Commentary: Even with near-zero interest rates, a global economic recession is almost certain
The US Federal Reserve howitzer will minimise chances of financial calamity, but more will be needed to arrest the effects of the COVID-19 pandemic, says the Financial Times' Robin Wigglesworth.
LONDON: The weekend was rife with rumours that the US Federal Reserve was readying a monetary bazooka to arrest the financial market turmoil. On Sunday (Mar 15) evening, the US central bank was ready with a howitzer.
In addition to slashing US interest rates by 100 basis points back to near zero, the Fed announced an additional US$700 billion in bond purchases; expanded its repurchase operations to soothe tensions in the Treasury market; opened enhanced dollar swap lines with several other big central banks; eased reserve requirements; and unveiled a credit facility for commercial banks to ease lending.
“This is a powerful package,” said Krishna Guha, vice-chair of Evercore ISI. “The Federal Reserve has gone close to all-in on its policy response to the virus crisis and freeze in fixed-income and credit markets.”
Joachim Fels, Pimco’s global economic adviser, argued “this is a close as it gets to ‘whatever it takes’”, a reference to the phrase used by Mario Draghi, the European Central Bank president at the time, to emphasise his willingness to fight the eurozone crisis by all possible means.
A SEVERE DOWNTURN LOOMS
However, there are limits to what central banks can do in such an extraordinary situation. Monetary policy cannot inoculate people against coronavirus, and the recent news has been unremittingly gloomy.
Entire countries are shutting down, and global industries — such as tourism, travel and hospitality — are on their knees. This is why equity futures are pointing to another steep decline in the US stock market on Monday, despite the Fed’s efforts.
At this stage, a global economic recession is virtually certain. Central banks cannot do much to stimulate demand if people are barricading themselves at home. Far more aggressive fiscal policy will be necessary to prevent a downturn from being severe.
Nor did the Fed unveil a measure to unfreeze the commercial paper market, a vital tool for companies that need to borrow short-term money. This is an issue that needs to be addressed — urgently.
The sudden revenue shortfall for many companies caused by the coronavirus outbreak has led to a spike in demand. At the same time, companies with extra money have been forced to pull money out of money market funds that are the commercial paper market’s bedrock.
Together, that has sent the cost spiralling higher, and led to expectations that the Fed would have to do something to prevent potential accidents.
SOMETHING FAR MORE DESTRUCTIVE
Nonetheless, at the very least the Fed’s forceful action ameliorates the danger that the economic damage ricochets through markets with the ferocity we saw last week.
There were signs that what might hopefully prove a short, sharp economic downturn could morph into something far more destructive.
That was particularly apparent on Thursday, when investors essentially dumped everything they could — even US Treasuries and gold.
While markets rebounded on Friday, after President Donald Trump declared a national emergency and vowed more forceful action, few investors believed that the crisis had passed.
Investors were still reporting that the Treasury market was dysfunctional — with extraordinarily wide gaps between the prices of almost identical US government debt, and elevated trading costs.
Liquidity across every market has atrophied dramatically, but investors are understandably alarmed at seeing even the US government debt market gumming up.
MORE WILL BE NEEDED
In short, the Fed’s actions will not dispel the miasma surrounding markets.
But it will lessen the chances of a financial calamity coming on top of the economic and human damage wrought by coronavirus, and more action is probably in the works.
“Policymakers including the Fed are in the process of pulling all the stops to mitigate the severe economic and financial disruptions caused by the most severe global health crisis in more than a century. More will be needed and will likely be forthcoming over the next few weeks and months,” Mr Fels said.