The coronavirus poses a risk to China's growth as the government races to contain the outbreak, and the global economy could suffer from disruptions in business activity.

The coronavirus outbreak in the city of Wuhan is clearly very serious from an epidemiological perspective. While data on the virus is changing rapidly, it has infected more than 73,000 people around the world, mostly in Hubei province. The death toll is over 2,000 as of February 18, 2020, including six people outside mainland China. It seems as though the fatality rate is around 2.6%, but many experts feel the number of cases is understated (see our January blog). Medical facts aside, there clearly has been an impact on China and the global economy.

Cities under lockdown

Wuhan, roughly the size of London, is pretty much on lockdown. The city, located on the Yangtze river, plays a role in manufacturing and is an important transshipment hub. China has restricted the movement of about 50 million people in an attempt to limit the spread of the virus. A large number of companies have closed their operations in China, disrupting economic activity. People are not going to restaurants, and factories are not making widgets. That said, large parts of the economy are operating normally, including the financial markets.

For the domestic economy, it matters how long these disruptions last.

There are global spillovers. Fewer Chinese tourists will travel to Singapore — or Paris — and fewer people from outside the region will travel to East Asia. Firms that rely on sales and exports to China will see weaker demand for their products, and companies reliant on inputs from Chinese factories will have to curtail their production. For example, Hyundai was forced to cut production at its Korean factories because of a shortage of Chinese-sourced parts, and companies selling luxury goods to China are reporting earnings problems. For the domestic economy, it matters how long these disruptions last. The longer they last, the more demand is lost permanently, and the greater the risk of disruption to production in the rest of the world.

A V-shaped effect

Under most scenarios nothing much will change over the long term. This is why economists are talking about a V-shaped economic impact. This means China's economy will weaken sharply and then quickly recover on improving virus data. The growth rate will not shift over the long term. Could it be worse than this? Under one scenario, things could get worse semi-permanently. A long economic disruption would affect the viability of some firms and the banks that extended loans. The government will have to take on the losses, leading to higher public debt. The jobless rate may rise. But so far this is a tail scenario.

China GDP growth holds steady

Global financial markets are another channel we have to watch. Amid fears about contagion, the dollar strengthened, commodity prices fell, and equity markets dropped. The faster China is able to overcome the virus and get its economy on the upstroke of the "V," the more likely it is these effects will diminish and even reverse. If risk appetite declines further, weaker commodity prices will hurt emerging markets and a stronger dollar will become a headwind for the United States. If equity market valuations are based on unrealistic expectations about the pace of demand growth in China, the outlook for returns will be worse.

So how big are these effects? We won't know with even moderate confidence until there is some stability in the rate of infection and the virus data. That would allow for the lifting of restrictions on China's economy. Many epidemiological models suggest the infection is nearing its peak. It may not be long before China returns to normalcy. But for now, the economic downturn is deepening. We are still on the downstroke of the "V."

Cloudy world economic picture

The coronavirus poses a risk to global growth because of China's size and its integration with the global economy. We could see an impact of as much as 2% on global growth in annualized terms during the first quarter of 2020. We expect that drop, however, will be temporary. Still, there is risk the negative effects will be larger if the virus data does not improve. The bigger the drop in activity, the longer the tail of the drop. The "V" will become a bit more of a "U" or, in the worst case, similar to something halfway between a "U" and an "L."

Has our global outlook changed? Annual output will be lower because of the drop in the economic activity in the first quarter of this year. And we are not optimistic going into the second half of 2020 since the virus could spread further and force other countries to take measures that will harm their short-term economic prospects. There is a chance that China's downturn will be deeper or last longer.

Next: Markets look to the Fed

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The Wuhan coronavirus poses a risk to China's economy over the short term, and there will very likely be some effects on global growth.