Markets: Knock, Knock, Knocking on the Fed Door. Fed: But I Ain’t Got No More.

Jean-Philippe Bry's picture

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Of course, that was even more true of non U.S. central banks as interest rates in a majority of countries were already at 0%, but it is now also true in the U.S. where the Federal Reserve just lowered rates to 0%.

Even the recent central bank cuts of 50 basis points (1/2 a percent) in the U.S., the U.K. and Canada all saw market declines after the move. The worst market decline follows the just announced cuts to 0%.  What is going on?  Monetary policy is out of ammunition globally to reflate economies and we have entered into the next phase of the post Great Financial Crisis.

“There are decades when nothing happens; and there are weeks when decades happen.”
(Vladimir Lenin)

A dramatization perhaps but we are entering a new phase economically which will also have political ramifications.

While monetary policy will continue to play a role, the market is demanding the next available tool to stimulate demand which is fiscal policy.

It should be recognized that neither monetary nor fiscal policy can directly address the simultaneous impact of the supply and demand shock to the economy the virus is causing. It can only alleviate its impact, especially in countries like the U.S. with a large portion of the population live paycheque to paycheque. A spike in job losses, even if temporary, is likely to see unpaid bills and the deferment of payments for car loans, mortgages and credit card loans, putting pressure on the financial system. Europe is much better equipped structurally to deal with spikes in job loses, which have started, by proactively accelerating their availability to the general population.

Nevertheless, going forward, more fiscal policy will need to be done to stimulate the economy once the virus reaches peak infectiousness. China has turned the corner here and is waiting to roll out a fiscal stimulus but will likely wait until the situation in Europe and the U.S. settle down to get the full appreciation of the situation.

Fiscal policy presents several challenges for democracies, as is currently playing out before our eyes in the U.S. where some commonsense measures to address the likely predicament of precarious workers as mentioned above, is a party partisan struggle. It should nevertheless pass relatively easily.

This is a major evolution in the post financial crisis world where monetary policy was for most countries, the only policy response since the Great Financial Crisis.

The big difference when discussing fiscal policy, and this will be very relevant when stronger measures will be required, and soon, is the politics amongst elected officials. Democracies are dependent on politicians to implement fiscal policy. This contrasts with monetary policy that relies on appointed officials who tend to be politically driven. 

Unfortunately for the west, this is going to present a major challenge.

“Every Lie incurs a debt against the truth. Sooner or later that debt is paid.”
(Valery Alekseyevich Legasov, Scientist investigating the Chernobyl nuclear disaster)

In the U.S., it increasingly appears we have reached the moment when the debt is getting paid. This comes at a time when: 

  • The U.S. public is more divided than any time in recent history.
  • Congress is divided with heightened political animosity bordering on contempt.
  • Politics is undergoing a general debasement of conventional norms.

This makes negotiating any meaningful stimulus package difficult.

In addition, several more challenges present themselves.

Any crisis, especially one of global proportions such as the COVID-19 requires global cooperation and leadership. Both are in short supply. The G20 recently had a conference call to discuss the pandemic and all they were able to communicate was that they would continue to monitor the situation. Where once the U.S., would lead such coordination efforts, today they are absent, and no one seems capable of taking their place.

It is not just policy making that is required today, but also cooperation between fiscal and monetary authorities to coordinate action. It is increasingly likely that fiscal policies will be monetized by central banks as part of this evolving process much like the Great Financial Crisis.

The risk is that politicians waste precious time debating before delivering necessary measures. Markets will not be kind to any procrastination or insufficient measures as we are witnessing as we speak with markets down double digits in days. In the end, politicians will do what is needed, but no one can evaluate the market damage that might have to be endured before getting there.

Finally, the quality and capability of both politicians and technocrats is on the decline. In 2008 the world was fortunate to have some extremely capable individuals, combined with some open-minded politicians, who were capable of navigating markets towards stability and ultimately recovery.  The approach required the ability to work with other countries and focusing on the collective interest. In other words, there was a recognition that serving the interests of all countries first would serve the interest of each individual country.  The opposite does not work.

Risks are thus a function of delays or inadequacies of politicians’ responses to the crisis. The Geopolitical Recession, written by Drummond Brodeur, is likely to accelerate. China’s controlled economic slowdown and subsequent supply disruption revealed the extent to which the world is dependent on China even in sensitive areas like pharmaceuticals. Supply chains were already being reviewed before the outbreak, but since the outbreak, one should expect more supply chains will be reconfigured to limit dependency. This has consequences for costs as it will be more expensive, negatively affecting company margins. This de-globalization process is likely to accelerate in the years to come.

In conclusion we have entered a new era where monetary policy is taking a back seat and fiscal policy is now the only effective tool to stimulate economies, at least in the western world. The challenges this presents is the risk of inaction and delayed reaction from politicians. Deglobalization is likely to accelerate, especially with respect to supply chains where the west is too dependent on China. This will raise costs and lower margins for companies. The geopolitical recession is likely to accelerate heightening tensions between nation states as trust is further eroded. 

Sources: Bloomberg Finance L.P. as of March 16, 2020, Signature Global Asset Management

 

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Published March 17, 2020

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