Date published: 01 March 2020
At the end of last week, Federal Reserve chairman Jay Powell cryptically assured markets that the US central bank would do the “appropriate” thing to counter Covid-19’s plague on equity prices. This is a carefully crafted promise of nothing specific, ensuring that the Fed can do anything it wants.
Even so, investors have taken it not only as assurance that US short-term interest rates will drop at least a full percentage point, but also that the Fed will expand its “whatever it takes” promise for financial markets into a no-holds-barred backstop for stocks.
If the Fed does step in, the aptly named dead-cat bounce in which prices recover only for a short while, should not be mistaken for resurrected animal spirits. No amount of rate cuts will cure a single coronavirus patient, nor will anyone frightened of illness decide to buy a new house, a car, or even a night out at a restaurant. Markets that are priced for a rescue ignore reality at great peril, and central banks that encourage them to do so run even greater risks.
The first problem with a central-bank rate cut as a restorative for markets is that it will not work.
The reason for this is simple: central banks have financial-market weaponry and coronavirus risk is not financial: it is, of course, an initially biomedical risk that is followed by risks of contagion — literally — for the entire supply side of the manufacturing and service sectors.
One reason markets flew so high late last month was market confidence that China had Covid-19 under control. This was not forward-looking, value-driven investing, but simple speculation. Rescuing speculators is not what central banks can, or should do.
Of course, it may now be true that Covid-19’s consequences are becoming genuinely macroeconomic, making central-bank intervention more sensible. However, hope that the Fed or any other central bank can counter genuine commodity shortages and service-sector disruptions with rate cuts, is only hubris.
In 2008, a blitz from the Fed calmed markets because the great financial crisis was what its name signifies: financial. A central bank can infuse liquidity into a market starved of liquidity or, in gentler times, nudge demand by lowering interest rates to spur borrowing and, then, buying. But when the populace heads for the hills, no amount of extra-accommodative policy can coax it down.
Further, when central banks intervene to cushion disruptions in supply chains, they cease to be central banks and become fiscal-policy tsars. Coronavirus’ macroeconomic risk comes not from lack of money but lack of treatment and cure. The pandemic’s second-order effect — supply-chain disruption — also has nothing to do with lack of cheap funds.
Instead, the problem is fear: fear that a lower interest rate cannot calm. Like the equity market, bond and commodity markets are reacting to hard news. Central banks confident that they can alter market sentiment with a rate cut have drunk too much of their own spiked punch.
Long-established fiscal policy recognises that fear of supply-chain shortages is best solved with supply-chain infusions. Historically, nations have thus solved for panic-driven commodity shortages with sovereign stockpiles such as the US Strategic Petroleum Reserve, a network of huge underground salt caverns at four sites along the coastline of the Gulf of Mexico.
The lack of any comparable facilities for empty hotel rooms, missing auto parts, and essential medicines cannot be solved by any amount of monetary-policy stimulus.
The Fed could of course go into the helicopter-money business, buying tonnes of copper or other commodities or even buying out Disneyland for a day or two. That might work, at least for a while. Even so, pandemic quantitative easing is a novel concept replete with problematic consequences. What would the Fed buy and why would it matter? Buying more bonds might lower rates to stimulate the economy, but an economy in quarantine cannot come out.
A precipitous rate cut, new-style QE, or some other market intervention of the Fed’s devising, share two common flaws. First, they will not work for long if coronavirus lingers, because the crisis has nothing to do with money, the Fed’s stock in trade. Second, even if the Fed finds a way to put a lasting floor under equity prices that restores market confidence and then miraculously eases fears of a pandemic, US equity markets will have been irreparably changed — and for the worse.
After the financial crisis, central banks talked a good game about ending too-big-to-fail financial institutions. If the Fed exercises its equity-pricing “put” yet again, it will validate those pressing for a rate cut, secure in the belief that moral hazard is the defining market principle of the post-crisis era. Too-big-to-fail banks will be succeeded by equity prices that are too high to fall. That is a sure-fire way to create crises yet unknown.
The writer is managing partner at Federal Financial Analytics in Washington, DC
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