US CENTRAL BANK PROVIDES MASSIVE STIMULUS

Update on Financial Markets 16 March

  • 16 March 2020
  • 10 minutes
  • Stocks continue to fall as virus spreads across the US

  • Central banks take further action to support companies during the shut-down

  • The potential for a sharp recovery in the post-COVID-19 environment remains

The virus spreads across the US

The virus has begun to take hold in the world’s largest economy, that of the US. Theatres and restaurants are in lock-down across cities such as Los Angeles and New York. This was inevitable given the way in which the virus has spread elsewhere.

The country’s central bank, the Federal Reserve (the “Fed”), has taken further substantial steps to try to support the economy. It has reduced a key interest rate to operate between 0.0% and 0.25% while also launching a bond-buying programme to inject $700 billion of new cash into circulation.

While these measures won’t slow the spread of the virus, what they can do is help provide as much cheap lending as possible to businesses and households that are dealing with the fall-out from the virus.

The Fed Chairman, Jerome Powell, and his predecessor, Janet Yellen, can take some credit for having resisted political pressure to lower interest rates in other more benign circumstances. Had they succumbed, they would have had little scope left now when financial assistance is really needed.

Co-ordinated approach is developing

As we have said before, a co-ordinated approach between international central banks and politicians is needed. The Fed has recognised this reality. In the 15 March press release supporting its latest moves, the Fed stated that it “is prepared to use its full range of tools to support the flow of credit to households and businesses”. In other words, the financial policymakers are doing what they can within their limited financial remit. Now it’s over to the politicians to complete the picture.

The US political administration has come in for some criticism over its relatively muted and slightly confused response to the crisis. But when the two most populous cities in the country go into a form of lock-down in election year, the politicians come under intense pressure to take decisive and substantial action.

Therefore, we expect the political response in the US to increase over the coming days. One of the necessary responses is slowing or preventing the spread of the virus, and that has economic consequences.

The economic implications

Prevention is better than cure, so restrictions on travel and gatherings are being imposed. The consequence of this necessary action is a temporary halt to daily life. And if factories, offices, schools and the like are closed, the normal flow of the economy is interrupted.

As a result, we are almost certainly facing a short-term recession, and investors are anticipating the fall in revenues by selling company shares. The more exposed those companies are to the restrictions (such as travel and leisure companies) the bigger the drop in their share prices.

Central bank moves cannot prevent this, they can only provide a potential lifeline to companies that need to borrow money during the tough times.

So far this year, major stock indices have dropped dramatically with the FTSE All World Stock Index having declined by as much as 26% between 12 February and 12 March. Stock prices continue to fall as the virus spreads and compounding factors, such as the slump in oil prices, contribute to the uncertainty.

Potential for a sharp recovery remains

No one knows how severe the economic situation will become. Until a cure or vaccine are developed, produced in sufficient volume and distributed, it’s a process of hunkering down and being patient. The consequent slow-down of daily life and, sadly, the substantial loss of life, will play out as the virus passes through society.

As things stand from an economic perspective, there is still the potential for a relatively sharp recovery after the virus has blown through. The policy responses we’ve seen to date have been designed to help companies and individuals bridge the financial gap between now and after the post-COVID-19 outbreak.

For those companies that can weather the storm, the pent-up demand should help economic growth to recover. This, in turn, should support company sales, jobs and general well-being.

But from what we’ve seen in China, Italy and beyond, that recovery is some weeks, possibly months, away. In the meantime, we will keep you informed of the situation and any relevant actions being taken in response.

Important information

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