Saudi Arabia. After failing to reach an agreement about how much oil to produce and sell on international markets, Saudi Arabia announced it would quickly ramp up production.
Oil prices had been falling as investors fretted about a possible recession. On Monday, they plummeted over 20 percent — the sharpest decline since the first Persian Gulf war.
The S&P 500 has tumbled 19 percent over the past few weeks, and Monday was its worst one-day decline in over a decade. The free fall has vaporized more than $5 trillion in stock market wealth.
Less than 10 minutes after markets opened in the United States on Monday morning, the sell-off became so steep that automatic “circuit breakers” kicked in and halted trading. It was the first time that has happened since the current circuit breakers were set in 2013. The S&P’s 7.6 percent drop came on the 11th anniversary of the start of the current bull market, one of the longest ever. A 20 percent drop from the high point would signal what’s known as a bear market, a marker the S&P 500 has only narrowly avoided for now.
The public health crisis is now threatening to turn into a financial one, which in turn could amplify the virus’s economic fallout.
“There’s panic,” said Dan Krieter, an analyst at BMO Capital Markets. “We’re heading into what looks to be a global recession, including the U.S.”
President Trump told reporters at a White House coronavirus briefing on Monday evening that “we are going to take care of and have been taking care of the American public.” He said he would meet with the Senate on Tuesday to discuss a payroll tax cut and help for hourly wage earners.
The downward cycle — there are signs it is underway — might play out like this: As the virus disrupts manufacturing supply chains as well as travel, consumer spending would fall and businesses would falter, and stock prices would plummet. The threat to corporate profits would send investors in search of safe havens, like government bonds, sending those prices up and their yields down, in turn straining the banking industry. Banks would limit financing for businesses, which would cut production or lay off workers to hoard capital.
Already, investors have hustled to safety, shunning corporate bonds and driving up the financing costs for many companies. And as they piled into U.S. government bonds, long-term interest rates fell to historic lows; benchmark 10-year Treasury bonds, whose interest rates until last week had never sunk below 1 percent, were recently yielding half that.
Hoping to forestall that spiral, the Federal Reserve on Monday said it would increase the volume of short-term loans available to banks to make it easier for them to continue lending. It was the second time in a week — after an emergency interest-rate cut last Tuesday — that the Fed had moved to stem potential fallout as the coronavirus sent markets gyrating.
Even for people who don’t have money in the markets, the developments are ominous. Large and small businesses hire or fire workers and buy equipment and raw materials based on their own financial strength and their expectations for how the economy will perform in the future. As companies retrench, it affects workers and suppliers, which then have to tighten their own belts.
Layoffs rise; wages decline. Consumers spend less.
Businesses in need of cash would normally turn to their banks for help in moments like this. But as banks get squeezed by sliding interest rates, their ability and appetite to lend to struggling companies diminish — the type of situation the Fed was trying to head off by increasing its short-term lending. At the same time, panicky investors don’t want to buy risky corporate debt, severing another potential lifeline for many companies. Investors are also yanking their money from mutual funds that invest in leveraged loans, a risky type of corporate debt that has become a popular way for many companies to finance their operations in recent years.
Capital Flight
Investors are pulling money out of mutual funds that invest in leveraged loans.
Investments in and withdrawals from leveraged loan mutual funds
–$2.3 bil.
Investments in and withdrawals from
leveraged loan mutual funds
–$2.3 bil.
The result could be a surge in bankruptcies as companies — in particular in the shale industry, where many drillers are deep in debt — tip over a financial cliff. More workers lose their jobs. Families cancel vacations and postpone big purchases.
Round and round the cycle goes, further sapping the economy.
“Markets want to hear that the global economy is open for business, and the problem is, it isn’t easy to say that going forward,” said Patrick Chovanec, chief strategist at the investment advisory firm Silvercrest Asset Management.
It is possible, of course, that investors’ gloom will prove to be overblown.
At some point, for example, the coronavirus is likely to stop spreading; it already appears to be easing in China and South Korea. If that happens soon, any economic damage from closed factories and canceled conferences and restricted travel may prove fleeting.
Perhaps Russia and Saudi Arabia will quickly reach an agreement. And until they do, there is a silver lining to rock-bottom oil prices: The resulting cheap fuel will be a boon to consumers and to industries like trucking and airlines.
All is not lost. Even after the decline on Monday, the S&P is still up 140 percent over the last 10 years. And the scorching bond market rally — bond prices go up as yields go down — has delivered outsize returns to many individual investors. Mutual funds and E.T.F.s holding longer-term U.S. government bonds were up 22 percent so far this year as of Friday, according to Morningstar.
In addition, low interest rates are good for people who own or are looking to buy a home. A mortgage refinancing boom is underway, and many borrowers will pocket substantial monthly savings.
Mortgage Refinancing Surges
An index of mortgage refinance applications, which tracks week-over-week increases, has surged since the start of this year.
Mortgage refinance applications index
Mortgage refinance applications index
“This is a temporary headwind to the economy,” said Rick Rieder, chief investment officer of global fixed income at BlackRock. “It’s temporary, but it’s a tornado-like headwind, so it’s going to be powerful for a period of time.”
He added that the amount of uncertainty in the markets is higher now than it was at the peak of the financial crisis. “I don’t even remember in 2009 the uncertainty being so high,” he said.
Governments and central banks are scrambling to defuse the precarious financial situation. In addition to the Fed cutting interest rates and making it easier for banks to borrow money, the Trump administration and Congress are discussing ways to stimulate the economy.
But that is unlikely to offer much immediate help.
“Many investors are anticipating fiscal stimulus within days, but that’s not typically how D.C. acts — even in emergency situations,” Henrietta Treyz, director of economic policy at Veda Partners, an investment advisory and consulting firm in Bethesda, Md., said in a note to clients on Monday. “It takes weeks to pass even the most urgent of legislation, and there are very few ideas circulating on Capitol Hill right now.”
In the meantime, the signs of stress are multiplying, especially in normally mundane corners of the financial markets.
In recent days, for instance, investors that buy ultra-short-term debt issued by companies — including a popular variety known as commercial paper — have started growing jumpy. Investors like money-market mutual funds are demanding much higher interest rates.
That drives up many companies’ borrowing costs, which makes it more expensive for them to operate. It also shows that institutional investors fear that an increase in corporate defaults could be imminent.
The good news is that the U.S. banking industry is, over all, much stronger than it was in 2008 as an intense financial crisis enveloped the world.
The energy industry, though, is shaping up to be among the hardest hit sections of the U.S. economy. Demand for energy was already set to decline with an economic slowdown. Then Saudi Arabia and Russia initiated a pricing war.
Shares of companies like Marathon Oil and Apache Corporation fell more than 40 percent on Monday, while Exxon Mobil stock fell 12 percent, and Chevron slid 15 percent.
Some of the companies that pioneered the shale boom, including Chesapeake Energy and Range Resources, were already in trouble, and their woes are likely to intensify. Chesapeake’s stock goes for pennies; its bonds are trading at a level that reflect investor expectations of a default. Range Resources, an early natural gas driller in Pennsylvania, is, like many of its peers there, slashing its capital spending.
That is likely to hurt the local economies in which the gas companies operate — another reminder of how the economy is in danger of getting sucked into a steep, sinking spiral.
The post Economy Faces ‘Tornado-Like Headwind’ as Financial Markets Spiral appeared first on NewsColony.
from WordPress https://ift.tt/335HsVp
Comments
Post a Comment