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Tags: central | banks | markets | coronavirus | fears | sentiment

Central Banks Won't Cure Markets' Coronavirus Fears

$50 bills in surgical masks
(Aleksandr Tannagashev/Dreamstime)

By    |   Monday, 02 March 2020 10:55 AM

The OECD published its March 2, Interim Economic Assessment Report under the title “Coronavirus: The world economy at risk” that gives an interesting view of where the OECD sees the world is today.

The report zooms in on the fact that growth prospects remain highly uncertain and that governments need to act swiftly and forcefully to overcome the coronavirus and its economic impact.

That said, at the end of last week, the S&P500 equity index was at its lowest level in almost five months, which means the U.S. equity markets saw the outlook, in some way, as it saw it in early October of last year.

(The S&P500 equity index measures the value of the stocks of the 500 largest corporations by market capitalization listed on the New York Stock Exchange or Nasdaq Composite, Investopedia explains. The intention of Standard & Poor's is to have a price that provides a quick look at the U.S. stock market and the economy.)

It might be helpful to recall, when looking back in time for a moment and using monthly data, we can see that the S&P500 has been below where it had been 5 months previously a few hundreds of time.

Back in October 2019, the fear was President Donald Trump’s trade tariffs. Today, the fear is fear itself. So, what were markets so afraid of?

If the fear of markets is a global recession, this still seems quite unlikely with what we know today.

Remember, for most advanced economies, the government is a large part of the economy. Markets and forecasters always tend to underestimate the resilience of the human spirit. People adapt and the bounce back is faster from the shocks than is normally expected. It’s easier to adapt faster today with remote working and online consumption that are clearly options for many people.

Expectations for fiscal policy stimulus should support the economy. Even things like closing schools may well turn out to be an economic positive when for example, as is the case in Japan, teachers are still paid but children need to be entertained, which involves spending money.

It’s also worth remembering that large listed companies are generally a small and unrepresentative part of the overall economy.

Fear and sentiment remain the focus. Fear and sentiment are not the same thing.

Politics may become significant. The virus sounds dramatic, but it isn’t so dramatic that politicians feel they have to come together in a show of national unity. That means that politicians may seek to exaggerate or to minimize the effects of the virus, depending on whether they are in opposition or in government, but as the main concern is fear, this does actually matter.

Measuring fear is of course hard. There is however evidence that in Italy for example, the population is more irritated than afraid. Irritation is probably good. People take precautions, but they carry on much as normal and are not pushed into panic.

Sentiment is not the same as fear. Sentiment opinion polls, were they corporate or consumer, have always had two problems:

  1. The sentiment opinion polls tend to exaggerate the underlying economic reality.
  2. When there is a big news story like the coronavirus, people answer rather with instinct than with fact.

We saw this with the business sentiment opinion polls during the recent trade conflict and we will see it again with this coronavirus.

There are assorted sentiment opinion polls out today. Markets will seize on them as being new information but they should remember they are not reality and events like the coronavirus bring their potential flaws to light.

Now, can Central Banks help? Central Banks, even Central Banks that are run by economists cannot cure the coronavirus. Central Banks cannot persuade people to go shopping, and Central Banks shouldn’t care that the S$P500 is down compared to five months ago.

However, if there is a sense that the coronavirus is causing cash flow problems for companies, in particular for small companies, or that lower demand is threatening companies’ ability to service debt payments, then Central Banks can help. Central Banks exist to control credit and liquidity problems.

In this context, on Friday afternoon, Fed Chair Jerome Powell published an unexpected but important statement that says “The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”

In simple words, Fed Chair Powell has opened the door for Fed action.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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Central Banks Won’t Cure Markets’ Coronavirus Fears
central, banks, markets, coronavirus, fears, sentiment
Monday, 02 March 2020 10:55 AM
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