“I hope the Fed gets involved, and I hope they get involved soon”, Donald Trump said at the White House on Friday afternoon, after the closing bell sounded on the worst week for US stocks since 2008.
Asked if the chaos on Wall Street qualifies as an economic crisis, Trump was non-committal.
“I think that basically it’s the unknown a little bit”, he managed. “But I feel very confident”.
The president is certainly free (perhaps even obligated) to feign bravery in the face of grave danger, but one thing that’s in short supply among market participants right now is “confidence”.
In the space of just seven trading days, US equities went from bubble to bust.
As stocks careened lower, the yen regained its haven status, posting the best week since July of 2016. You might recall that the currency recently lost its luster as a safe harbor.
Gold – which had, of course, been on a ridiculous tear – was liquidated Friday. And I mean that literally. In case you somehow missed it, investors were clearly selling to meet margin calls in other assets.
It all makes for an astonishing turn of events, and in many ways encapsulates the sum of all fears for those who have followed markets closely in the post-crisis years. Somehow, the role of modern market structure in all of this is still underappreciated.
What we saw this week was what happens when fear of the unknown triggers the very same liquidity-volatility-flows feedback loop that’s played havoc with markets during previous routs. Only this time around, there’s no obvious link between any prospective monetary policy intervention and mitigation of the proximate cause of the market’s consternation.
Jerome Powell’s statement on Friday afternoon was short – even terse. But, again, it is by no means clear that Fed cuts are going to do anything other than shore up market sentiment. That’s “not nothin'” (as they say) if it keeps the vaunted “wealth effect” from slamming into reverse and deep-sixing consumer spending. However, if the coronavirus outbreak worsens in the US, consumer spending will suffer anyway. Nobody who was scared to get on a plane or a train or go shopping in the city or attend a large public gathering is going to change their mind just because the Dow recovers. The vast majority of Americans don’t even know what the Fed does.
“Globally, people are going to avoid unnecessary public contact. People are no longer worried about buying a house or a car, their primary concern is whether the virus will emerge in their area, will their kids school close and will their family be quarantined”, JonesTrading’s Mike O’Rourke wrote, adding that “this crisis will pass over the next several weeks or months, but make no mistake, conspicuous consumption is fading rapidly as consumers worry about what is truly important to them”.
The collision of supply chain worries and jitters about consumer markets manifested itself dramatically in, for example, the worst week for Apple since 2008.
Panic over demand destruction in commodities drove crude to its worst week since the crisis. WTI futures fell a truly astounding 16% in five days. OPEC will meet next week, but a production cut won’t be enough to put a floor under prices if news of quarantines and travel restrictions continues unabated.
None of the above is to say the Fed shouldn’t (or won’t) act. They should, and they almost surely will. Goldman, BofA, Citi, Barclays and Morgan Stanley all changed their Fed calls Friday to forecast cuts in March, in line with money market traders, who have spent the last 48 or so hours effectively cornering the FOMC.
But even Trump seems to realize that rate cuts cannot solve a virus. The Washington Post on Friday said the administration is considering targeted tax cuts in a bid to help bolster market sentiment. That might actually be more effective, and is consistent with the approach adopted in China and South Korea. This is a situation that calls (indeed, begs) for a focused response. A broad, policy rate cut will support stock prices, which will be helpful (consumers will be more comfortable spending once they see green on the screens), but only assuming there are no quarantines or serious virus outbreaks in the US.
A rate cut might also help by pushing the dollar lower and ensuring borrowing costs for corporates don’t become prohibitive. US oil and gas explorers were pushed to the edge of distress this week, for example.
To the extent the Fed can accomplish some good with a cut, their efforts are welcome, but the point is simply that the old adage about monetary policy not being a panacea goes double in situations when the problem is rooted not in economics or finance, but in biology. Monetary policy is never a panacea, but especially not during a pandemic.
Of course, that won’t stop people from trading on any emergency central bank action, and quite possibly in “grabby”/”squeeze” fashion (see “All Bets Are Off“). But for average people, another 25bps or 50bps isn’t going to make a shred of difference.
“It’s hard to make a call on when this equity correction will turn, especially after such a long period of low-volatility gains [but] central banks will… step in if they fear self-enforcing trends and market dislocation emerging”, ING said Friday. “While credit spreads have certainly widened, we are yet to see major problems in the interbank space [but] for the time being, we expect financial asset prices to stay under pressure”.
Wells Fargo was a bit more constructive. “This we can tell you – the S&P 500 risk premium is at a multi-year high, the relative returns to risk aversion assets are at an extreme, and we have a better understanding of the risks and potential damage from the virus”, the bank’s Chris Harvey said. “While we can provide no guarantee valuation, risk pricing and market direction have created a more attractive risk/reward for equities and we suggest adding risk to the portfolio as well as putting new money to work”.
That may, in retrospect, be a great call. But the risk is both clear and present.
After the bell on Friday, California reported its second case of COVID-19 from an unknown origin. The patient, a 65-year-old Santa Clara County resident, has no travel history to locales beset by the virus, and, as far as officials know right now, no connection to anyone with the disease.