The Federal Reserve took a massive series of policy measures on Sunday whereby Fed Chair Jerome Powell also cancelled this week’s FOMC meeting.
In his emergency press conference the Fed Chair said among other things “It’s very hard to say how big the effects will be or how long they will last. That’s going to depend of course on how widely the virus spreads, which is something that is highly uncertain and I would say, in fact, unknowable” Reuters reported.
So, what intents the Federal Reserve to do?
- First, the Fed will make it easier for banks to provide loans to small businesses. In fact, this is long overdue and not quite as focused as the European Central Bank (ECB) or the Bank of England (BoE) in their policies, but better late than never. The failure to do this alongside the Fed’s last, rather inept rate cut, was one of the biggest worries to date.
- Second, the Fed will undertake quantitative policy by buying government and mortgage bonds, and by providing other liquidity to markets. Dollar liquidity will also be provided internationally via other Central Banks by using the swap line arrangements, although, with reduced global demand and global trade already “damaged” by the trade tariffs, this liquidity may not be needed as much as in the past. The financial markets stabilization measures are an important measure because financial markets need to function if governments are to fund their fiscal policies to deal with the coronavirus.
- Third, the Federal Reserve cut rates to affectively zero. This doesn’t really matter that much now, but it will matter when the economy begins to bounce back, which of course it will.
Investors could do well taking note that the objective of the Fed’s policy now is not to stimulate. You do not stimulate in a lockdown or quarantine. It would be absurd to have economic policy and health policy trying to completely oppose each other in their objectives. The objective of policy is to limit the downside risk. The coronavirus is primarily a “demand shock”. Consumers spend less money overall if they’re advised against gathering in groups.
Of course, a lot of spending will happen anyway. Housing and utilities for instance. Some spending will increase. Panic buying is spending. It’s wrong spending but it’s still spending. Spending online is rising. But overall, people spend money on being social and that will decline.
The problem is that if solvent businesses have cash flow problems because of a short but severe decline in demand, they could trigger a downward spiral. If good businesses close, then people lose their jobs. That makes the demand shock worse and, critically, means the demand shock lasts beyond “peak fear” of the virus. This is why the Fed’s planning to help businesses is the single most important policy decision of the Federal Reserve.
On Saturday we also got fiscal support when Congress broadly agreed on a package of measures that will among other things extend paid sick leave to some but not all workers with tax breaks offsetting the costs to employers, Politico said.
Testing for the virus is now also free and there is more funding for things like food stamps.
It’s very hard to cost the package because it depends on how many people will take paid sick leave for instance, but it amounts to maybe half of a percentage point of U.S. GDP that is probably not enough given the severity of the crisis.
Interestingly, opinion polls suggest that the full extent of the crisis has not yet hit U.S. consumers and views are still, remarkably, affected by political partisanship, the Hill said.
Besides all that, China produced economic data for January and February which was significantly weaker than expected. Both industrial production and retail sales have slumped. China’s measures included full quarantine rather than the more muted lockdown responses elsewhere. The effect is to deepen the near-term impact of the virus on their economy.
The speed of China’s bounce back for March will now, in part, depend on the international demand shock that arises from the fear of the virus. China is a domestically focused economy and domestic stimulus measures remain very important, but international demand does have a role, the South China Morning Post said.
Finally, Goldman Sachs informed on Sunday it had revised down its U.S. GDP forecast for 2020 to 0.4 percent from 1.2 percent originally, which is of course of interest to investors, Reuters reported.
No, we haven’t seen the bottom yet.
Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.
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