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In the face of COVID-19, a “pandemic” that has pushed some of the strongest economies of the world towards a global growth downturn, as one set of the world’s eyes are set on the medical system, another set of uncertain onlookers are glued to the updates from the Central Bank.
In a pre-emptive move to insulate the economy from the looming threats posed by the coronavirus outbreak and a desperate effort to reverse the negative economic outlook, the Federal Reserve recently announced an emergency rate cut to nearly zero (slashing the interest rate by half a percentage point), the biggest one-time cut since the depths of the 2008 Crisis. The question now is- Was the emergency rate move well-thought and actually directed towards combatting the volatile patch of the Wall Street, or was it just a rushed decision taken by the policymakers to prove their competence under the pressure of Trump’s hectoring?
A day prior to the Fed’s surprise action, in the hopes of a rate cut, the Dow soared nearly 5% and witnessed its biggest percentage gain since March 2009, followed by overnight swings dipping into and out of negative territory, after eventually plunging 700 points and turning solidly red in the afternoon trading.
Is it possible that the aggravation of investor anxiety outweighs the improvement of market sentiment as a result of this move? The Fed’s decision to move in between scheduled meetings sends out a signal that economic fundamentals are crumbling, the fiscal authorities are panicking and are only trying to buy more time in order to figure out a response to the evolving risks. CNBC’s Jim Cramer said, “…the weakness must be much more than I thought…I’m now more nervous than ever.” Worries about the Fed’s impotence in the face of economic risks from the coronavirus quickly fuelled a market sell-off.
With the major indices being more volatile than ever, bank shares hit a record low. As investors gasped for a sense of security, demand for bonds shot up, pushing the 10-year yield below 1% for the first time in history. An approximate correlation coefficient of -0.4519 between the percentage change in the number of COVID-19 cases and the percentage change in the Dow Jones Industrial Average explains the triggering of the “limit down” circuit breakers. With more than 4000 cases of the novel coronavirus having been reported in the U.S, the index is now down almost 27% from its peak, entering into the bearish-market territory for the first time in more than a decade.
Positive prospects do prop up for the real estate and car market, bringing a mild sense of relief to those looking to refinance mortgages and those facing prime rates or variable rates on credit cards as the Fed’s benchmark rate is pegged between 1-1.25%, preventing “the type of starving of credit that nearly toppled the global economy into a depression in 2008”.
However, the rate cut does nothing to fix the broken supply chain, increase in the number of sick workers and delayed orders. With the educational institutions already shut down, the rapid spread of the infection, and countries going into lockdown, it is not long before we witness a “sudden stop” in the travel, tourism, hospitality, entertainment, retail, and housing sectors. In anticipation of such an economic slowdown, will the borrowers, who are now underwater in the house, really benefit from low borrowing costs? Meanwhile, savers lose purchasing power by the day as interest rates fall lower and lower.
With the US facing a situation as fluid as this, it becomes essential to question whether China’s preventive actions- restricting air travel, closing movie theatres, shuttering factories and quarantining workers – actions which have temporarily hurt the economy but helped it slowdown the virus’ spread, better suited to battle the pandemic ?
Social distancing has indeed helped China bring the crisis under control and reverse the escalating cases from 1000 per day at the peak to a couple dozen per day after the unprecedented public health response. China might be moving toward a much vaunted “V-shape recovery” as the second quarter nears and the effects of the pandemic on supply and consumption become clearer.
However, the U.S. is substantially more reliant on services than China is. For example: health spending is 17% of the U.S. economy – more than triple the proportion spent in China. On the flip side, agriculture, a sector not noted for day-to-day social interaction and so potentially less harmed by social withdrawal, is a 10 times larger share of China’s economy than that of the U.S. So when people pull back from interacting with others because of their fear of disease, the things they stop doing will frequently affect much bigger industries in the U.S.
The bottom line is that U.S. may have more to fear from an old-fashioned “demand shock” that emerges when everyone simply stays home than the global “supply shock” set off by the coronavirus outbreak and its impact on supply chains.
The need of the hour is to focus on the thinly capitalized companies, the small and medium-sized companies that are “week-to-week” and might soon have to lay off their workers and close down.
“The Fed obviously cannot address the virus itself by cutting rates, but they can hope to short circuit the potential for a negative response in financial markets that could make the economic impact of the virus even worse.”