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By Anna Snyder - March 16, 2020
As the COVID-19 outbreak spreads worldwide, central banks and government officials are injecting massive monetary stimulus into the global economy. The Federal Reserve (Fed) slashed interest rates in a rare Sunday afternoon announcement—its second emergency rate cut this month. Despite these efforts, investors remain skeptical that these emergency measures will ward off a global recession, fueling market volatility.
We haven’t seen a meaningful fiscal response. Yet, we believe there’s currently growing demand for major support packages.
On March 15, the Fed cut its federal funds rate target a full percentage point to a range of 0% to 0.25%. It also added $700 billion in new purchases of U.S. Treasury and mortgage-backed securities (MBS) and implemented a variety of programs designed to stabilize the banking and financial systems.
The Fed’s actions can’t prevent an economic downturn, but policymakers hope to prevent worsening financial conditions by assuring ample liquidity. At a minimum, the Fed’s recent moves may help the Treasury and MBS markets, where liquidity conditions were becoming exceedingly tight. The last time the Fed took such measures was during the 2008 financial crisis.
So far, the U.S. fiscal policy response adds up to less than 0.3% of gross domestic product (GDP). It includes an $8 billion aid package to develop virus treatments and provide financial support to states. President Donald Trump also declared a national emergency on March 13, freeing up an additional $50 billion in federal funding.
Last week, the U.S. House of Representatives passed legislation making virus-testing free and providing paid sick leave for workers affected by the disease. The bill has moved to the Senate for consideration. The size of the current deal is unclear, but we expect a $200 billion to $300 billion (0.9% to 1.4% of GDP) package in this round. The total dollar amount may even be larger, given the growing bipartisan support for a massive fiscal response. Lawmakers are also working on a broader economic plan to help struggling businesses and individuals.
Social distancing measures have led to broad shutdowns in the U.S. Data highlighting the drag on economic growth are just coming in, but we expect growth to decline significantly in the coming two quarters. Early signals support this expectation: The New York Fed’s Empire Survey of Business Activity posted its largest drop ever in March.
Unlike the Fed, central banks in Europe and Japan have few monetary options left. Rates are already very low, and monetary policy is accommodative.
Policy rates in Europe have been 0% or lower since 2016, and the European Central Bank (ECB) relaunched a bond-buying program late last year. On March 12, the ECB announced a stimulus program aimed at injecting money into the economy and supporting bank lending. However, it did not cut its key policy rate, which disappointed markets.
Similar to the ECB, the Bank of Japan has little room left to act. Interest rates have been -0.1% since 2016. At an emergency meeting on March 16, policymakers increased the pace of their asset purchases and announced a new loan program. But they also didn’t cut their key policy rate.
So far, politics and high debt levels have limited governments’ ability to deliver fiscal responses. In the eurozone, severe economic shock is likely—they’ve been hit hard by the virus. Yet European leaders still haven’t offered a coordinated fiscal response. In Japan, there’s growing demand for more stimulus. But massive debt is tying the government’s hands. Japan’s debt-to-GDP ratio stands at more than 280%--the highest in the world.
In the 2008 financial crisis, we experienced a run on the financial system. Today’s market volatility, however, has more to do with economic uncertainty.
The Fed is using everything in its toolbox to keep the system well-oiled—including ultra-low interest rates. These moves may ultimately support markets in big ways. However, virus prevention measures, such as social distancing and quarantines, are limiting the near-term effectiveness of that stimulus. People stuck at home tend to spend less money.
That said, once economic conditions start to improve, we expect markets to stabilize—possibly toward the second half of this year.
We think the Fed and other central banks will continue to try and assure markets. This means they may continue their hyper-aggressive support for as long as necessary.
We also believe we will need substantial fiscal support to prevent a sharp global recession. This support may look like:
Policymakers may have been slow to answer the growing economic issues with fiscal packages. But we think they will ultimately do whatever it takes to prevent a sharp slowdown this year.
We believe the best course in these trying times is to remain calm, focused and diversified. For most long-term investors, now is not the time to change course or abandon a carefully crafted investment strategy.
An inverted yield curve may signal trouble in the water. Despite the bond market’s warning, we still believe the U.S. economy may remain resilient.
The Federal Reserve surprised markets with an emergency 0.50% rate cut on March 3. Our investment managers explore the move and potential market responses.
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