We should expect markets to look through the current exogenous shock
- Tuesday, March 17, 2020
US equity markets yesterday saw double-digit falls at close to -12%, the worst single day since Black Monday October 1987, and only the third worst session since October 1929.
As well as the fall in equities, yesterday also saw a breakdown in the traditional release valves that markets seek in times of stress. Government bond prices and gold prices, both typically inversely correlated to equities in times of uncertainty, also fell, and even gold has now fallen some 13% below its recent peak. Investors are seeking cash as their safe have.
These moves yesterday and in recent days suggest that markets have moved beyond a debate around the likely near-term impact to global growth and corporate earnings from the Coronavirus outbreak. The moves that we are now seeing suggest markets are debating the tail risks of either a liquidity crunch or a solvency crunch.
Whether either of these two outcomes is likely, depends on the response function from governments and central banks, who are the sole market actors that can resolve these risks in these situations.
In recent days, we have seen an escalation of monetary policy response, culminating with the US Federal Reserve (Fed) cutting interest rates down to zero, injecting liquidity into interbank markets and restarting quantitative easing with no determined upper limit. Such policy action is important as it guards against a shock for the demand-side of an economy. However, interest rates typically act with a lag of 18-24 months, and whilst this action now will accelerate the economic recovery when it comes, it will provide much less support in the immediate days and weeks ahead. In the very near-term, the focus is on fiscal policy from governments. As the Fed Chair Jerome Powell remarked following the latest Fed action, from here ‘the fiscal responses are critical’.
Yesterday, a G7 joint statement said they would ‘do whatever is necessary’ to support the global economy. Separately, the Eurogroup of eurozone finance ministers have announced that they have ‘decided fiscal measures of about 1% of GDP’ for this year to support the economy, and have ‘committed to provide liquidity facilities of at least 10% of GDP consisting of public guarantee schemes and deferred tax payments’ and that ‘these figures could be much larger going forward’. In the US, lawmakers are expected to discuss early proposals for a possible new Coronavirus aid package which might provide according to one Senator, ‘an immediate infusion of at least US$750bn’ to respond to the crisis including funds for small businesses and expanded unemployment insurance. There has also been some support for the idea cash payments of US$1,000 for every American to support economic activity, and which would echo the similar moves seen taken by Hong Kong policy makers recently.
It is our view that global fiscal and monetary policy measures will not only become increasingly coordinated but that their scale will prove sufficient to avoid the liquidity and solvency tail-risks that markets fear. To be clear, both risks are avoidable. Indeed, it is our central assumption that both governments and central banks will deliver significant and overwhelming policy responses to meet these twin market fears. Whilst policy errors are possible, we see increasing co-ordination both between monetary and fiscal policy as well as between countries and governments. As businesses and consumers are given the breathing space to manage the next one or two quarters of significant disruption, we would expect markets to then look through the current exogenous shock.
Chris DaviesChartered Financial Adviser
Chris is a Chartered Independent Financial Adviser and leads the investment team.