Market Overview

16 March 2020

The Fed Could Not Wait, Markets Do Not Know How to React

The second emergency move by the US Federal Reserve (Fed) in two weeks, when they cut interest rates sharply to zero level, and did it again in haste on Sunday evening, just three days before the scheduled meeting. The move in no way calmed the markets, but rather shocked them.


The Fed said in its statement: "Available economic data show that the U.S. economy came into this challenging period on a strong footing. Information received since the Federal Open Market Committee met in January indicates that the labour market has remained strong through February and economic activity has risen at a moderate rate. Job gains have been solid on average, in recent months, and the unemployment rate has remained low. The committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals. This action will help support economic activity, strong labour market conditions, and inflation returning to the Committee's symmetric 2 percent objective".


The text has a somewhat academic style, and the very decision was long-awaited and could be perceived as some serious support for the global financial system and the economy. But the move was entirely unexpected this early and has scared everyone. Are things really that bad? Does the Fed know something so creepy that its officials can't even wait for three days? This was probably the first idea that comes to mind.


It's clear so far that this was a coordinated action by several central banks, including similar interest rate cuts by the Reserve Bank of New Zealand (RBNZ) and the Bank of Canada (BoC) and even doubling the quantitative easing (QE) program by the Bank of Japan (BoJ) and some other countries, like Australia and South Korea. The "conspiracy" theory is common among some traders as if all these central bank actions are in place only to refinance the $22 trillion US national debt and large public debts of other G7 countries. However, the markets that do not try to delve into the deeper meaning of events, at least for as long as this fits well into the logic of the panic we have been feeling so far. It is not a surprise that such a sentiment drove stock indexes like the US S&P500 and Nasdaq100 and all European shares' indexes down. Trading on the S&P500 index had to be suspended at night and resumed with a further decline in early trading hours in New York.


However, if the main goal was really to lower the US Treasury yields as much as possible, then that is exactly what the Fed has yet to achieve: the benchmark ten-year yields for the US bonds have decreased from 0.95% at Friday's close to a low of 0.65% today. Investors do not believe in exacerbated, scary "fairy tales" and anticipate a gradual recovery in the stock markets that might be expected in a few weeks. Such scenarios are not a guarantee, but they may be fuelled by the recovery in China as the country officially declared it has passed the peak of the epidemic. Temporary hospitals are closed in Wuhan and while the US is just closing the borders to European citizens, Chinese medical teams have already arrived in Italy in order to share their experience with combating the virus and to also provide boxes of medicines, which have musical excerpts from Puccini's "Turandot" opera enshrined on them, which acts as a humanitarian aid as well as a medical one


Notwithstanding the positive developments in China, the overall picture of the virus situation in the rest of the world is dire. European borders are temporarily blocked for travellers. Many people in big cities and small towns are just sitting at home due to the quarantine measures. No doubts that the Q1 and Q2 of 2020 corporative reports of the vast majority of companies will report substantial losses or, at least, significant decreases in profits. Apple Co has already closed all offline stores outside China at least until March 27. Shops in the US could operate on a reduced daily schedule as vice president Mike Pence declared. On Monday Goldman Sachs lowered its forecast for real GDP growth in the US from 0.7% to zero % year-on-year. These are not many reassessment, but who can be sure that the markets have already fully discounted all these troubles and that the consequences on the current prices of the huge correction, has already taken place?


Investors could still prefer to wait longer and to hold their cash in safe assets. These assets are the government bonds, first of all. Not necessarily of an American origin, as the US Treasury would have preferred. The European bonds are already less different in terms of yield if they were compare with the US bonds, but the European central bank (ECB) conducts more balanced, adequate and predictable approaches in the eyes of investors. In addition, the ECB has nowhere to further lower interest rates, as they are already well in the negative zone. The emergency QE volume in Europe is now at €120 billion, and not $500 billion like in the United States, or ¥12 trillion like in Japan.


European financial authorities do not see the point of throwing extremely large amounts of money on the market and devaluing it any further. If investors are imbued with this philosophy, there is a chance that demand for European bonds may grow aligned with the Euro. Nevertheless, there is a chance that investors may prefer US assets instead, despite the increasingly less interesting yield and too large-scale quantitative easing, as it was in 2008-2009, even despite the fall of the largest American investment bank, Lehman Brothers, and the mortgage crisis which originated in the US. If this is the case then the Dollar could gain even more against the Euro this time, versus the entire basket of reserve currencies. Emerging markets' currencies may suffer the most ,as will the Turkish lira, or the Brazilian real, or the South Africa's rand.


Gold spot and Gold futures are considered more as risky assets from which profit can be gained from past growth but not as a safe-haven in a present situation. There is a feeling that many market participants are really shocked and do not know where to go. It is likely that both the market crowd and individual smart investors will need at least a few days to see the essence of what is happening, and only technical indications may be wise signs to follow during this time of very turbulent news.


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