Avian flu: what impact on financial markets?

What would the economic impact of an avian flu pandemic be? A short but useful overview of recent studies has been provided by HSBC's chief economist in Australia and New Zealand, John Edwards. His piece, Assessing the economic impact of a flu pandemic (PDF), argues that the financial market responses would be key, but has been largely overlooked by those studies. Here's his assessment:

The surprising and not quite credible conclusion from the current crop of studies is that despite the large number of deaths, despite the estimate that four out of ten people in the developed countries would be infected and despite the recognition that the epicentre of the pandemic would be in countries such as China and India which are now important to global output growth, the economic impact would be only moderately severe.

...All the studies rightly recognize that the economic impacts are difficult to forecast, as is the nature and progress of a pandemic. The economic impact is highly sensitive, for example, to the duration of the pandemic. If most of the infections and deaths take place over a couple of months the economic impact would be much less severe than if it lingered on for a year.

The main economic impacts evaluated in these studies are on supply and demand for goods and services. Because of illness and fear of infection, the numbers of hours worked falls sharply during the pandemic. For the same reason people are reluctant to shop, visit a bank, eat out, go the movies or sporting events, or travel. While the fall in hours worked and production lost can be related to the incidence of the disease, the response of demand is harder to predict and will be more important. As the ADB finds, the fall in demand is much more important than the fall in supply.

Although they don’t model it, the studies usually recognize that the financial market impact could well amplify the impact on the demand and supply of goods and services.

Equity markets would be very badly hit, particularly because many stocks are now priced on the assumption of continuing strong global growth and rising profits. The vast majority of business corporations would see profits plunge, with falling production and sales but fixed short term costs. The pandemic could be expected to be over in a year or less, which should put a floor corporate losses and thus on the fall in equity prices. The sell off would also and immediately include corporate bonds, so credit spreads would blow out and new issues would be impossible. But since central banks are likely to respond to the crisis with sharply lower interest rates there will be a sustained rally in sovereign OECD government bonds. Cash would also be popular, and gold.

The currency market impact would favour safe haven currencies with deep sovereign bond markets, against any emerging market currency or peripheral currency. The New Zealand dollar would plunge, which would help New Zealand. The Australia dollar would also weaken, partly because commodity prices and interest rates would fall. The US dollar would attract safe haven flows into US government bonds, but US interest rates would probably fall faster and further than European or Japanese rates. The much criticised “global imbalances” would be mitigated but in the worst possible way as US imports and East Asian exports both tumbled.

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It sounds kind of morbid to say, but we’ve clearly discovered that a large loss of credit affects the market more deeply and fundamentally than a loss of life. And not just with a pandemic. The market sure dropped on 9/11, but steady investors won out after the panic had subsided.

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Searched for the information on this theme, and only here I found it. The much criticised “global imbalances” would be mitigated but in the worst possible way as US imports and East Asian exports both tumbled.