The World Health Organization could raise its pandemic alert level to phase 4 or 5 as a deadly swine flu outbreak shows no signs of slowing.

What does this mean?

The WHO designates six phases of pandemic alert for informing the world of the seriousness of the threat and the need to launch more intense preparations and measures.

We’re currently at phase 3. A full-blown pandemic, level 6, denotes sustained, human-to-human spread over many countries of a new and serious virus.

Here are details of the six phases, along with the possible impact on financial markets:

PHASE 1: Low risk of human cases

PHASE 2: Higher risk of human cases

PHASE 3: No or very limited human-to-human transmission

• Market impact limited to short-term swings lasting a few days though further jolts to financial asset prices could be seen if governments or major forecasters cut growth predictions.
• Global equity markets suffer moderate setback, with underperformance in particular sectors (transport, travel, leisure, and commodity shares) that are seen most vulnerable to further deterioration in trade flows, travel.
• Minor flows into the most liquid bond markets, causing moderate declines in yields in these markets.

PHASE 4: Evidence of increased human-to-human transmission

• Concern about the impact on global economic activity starts to weigh on the wider equity market. Mark Bon, fund manager at Canada Life in London, estimates an upgrade to level 4 would see stock markets suffer a sudden sharp drop of 7 percent. Relative performance of stock markets could be determined by their economies’ exposure to infected countries and by their stock piles of relevant drugs and vaccines.
• Further flight to the most liquid bond markets, with curve steepening seen on the cards as investors are expected to favour the front end and cash-like short-term bills. David Keeble, head of fixed income research at Calyon in London, says any WHO upgrade of the alert level could see 10-year Bund and Treasury yields fall about 20-30 basis points within days of such move.
• Yen and dollar expected to continue to strengthen, particularly against higher-yielding currencies as above. Any concern about renewed stress in the financial sector will stoke speculation cash could be pulled back to the United States to bolster balance sheets in a rerun of what happened during the financial crisis.

PHASE 5: Evidence of significant human-to-human transmission

• Further sharp and broad-based drop in equity markets. Canada Life’s Bon estimates an escalation to levels 5 and 6 could swiftly knock 15-20 percent off world shares.
• Market trading volumes could start to dip, especially if swine flu were to become more widespread in the United States. However, most banks have disaster recovery programmes so they can continue trading in other locations.
• Stronger move into cash. Shorter end of yield curve also continuing to outperform. Still, expectations that central banks will embark on quantitative easing or pursue such strategies for longer will also push down yields at longer end.

PHASE 6: Efficient and sustained human-to-human transmission

• The World Bank estimated in 2008 that a flu pandemic could cost $3 trillion and result in a nearly 5 percent drop in world gross domestic product.
• Sharp falls in market trading volumes and illiquid market conditions, especially in affected regions.
• Sharp, broad-based decline in stock market indexes
• Flight to cash becomes even more pronounced. Investors demand big premiums to hold all but the most liquid sovereign debt, markets risk seizing up.

Are you worried about the swine flu? Let us know in the comments section if you’re doing anything differently in light of the threat.