Here we are, once again the Federal Reserve, arguably the most influential central bank worldwide, decided to intervene by cutting the base interest rate by 50 basis points to 1 – 1.25%. The unexpected decision came out a few moments after the G7 conference call between the main central bankers and G7 Finance Ministers and stated basically that no major intervention would be implemented although they would keep a close eye on the virus impact on the real economy. Now, the capital markets have firstly welcomed the rate cut, but then they rejected the decision as not “enough” to discount such a source of disruption as the COVID-19.
The equity market immediately jumped 1.5% momentarily following the Fed’ press release to then fall back almost 5%, closing roughly 3% down on the day. The bond market, on the other hand, not only kept rallying on the Fed’s liquidity inject, but it then stretched to the historically lowest 0.7% US 10Y Treasuries Yield (see “Chart of the week” below).
The outcome unfortunately for the Fed not been as good as expected, as the credit market is now pricing in a further cut of 50 basis points during this month’s FOMC meeting. If the Fed does decide to follow the market’s expectation, then the United States of America will not have any protection if/when recession finally floods the economy, bringing a high unemployment rate, low consumer spending and credit, crashing housing market and, last but not least, corporate defaults due to poor cash flow generation.
This could start the infamous “capitulation phase” where investors just panic and run for cash & equivalents like investments. The COVID-19 fear, which in the first 2 months of 2020 has been dramatically underestimated, has potentially a massively disruptive power in economic terms.
Simply put, people won’t consume, won’t spend, won’t buy houses, won’t go to work and likely won’t even interact with other humans for fear of contracting the virus from asymptomatic individuals. Meanwhile, bars, transportation vectors, grocery shops, cinemas, train stations, post offices, local bank branches will all be shut down. That might sound like a plot of a Sci-Fi movie, but it mirrors what has been happening in the Northern Italian regions for the past couple of weeks. Economy stagnation, extremely low inflation (due to both no spending and zero interest rates) and supply-chain disruption are on the way.
The main hope is that the healthcare system, top pharma top companies the WHO and the most powerful countries in the world will for once focus on finding a cure/vaccine to assist infected people and prevent further contagion. While central banks are now hopeless as their impact on the real economy equates to zero as they only seem to focus on the “health” of the financial system, ultimately harming it, the governments CAN still stimulate the economy from a tax cut perspective and should incentivise people to avoid any gathering or crowded place for the time being.
Together we can all hope for a de-escalation and hopefully in a few months this terrible threat will only be in our nightmares. On a positive note, when all of this will be over, the stock market will offer value and be easily accessible that everyone will have the opportunity to ride the next bull-run.
The Federal Reserve unexpectedly cuts the base interest rate in the USA by 0.5%, few minutes after zero outcome G7 emergency conference press release stating “We, G7 Finance Ministers and Central Bank Governors, are closely monitoring the spread of the coronavirus disease 2019 (COVID-19) and its impact on markets and economic conditions”.