Coronavirus and its impact on the financial markets: Yahoo U
The spread of the new coronavirus in the United States had financial markets churning for the last two weeks, raising the question: What risks do the virus pose to the U.S. economy?
As of Saturday, there were 153,503 confirmed cases of the coronavirus or COVID-19 globally, according to Johns Hopkins University. The U.S. had 2,488 confirmed cases and 51 deaths.
Markets have soured quickly as the U.S. count ramped up. On Wednesday, the Dow Jones Industrial Average officially entered a “bear market,” which is when the market falls 20% from its most recent high.
But headlines on the stock market may not be as relatable as those impacting everyday Americans. Airlines are cancelling flights en masse, Disney closed its iconic Anaheim amusement park, hotel revenues are sinking amid weaker tourism, and restaurants are struggling to keep their doors open as people are told to stay inside.
These four industries alone — airlines, amusement parks, hospitality, and dining — total $1.2 trillion in contribution to the U.S. economy, or 5.5% of GDP, according to data from JPMorgan and the Bureau of Economic Analysis.
For a country that derives 70% of its economy from the U.S. consumer, any impact to these industries could have serious effects.
But a pullback in spending would not be as devastating as job losses. The same four industries represent almost 17 million American jobs, or 11% of the U.S. labor market.
The concern: that businesses ranging from large publicly-traded retailers to mom-and-pop shops on Main St. will be forced to close and layoff workers as a result of low consumer activity. If that happens, the lack of income at all could result in a further drop in confidence.
Employment data covering the acceleration of coronavirus in the U.S. has not yet been released, so it is unclear if the layoffs are happening yet. But as of February, the U.S. labor market looked resilient, with the unemployment rate at a 50-year low of 3.5%.
Corporate default?
The worry is that the coronavirus will, at some point, disrupt companies to the point of default.
One key market to watch is corporate debt, where investors can buy bonds that companies issue for the purposes of fundraising.
Corporations appear to be more levered today than they were in the 2008 financial crisis, meaning credit quality is becoming a concern, particularly with younger companies. For example, credit rating agency Moody’s says about 40% of 2019 first-time corporate issuers in North America had BBB ratings, twice the percentage during the last recession.
High yield bonds have ratings even worse than BBB and have also been a focal point of possible financial trouble.
In a macroeconomic shock like the one presented by the coronavirus, corporations may face a wave of ratings downgrades if their financial positions begin to deteriorate. If the downgrades are widespread, corporate bond buyers may shy away from playing at all in the market, thus drying up liquidity.
If no one is buying those bonds, the yield may end up spiking in an effort to attract some investors. This is why bond yield spreads, in which the yield on one security is compared to the yield on another, are one way to measure the appetite of investors to take on corporate debt.
Yields have spiked in recent weeks, according to data from UBS.
Fed steps in
To insulate the U.S. economy from any potential macroeconomic shocks that may arise from coronavirus-linked disruptions, the central bank lowered interest rates by 50 basis points in an impromptu announcement on March 3.
But financial conditions quickly deteriorated after that, as the coronavirus continued to spread in the U.S. with little sign of containment.
The stock market continued to sell off, and in recent days, a strange phenomenon occurred: Treasury yields rose.
In a normal risk-off dynamic, yields on U.S. government debt tend to fall as investors shift from risky assets (like stocks) to fixed income “safe haven” assets like Treasuries.
The unusual rise in Treasury yields raised concern that liquidity was drying up in a critical corner of finance largely seen as among the most liquid markets in the world.
On Thursday afternoon, the New York Fed announced a bazooka of over $1 trillion in temporary liquidity in the form of short-term repurchase agreements.
The “repo” market provides financing for banks and broker-dealers at the center of the economy, allowing the levered institutions to cover positions on their balance sheet by lending sums of cash to one another.
By making over $1 trillion available to dealers, the Fed hopes to provide ample funding to confidently support trading in the U.S. Treasury market.
But Fed Chairman Jerome Powell has cautioned that monetary policy can only do so much, pointing out that the coronavirus is a health crisis first that needs to be addressed by fiscal policymakers.
“That response will come, in the first instance, from healthcare professionals and health policy experts. It will also come from fiscal authorities should they determine that a response is appropriate,” Powell said March 3.
Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.
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