What has Covid-19 really done to the World?
The Big Picture
Substantive threats of trade wars and tariffs forced a new perspective on global supply chains, vendors, suppliers, etc. and a realization of how inter-dependent the world is. These complex, interwoven networks are responsible for moving an enormous volume of international and domestic goods. Covid-19 has shown an even uglier side to its weaknesses. The virus-driven lower demand has impacted this global network, and is mirrored in many indicators.
Lower demand for commodities and raw material has pushed freight rates lower; dry van spot rates declined 5.2% in February. North America’s largest container line conference, Trans-Pacific Maritime TPM2020, was cancelled this week, literally on the eve of its opening. There have been reports that Very Large Containership Vessels (VLCVs) are leaving Chinese ports filled to just 10 percent of their capacity.
The Baltic Capesize Index (BCI) has moved into negative territory for the first time ever in its 30-year history. Implicitly, it is an index about Chinese imports of iron ore, a proxy for industrial activity and production in China. Charter hire rates for Capesize vessels are incredibly low now - $2,500 pd (when it costs $7,000 pd just to operate such a vessel and before counting for the capital costs).
The Economic Commission for Latin America and the Caribbean (ECLAC) is estimating a contraction of -1.8% in regional Gross Domestic Product (GDP), which could lead to unemployment in the region rising by 10 percentage points. There are three main impact vectors: falling exports (those to China estimated to drop 10.7%), tourism ( 3 month ban = 25% contraction) and interruption of supply chains (mainly from Mexico and Brazil.)
China is now much more developed and integrated with the global economy—growing from 9 percent of global manufacturing output in 2003 to more than 28 percent today. Slowing Chinese demand is darkening the outlook for suppliers. According to conservative estimates from Reuters, China’s economic growth is expected to slow to 4.5 percent in the first quarter of 2020—the slowest pace since the 2008 financial crisis and could cost the global economy $1.1 trillion in lost income.
IHS Markit estimates a sharper contraction than earlier expected, with 2nd quarter GDP growth plunging to -13%, GDP contracting 1.7% in 2020 (year over year), unemployment approaching 9% by December, and inflation slipping to 1.3% in 2021. Their forecast assumes that the shock to consumption traces out a steep drop in March and April, a flat valley through July, and a gradual recovery from August to June of 2021.
Millions of workers will directly feel COVID-19’s effects, centered around transportation hubs . The country’s 192 largest, very large, and midsized metro areas combine to employ 7.2 million of these workers, or 78% of the U.S. total.
Brexit talks were to be completed by the end of the year, but both the U.K. and EU chief Brexit negotiators are in self-isolation, both having tested positive. The exit and transition period will possibly be extended, meaning the U.K. would continue to make financial contributions to the EU -- helping it fill the £60 billion ($70 billion) hole that will be left by the U.K. withdrawal.
One of the more interesting trade responses has been the EU member states adopting export restrictions on certain medical protective equipment, such as protective goggles, respiratory masks, protective coats, protective suits and gloves. Within the EU, the guidelines stipulate that member states should preserve the free circulation of all goods. In particular, they should guarantee the supply chain of essential products, such as medicines, medical equipment, essential and perishable food products, and livestock.
fig 4 - Covid-19 deaths by country
The effects of reduced trade on FX is but just one of many factors. Net exporting countries typically enjoy a strong currency to due to external demand; however this effect is drowned out in times of high uncertainty by the unwinding of the carry trade, and the concept of "Safe-haven" currencies.
Once their higher yielding positions have been sold off, investors go back into the lower yielding "borrowing currencies" (EUR CHF JPY are all 0% or below) to repay their liabilities. These profits are now in cash and in low or negative yielding current accounts. Typically at this stage investors will move into their local currency. Despite the trillions of debt the US owes, the low-interest environment has cemented them as the ultimate safe haven currency. Thus, the USD has been rising against most currencies (even against the other safe haven CHF and JPY) for the last two months.
This rush to the USD will likely unwind when the world economy returns to some semblance of normal, but that's not likely before 2021.