Are the markets overreacting or is the US economy on the brink of a major hit? Well, there are two potential scenarios.
In this possible economic scenario, the virus is contained in the next few weeks with the economic impact lasting until March and April. Travel, tourism, entertainment (casinos, amusement parks, live performances) account for 7% of US GDP. Disruption to this GDP over the next few weeks or three months could potentially face a 10% drop, lowering the US economy by 0.7% For an economy that is growing roughly around 0.5% in a quarter, this is a big drop.
Restaurants will suffer and disruptions to supply chains will occur, this will lower business confidence which will be reflected in the market. However, in May and June, if virus fears reduce, the economy could benefit from a bounce-back as consumers resume regular life and spending.
Essentially, although the virus has hit the US market, this set back could only be temporary if the virus is contained in the following few months.
In the second scenario, the virus is not able to be contained leading the US to a prolonged economic disruption that continues beyond April. This has the potential to trigger a recession.
If the outbreak continues throughout April the infection rate would increase rapidly with supply and consumer chains affected. There would not only be a longer period of lower spending as mentioned in the first scenario but what economists call “second-round effects” that create a deep impact. The prolonged disruption could lead to lower consumer and business confidence. A business holding onto employees in the hope of a market bounce back could start laying them off leading to households with less income to spend in the long term.
Due to all of these impacts, it would be extremely difficult to avoid a recession. Long term interest rates are already near to zero which drastically limits the Federal Reserves’ ability to boost the US economy. In this event payroll tax cut could help, however, the lack of spending is not due to cash flow issues but due to the lack of willingness to spend.
With many wondering what the economical cost of the virus is, ultimately the impact on the markets depends on the likelihood of an outbreak enduring.