Indeed, just as the Fed’s initial 50 basis point rate cut the weekend prior spooked markets by demonstrating the Fed’s growing anxiety about the economic and financial impacts of the coronavirus, the one percentage point cut last weekend to the federal funds rate, to zero, and a return to quantitative easing only compounded the fear.
What the Fed’s actions did do – and were designed to do – was to restore some order to bond and credit markets that were malfunctioning. The US Treasury bond market is usually the global safe haven for nervous investor but last week even that market was hit by a scramble by investors and companies for cash.
Whether it’s drawing down credit lines or selling their bond holdings it is apparent that companies and individuals are doing whatever they can to build their cash reserves. The initial and biggest financial impact of the virus is on business and households’ cash flows.
The Fed and the Reserve Bank, and their central banking peers, have all acted to drench their systems with liquidity and it has had an immediate effect. Bond yields that were rising even as equity markets fell – they normally have an inverse correlation – fell sharply on Monday.
With their tools limited and their capacity to stimulate economies near-exhausted, the best the central banks can do is to ensure that there is plenty of liquidity in their systems and credit remains available.
The coronavirus is exposing the limitations of central banks that maintained their financial crisis policies for more than a decade after the crisis had ended and also the naivety of investors who believed the banks’ fear of financial market turmoil would underwrite an infinite rise in asset prices.
Donald Trump, who only a week ago was threatening to sack or demote the Fed chairman, Jerome Powell (not for the first time) for being slow to cut US rates got what he wanted, in spades, and the markets that he has placed so much emphasis (and his hopes of re-election) on fell apart. The US market is now only five per cent above its level when Trump took office. It had been almost 50 per cent higher.
So much for the “Powell put,” or the conviction that the Fed would always bail investors out.
The subsidence of bond yields in the US, and (albeit not as dramatically) in Australia provides an insight into market expectations of the economic outlook. It’s bleak.
The US two-year Treasury notes are yielding 36 basis points (208 basis points lower than a year ago) and the 10-year bonds 72 basis points (187 basis points lower). The Australian two-year securities yield 50 basis points and the ten-year bonds 97 basis points.
Yields so meagre are further evidence of the market expectation that the impact of the pandemic is going to be very severe and long-lasting.
The first data that provides an insight into how bad the economic effects might be came from China on Monday. Factory activity in January and February was down 13.5 per cent on the same month last year, the fastest contraction since the data was first compiled in 2005. Investment was done about 25 per cent. Retail sales were down more than 20 per cent. Unemployment spiked to 6.2 per cent in February.
The impact of the coronavirus on China was significantly worse than anticipated and efforts by China’s authorities to re-open factories and rebuild production are going to be undermined by the collapse in global demand as the virus spreads elsewhere.
China’s growth rate this year will be its lowest in at least three decades. Unlike during the financial crisis, it’s not going to bail out our economy, the most exposed developed economy to China.
There is no floor for sharemarkets in the current panicky environment.
As we saw last week that doesn’t mean there won’t be sessions or days where there’s sufficient buying to produce a rise in prices. There are investors who perceive bargains when there is distressed selling.
The outlook, as the VIX index is signalling, however, is for extreme volatility and a continuing trend lower unless and until the rates of infection in the developed economies, most particularly in the US, start to plateau.
Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.