Parts of financial markets are pricing in a global recession

The fall in global stocks has been precipitous and swift, with trillions of dollars in value wiped off markets in a matter of days. Driving the decline: the spread of the novel coronavirus around the world, which is dealing an unexpected shock to the economy.

Despite the velocity of the plunge — which has been undeniably dramatic — stocks are experiencing a garden variety correction for now, Ed Yardeni, president of Yardeni Research, told me. The S&P 500 finished Friday down more than 12% from its all-time high reached on Feb. 19. A bear market would requite a fall of at least 20% from that recent peak.

Historical context: As with corrections in December 2018 and Black Monday in 1987, valuations are coming back down in anticipation of a hit to economic growth and therefore corporate earnings, Yardeni said. Should the health crisis be reined in over the coming weeks, investors could regain their confidence, looking ahead to a rebound in earnings in the second half of the year.

But bond markets are telling a different story, Yardeni warns. The yield on the benchmark 10-year US Treasury note has collapsed to an all-time low, touching 0.66% on Friday as traders pile into safe-haven assets. "[Bonds are] starting to predict the zombie apocalypse," he said.

It doesn't help that any further intervention by the Federal Reserve could help ease financial conditions, but wouldn't boost the economy because of the nature of the shock.

"If governments continue to respond with quarantines and border closings and restricted air travel and closing schools ... that's going to cause a [global] recession no matter what the Fed is doing," Yardeni said.

Oil markets are also pricing in a recession, with Brent crude futures, the global benchmark, dropping more than 10% last week to $45.27, its lowest level in nearly three years. Prices have plunged 34% since early January.

The big picture: Significant parts of the markets are flashing a recession warning, though some economists aren't quite there yet. Many have downgraded their forecasts but still expect some economic growth this year. Those outlooks, however, come with big asterisks.

See here: Oxford Economics, a research firm, now pegs global growth in 2020 at 2%, 0.5 percentage points below its forecast in January. But it warned Friday that "larger revisions may be required" if shutdowns related to the coronavirus drag on, or "if more draconian actions are needed in the event of a global pandemic."

"Our scenarios suggest that the latter could push the global economy into a deep recession," said Ben Mays, the firm's director of global macro research.

The European Central Bank could cut rates. It won't help

The Federal Reserve's emergency interest rate cut last week did little to soothe jittery markets on edge about the coronavirus epidemic.

Don't expect a different result should the European Central Bank follow suit this week.

The central bank will announce its latest interest rate decision on Thursday. Economists think that the ECB, under the leadership of Christine Lagarde, will push interest rates further into negative territory, possibly trimming interest rates by a tenth of a point. But the impact on markets and the economy will probably be minimal.

Rates are already at record lows. "They've got very limited room to go further," Andrew Kenningham, chief Europe economist at Capital Economics, told me. "There just isn't that much more ammunition."

Interest rates are also negative in Japan. And the Fed has only four quarter-point cuts to go before it reaches zero.

Markets know that central banks will soon have to get creative, and should the shock deepen, they could be out of tools. Interest rates aside, Lagarde may find it difficult to expand the ECB's bond-buying program, which is controversial among some members of the central bank's governing council.

"Policy failure is here," George Saravelos, global head of currency research at Deutsche Bank, told clients on Friday. "We disagree with central bank pronouncements that there is room to fight the crisis."

Up next

Monday: Stitch Fix earnings

Tuesday: China inflation data; Dick's Sporting Goods earnings

Wednesday: OPEC monthly report; UK budget released; US inflation data; Luckin Coffee earning

Thursday: European Central Bank interest rate decision; Dollar General, Broadcom, Gap and Slack earnings

Friday: University of Michigan consumer sentiment survey