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Panic breeds panic: The Fed gave the markets what they wanted and the markets tanked

Their reaction is even more curious given that the markets rose sharply on Monday after the Fed said at the weekend that it would “act as appropriate’’ to support the US economy. The Fed did act and the markets slumped.

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That response was partly because it dawned on investors that an emergency rate cut – it was the first time since October 2008, during the financial crisis, that the Fed has announced a rate cut between scheduled meetings – confirmed that the Fed believed it was responding to an actual economic emergency.

The size of the cut – 50 basis points rather than the usual 25 basis points – underscored how seriously the Fed regards the economic impacts of the epidemic.

There was a whiff of panic in the unusual nature of the Fed move, which unnerved the markets.

Beyond what the rate cut says about the Fed’s view of the severity of the economic threat posed by the coronavirus, the markets’ reactions were also a belated recognition that rate cuts won’t halt the spread of the coronavirus or fill empty shelves.

The Fed’s chairman, Jerome Powell, summed up the powerless of central banks to do anything other than ensure credit is available and, at the margin, help provide a fillip for households and businesses.

For the first time since October 2008, the Fed announced a rate cut between its scheduled meetings.

For the first time since October 2008, the Fed announced a rate cut between its scheduled meetings.Credit:AP

“We do recognise a rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that. We don’t think we have all the answers,’’ he said.

That puts into context the impotency of central banks to respond to a global health crisis and undermined the previous investor conviction that the Fed could always bail them out.

Even though Trump immediately called for more rate cuts and the market is pricing in further Fed moves – perhaps as soon as the meeting scheduled for March 17 and 18 – it is containment and ultimately an effective vaccine that will eventually end the health crisis and calm the markets.

The Fed, and our Reserve Bank, are doing the only thing they can do while knowing how inadequate their tools are to limit the economic fallout from the virus.

Similarly, those governments with the scope to stimulate their economies – and it is clear that there will be a “targeted and measured’’ package from the Morrison government – also realise that, at best, they will blunt the impacts.

What the actions of the Fed and RBA, and the other central banks, might do is avert the threat of a seizing up of credit pipelines.

Last week the US corporate credit markets briefly closed to new issues an there were record outflows from mutual and exchange-traded funds exposed to higher-risk loans.

Wall Street gained initially on the Fed announcement, before plummeting to finish deep in the red.

Wall Street gained initially on the Fed announcement, before plummeting to finish deep in the red.Credit:AP

Ensuring credit is available, and a little cheaper, for the more highly-leveraged companies and/or those more directly impacted by the coronavirus might help prevent avoidable corporate failures that could, in the current fearful environment, generate wider and quite damaging credit crunches.

The G-7 finance ministers also met on Tuesday to consider their response to the crisis.

The best they could come up with was a pledge to closely monitor the spread of the virus and “use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.’’

The absence of actual action provided another layer of disappointment for investors and analysts although even strong measures like those Italy is deploying – a $6 billion package that includes tax credits for businesses whose revenues fall more than 25 per cent and broader tax cuts – are a response rather than a solution.

It is notable that the heavily-indebted and economically anaemic Italy – one of the worst-hit countries outside of China – has produced a package that represents stimulus of only about 0.2 per cent of GDP.

Italy has announced a $6 billion stimulus package in response to the coronavirus epidemic.

Italy has announced a $6 billion stimulus package in response to the coronavirus epidemic.Credit:AP

That underscores the concerns that, if the virus continues to spread and the economic and financial shocks continue to swell and threaten to decimate global growth, neither the central banks nor their governments have much capacity to respond.

The Fed has only four 25 basis point rate cuts before the fed funds rate is zero and the RBA only two.

Beyond that the Fed would be back firmly into quantitative easing territory and the RBA, now with a cash rate of only 0.5 per cent, would be joining it.

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The US entered the financial crisis with a debt-to-GDP ratio of about 60 per cent. Today that ratio is above 80 and rising sharply – the Congressional Budget Office has forecast that debt will be almost 100 per cent of US GDP by the end of this decade.

In Australia, a surplus of nearly 4 per cent of GDP ahead of the financial crisis is now a gross debt-to-GDP ratio of just over 42 per cent, providing more capacity to spend than most other economies – the global government debt-to-GDP ratio in advanced economies is more than 100 per cent – if what are now shocks to quite specific segments of the economy develop into a more broadly-based and destructive economic downturn.

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