The Fed goes all in
By David Nelson, CFA CMT
At 5PM EST Sunday, in response to the spread of the Coronavirus the Federal Reserve announced they were cutting the Fed Funds rate to 0.00% – 0.25%. To keep financial conditions from tightening the Fed cut 100 basis points. After the worst week for markets since the Financial Crisis the probability a significant cut would happen at or before the next FOMC meeting was close to 100%.
Additionally, the Fed is pointing to coordination saying it was working with other central banks to enhance dollar swap lines and would increase its balance sheet by $700 Billion.
The near zero or even a negative fed funds can be an effective tool if inflation is subdued. With energy prices in secular decline now torpedoed by a Saudi oil price war along with subdued economic activity inflation should remain in check.
However, a balance sheet about to hit a new record high exceeding the 2015 high of $4.5 Trillion begs the question just how high do they think they can push the edge of the envelope when it comes to the good faith and credit of the United States.
Fed Balance Sheet
With much of the country hunkered down trying to wait out the viral storm economic activity grinds to a halt. Stocks are trying to price in just what the expected earnings will be 12 months out. The simplest of all valuation metrics is the Price/Earnings ratio or P/E. We know the price [P], but the [E] or earnings is a complete unknown. In that mindset investors are pricing in what they believe is the worst-case situation.
Several companies have or will soon announce significant changes. Delta (DAL) recently said it would cut 40% of capacity and over the weekend Apple (AAPL) announced it was closing all retail stores outside of China until March 27th. Others will follow in the days ahead.
The narrative here in the United States changed in a very short amount of time and at a pace many including yours truly didn’t anticipate. When you walk into your local supermarket and see people in masks wearing rubber gloves it begs the question what changed. Our response has changed and for the most part that is good. Yes, there is a fair amount of hysteria but there’s also good advice available on hygiene as well as social distancing. It’s the last part that leads to the most draconian steps being taken.
The list of activities being cancelled or postponed is too long to mention. From sporting events and concerts to the closing of your local schools are just the tip of the iceberg. Over the weekend CDC issued guidelines that gatherings over 50 people should be cancelled for 8 weeks. NYC and LA have closed restaurants and bars allowing delivery only.
Given the above avoiding a recession will be difficult. Q1 was half over before the COVID-19 hit and may still come in about flat but Q2 is just this side of a lock of printing a negative number. How deep is unknown.
The other side of this of course is at some point this will pass. Some of the economic activity shutdown today will be picked up in the latter half of the year. Goldman’s Jan Hatzius put out a note this weekend pointing to a recovery that could start after April. Optimistic, for sure but at some point, the virus and draconian measures being taken today will pass.
It’s difficult to buy into the idea of an economic recovery when everything in your hometown has been cancelled but if history is any guide a it will happen. How long the Coronavirus takes to make its way through the system and in turn just how quickly we can restart the economic engine will provide a roadmap to the road ahead.
While I view the Fed action as welcome and helps grease the gears of the financial system any real recovery will come when the news cycle regarding COVID-19 changes. The rate of change in China has clearly slowed. The John Hopkins website above is a good place to view the pace of the disease and just how fast it is spreading one country at a time. As you can see in the lower corner the number of new cases in China is flatlining. That’s what we need to see here and until then wild swings in the market will be commonplace.The lower right hand corner of this map is key. When the bottom line “Outside China” starts to look like “China” the worst will be over.
The first quarter closes in a couple of weeks and soon after we will see a wave of negative guidance as few companies have a handle on what the balance of the year looks like. I think any earnings news will take a back seat to the macro backdrop and just when we can expect the rate of change for the viral outbreak to flatten.
High on my list of economic indicators to watch in the weeks ahead is the weekly unemployment claims numbers we get every Thursday. The inevitable hit to the jobs market will likely show up there first.
In a rare show of cooperation between Democrats and Republicans the House passed sweeping legislation this weekend with strong bipartisan support to help provide a fiscal backstop. Expect more to follow.
The news cycle is fluid and often inaccurate. I’ll do my best to sift through the noise and get you the best information I can. Please feel free to reach out with any questions.