Global risk assets had another tumultuous week, responding to the spread of the coronavirus, paltry efforts to mitigate its economic fallout, and Biden’s ’super Tuesday’. Over the past week, major equity indices finished marginally higher, but not before stomach-churning ups and downs of thousand point intra-day swings. Global government bond yields plunged, with US Treasury yields reaching historic lows near 0.70%.
In response to the growing global economic and earnings risks posed by the virus and the inadequacy of the policy response thus far, investors will remain skittish, more likely to shed than add risk.
Monetary policy is not the best tool to deal with the economic consequences of the pandemic. While it is perfectly understandable that the Fed would cut rates, as it did in emergency fashion this past week, it is equally clear that the rate cut would not impress markets. This was evident following the Fed’s move.
As we have already written, governments worldwide need to take concrete steps to stabilize economic activity and reassure markets.
- First, targeted fiscal policy stimulus in the form of temporary cuts in sales, VAT and payroll taxes, augmented by expanded unemployment benefits, is required to offset slumping private sector spending.
- Second, companies most affected by the pandemic – those in the travel or hospitality sectors, or those with exposed supply chains – should be eligible for emergency government loans and guarantees to keep them afloat should they tip towards bankruptcy.
- Third, central banks and finance ministries must state publicly and unambiguously that they will be prepared to intervene to prevent the ‘black swan’ of a potential seizure in the global credit markets. Credibility, backed up by the government balance sheet, is a powerful stabilizer.
To not act in the face of severe natural disaster is an abrogation of the social contract governments have with their citizens. Moreover, early action is both more effective and cheaper than responding to the economic and financial pain. As Benjamin Franklin famously said, an ounce of prevention is worth a pound of cure.
What does this mean for markets and investor behavior? Simply put, unless the public sector balance sheet is put squarely in play to mitigate the economic and financial risks associated with the pandemic, investor risk appetite will not be restored, and markets will continue to careen wildly. Investors will use any opportunity to sell equities and corporate bonds, and to park their proceeds in government bonds and cash.
In this environment, incoming economic data will provide little solace. This was clear last Friday, when a solid February US employment report (including upward revisions to prior months’ jobs growth) failed to impress investors. And, incoming data is always subject to skew. Backward looking reports that evidence past economic strength will be dismissed as pre-virus irrelevant, whereas figures such as today’s double-digit declines in Chinese exports for the month of January will be seen as affirmation of the pandemic’s pernicious impacts on global growth.
Finally, proprietary ‘fair value’ model estimates of bond yields make interesting reading. Following the latest plunge of US ten-year Treasury yields to historic lows near 0.75%, the bond market looks significantly over valued. But are investors over-doing it? By ‘reverse-engineering’ the models, it is possible to infer what investor expectations are consistent with observed market prices. The answer is a global manufacturing recession accompanied by roughly three more quarter-point Fed rate cuts. Absent a slowing of the pandemic, the advent of a vaccine, or a heavy dose of fiscal stimulus, yields probably deserve to be this low.
Which is to say, the time has come for thoughtful government economic policy to swing into action. The more determined, targeted and, frankly, awe-inspiring the policy measures are, the more likely the economic pandemic caused by the coronavirus can be held in check. Until then, investors will remain unimpressed, markets will remain volatile and the risk of a global financial crisis akin to 2008 will continue to rise.