The Fed Open Market Committee was set to meet this Tuesday and Wednesday and the market was expecting a 100bps rate cut to the emergency zero level. Instead, the Fed shocked the market with a Sunday rate cut of the expected 100bps and surprise announcement of a $700 billion bond buying program, aka Quantitative Easing 4. This certainly feels like a panic move by Chairman Jerome Powell and the Fed. A Sunday afternoon rate cut is unprecedented. The market didn't take it well with US futures opening limit down -5% and then stocks tumbled at the open to trigger a 15 minute pause in selling. What does it all mean for investors?
Monetary Policy rendered useless... for now
In our conference call for investors, we talked about how monetary and fiscal policy is rendered useless in the short term because of the coronavirus, COVID-19. Demand has dropped off a cliff and people are making the right move by creating social separation. This is terrible for business but the right decision for humanity. We must first stop the spread of the virus and then we can think about saving the economy.
In the short term, no amount of stimulus will help the economy. Loans to businesses are needed to keep companies afloat but it won't help with demand. Once the virus is contained, stimulus can help to speed the recovery. We hope to see all Western nations make the right decision to lock down their countries for two to three weeks to stop COVID-19 - the momentum is moving this way but with each day, it costs not only the economy but human lives.
This Time is Different - Quantitative Easing
Since the Great Recession, the Fed has had success with Quantitative Easing as it used its financial might to drive interest rates lower and the market higher. As you can see from the chart in each QE period, the market soared higher. So will it work this time?
We have our doubts, at least in the short term. This time is a completely different environment. While the economy wasn't very strong and was dealing with weakness in Europe in previous QE programs, the coronavirus is causing a sudden drop in global demand. Furthermore, we are much later in the cycle and unemployment is already at extremely low levels. It doesn't matter what the Fed does, jobless claims will skyrocket in the coming weeks as restaurants and businesses are forced to lay off workers to cope with the fallout in demand.
The Fed has limited ammo left in its arsenal. It could make even more asset purchases, buy equities like the Japanese, or try negative rates; but none of these options are particularly appealing. The ball is essentially in the court of fiscal policy if and when COVID-19 is stopped.