Financial markets are sending central banks a stark message: tackling the economic impact of the coronavirus isn’t just about easing financial conditions.
It’s about getting ready for a sudden stop.
Plunging equity markets reflect the fear that economic activity is going to slump in the second quarter, before hopefully rebounding in following months. A catastrophic collapse in corporate revenue and household income from a global pandemic is something the Federal Reserve has no history of facing in the postwar period, and one it can’t solve alone.
“I don’t think the Fed can deal with a sudden stop,” said Glenn Hubbard, dean emeritus at Columbia University’s business school, who suggests fiscal policy makers consider revenue-replacing grants for small businesses. “I would urge policy makers to not at all be cautious to try and get out in front of this and stop the demand doom loop.”
U.S. lawmakers have scrambled to fill the growing hole in demand with a fiscal package of as much as $1.3 trillion, including a proposal to send money directly to families.
Meanwhile, U.S. central bankers have slashed interest rates to zero, announced asset purchases of at least $700 billion, unleashed emergency measures to keep credit flowing and are still continuing to work on other ways to support the economy.
Just before midnight Wednesday in Washington, the Fed announced yet another emergency stop gap, saying it was launching a program to support money market mutual funds — a cash-like vehicle commonly used by individual investors and businesses — that echoed its steps in the financial crisis.
More to Do
“The question is what more can we do in terms of dealing with the real challenges that small businesses and households will have,” Philadelphia Fed President Patrick Harker said in an interview on Wednesday.
He cited the term auction facility used by the Fed during the financial crisis to advance loans to banks, and said direct lending to U.S. municipalities was worth discussing.
While all these measures matter, economists said the most vital step was a public healthcare response that controls the virus to the point where people can resume more normal lives.
‘Grinding to a Halt’
“The entire global economy is grinding to a halt,” said Julia Coronado, founder of MacroPolicy Perspectives LLC in New York. “Banks have balance sheet strains because every smart company in the world has drawn on their credit lines.”
Investors dumped securities on Wednesday in alarm, with sectors like entertainment and travel getting particularly hammered as customers across the nation stay home.
U.S. stocks closed down more than 5%. Even one of the world’s safest assets, U.S. government 10-year notes, tumbled with the yield rising to about 1.19% — up from a historic low of 0.31% set last week. Oil prices tumbled to an 18-year low.
“The Fed is all in now and doing the right things so far,” said Andy Brenner, head of international fixed income at National Alliance. “But they will have to do more. And in the financial markets you are seeing people sell everything they can just to raise cash.”
Cross-currency basis swaps for euro-dollars, a proxy for how expensive it is to acquire dollars, have only retreated slightly from a 2011 extreme set on Tuesday.
The gap between the London interbank offered rate and overnight index swaps — a bellwether measure of banks’ struggle for cash — remains near its widest level since 2009.
Companies trying to get money via commercial paper are still paying elevated levels, though rates on 30-day maturities have eased to about 3% from over 3.5% on Monday.
Such strain guarantees the Fed is looking for more ways to keep markets functioning. What it can’t overcome is the temporary but still major economic hit that coronavirus is likely to deliver.
The Lamps are Going Out
JPMorgan Chase & Co. chief U.S. economist Michael Feroli estimates U.S. growth will shrink an annualized 4% in the first quarter and by as much as 14% in the following three months, before activity picks up smartly later in the year.
“The Fed has already done a lot, and will remain creative in trying to do more,” Feroli said in a note to clients titled “The Lamps Are Going Out All Across the Economy.” He saw the Fed keeping rates near zero through the end of 2021.
It is difficult to see what response right now would calm markets and restore confidence. But at some point, Fed Chairman Jerome Powell will have to offer a strategy, said Roberto Perli, partner at Cornerstone Macro LLC in Washington.
“What the Fed is doing and can do is prevent things from getting worse,” said Perli. Eventually, officials will have to “explain what the problem is, what is the strategy, and why this strategy should work.”
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