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Can central banks fight off the effects of coronavirus?

On Tuesday morning, the Fed stepped in and cut the Fed funds rate by 50bps in an emergency move to try and calm markets over coronavirus fears. Markets immediately spiked up but then sold off throughout the day. The market is expecting more rate cuts this month from the Fed and the ECB. For investors, the question is: can the central banks fight off the effects of coronavirus? The answer is yes and no.

Beginning with No

I liked this quote from billionaire hedge fund guru Ray Dalio:

As far as central bank policies are concerned, interest-rate cuts and increased liquidity won’t lead to any material pickup in buying and activity from people who don’t want to go out and buy, though they can goose risky asset prices a bit at the cost of bringing rates closer to hitting ground zero.

I agree with Dalio that rate cuts will do little to stimulate the economy. If the virus isn't contained, people may be reluctant to go out and spend. This could put a serious dent in the US economy which is driven by the consumer.

It is still unclear what the overall economic effects of the coronavirus will be. Clearly the most effected are travel and tourism. It is no surprise that airlines and cruise companies have been crushed over the past couple of weeks.

But don't sell all companies because of fear. Even with a pandemic, people still need to eat and take their medications. In addition, you could make a case that it will benefit other companies like Amazon as people will just order more from home.

Central banks can boost financial markets

Clearly the central bankers are concerned with the sharp pullback in financial markets with the S&P 500 falling 13% in just over a week and interest rates falling to all-time lows.

The Fed stepped in with an emergency 50bps cut for the first time since 2008. This is truly a rare event but occurred multiple times in the 2001 and 2008 market crashes.

emergency rate cuts

Fed intervention in the markets is often cheered. Even if you are extremely bearish because of the coronavirus, keep in mind that rate cuts can have massive impact on the financial markets and as Dalio says they can goose asset prices which occurred in the 2001 and 2008 market crashes.

Looking back at some of those 50bps emergency rate cuts, after the March and September 2001 rate cuts, the S&P 500 rallied over 20% each time. After the the August 2007 rate cut, markets hit a record high in October. Furthermore after the January 2008 rate cut, the S&P rallied over 10% and then traded sideways until the true crash which happened in the fall of 2008.

In conclusion, the central banks can't boost economic activity but they can provide asset price inflation over the short term. The market is predicting another 50bps cut at the next Fed meeting in two weeks and also expects more stimulus from the ECB and BoJ. This is a coordinated effort to stabilize global markets and hope that the coronavirus is contained sooner than later.

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About the Author: Chris Wang

Chris Wang

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