Why Is Federal Government Action Not Shoring Up Markets? Alternative Explanations
March 17, 2020
This joint commentary has been edited by Scott Kennedy.
On Saturday the U.S. House of Representatives passed a bill with a wide array of economic relief measures. Then on Sunday the Federal Reserve Board took major actions to provide support for the American economy by lowering benchmark interest rates to near zero. But rather than react positively, global financial markets fell precipitously on Monday. Asian and European markets were all off significantly. In the United States, the Dow Jones Industrial Average ended down 12.94 percent, the S&P 500 was off 11.99 percent, and NASDAQ dropped an equally horrendous 12.32 percent. Markets are cumulatively down over 25 percent since mid-February.
Q: Why have markets not reacted more positively to the efforts of the Fed, Congress, and others?
As displayed below, a survey of CSIS experts (as well a survey on Twitter) found no consensus. Although the discussion is centered around the events of the past few days, the discussion speaks to larger questions about what would constitute a successful public policy response to the crisis. The differences of opinion highlight the central dilemma policymakers face about distinguishing between the root cause and symptoms of the crisis and to what extent responsibility for action sits with Washington, other governments, or a globally coordinated response. My CSIS colleagues and I will continue to update our analysis as additional policy measures are announced and actions taken.
A1: It’s the Virus, Stupid (William Alan Reinsch and Scott Kennedy)
While no doubt well intentioned, the various interventions so far by the Trump administration, the Federal Reserve Board, and the House of Representatives have neither calmed financial markets nor assuaged public uneasiness, which is bordering on panic. In fairness, other governments are not having much better luck. This is largely because the disease is so easily transmitted, but it is also a sign that governments around the world, including the U.S. federal government, have failed to create public confidence in their handling of the situation. Contradictory statements by different officials, unconvincing promises that are totally contrary to the facts, the lack of clear unified national guidance on everything from testing to “social distancing,” and the looming likelihood that the United States will not have the resources and equipment it needs to treat the victims when the pandemic peaks all have combined to effectively negate efforts to prop up the financial markets.
That does not mean those efforts have been useless, and it is entirely possible the situation would be even worse if they had not been undertaken, but it is clear they have not restored public confidence. Since this is at its root a public health crisis, not a financial one, efforts to stimulate and stabilize the economy are unlikely to be successful, no matter how large and well-coordinated they may be, until the other problems mentioned above have been addressed.
A2: A Good Start (Scott Miller and Stephanie Segal)
The Fed lowered its headline federal funds lending rate by a full percentage point, to 0-0.25 percent, returning the rate to 2008-2015 levels. With this move, central banks in Europe, Japan, and the United States once again have policy rates at or below zero. Further, liquidity provisions were expanded via an enhanced dollar-swap facility coordinated with six other central banks along with a 25 basis point (0.25 percent) reduction in the price of the swap and extended repayment terms; at least $500 billion in Fed purchases of Treasury securities and $200 billion in agency mortgaged backed securities; and expanded access to the discount window and encouraged commercial lenders to use capital and liquidity buffers to lend to customers.
Uncertainty has fueled a rush to the safety of the U.S. dollar, and the Fed’s actions to enhance liquidity should help markets find their footing in the face of widening bond spreads. Equity markets, however, remain volatile, with trading halted automatically twice in the past three trading days. Equity market movements reflect not only broader liquidity concerns, but also the fact that earnings – the “E” in price/earnings or “P/E” ratios that guide stock valuations – will decline, but nobody knows by how much. In this context, the immediate impact of the federal funds rate cut is unclear, but it represents a constructive step to address the risk that the economic downturn turns into a full-blown financial crisis. Despite the Fed’s significant actions over the weekend, more may still be needed, in particular to address the “sudden stop” of financial flows to parts of the financial system including many emerging market economies.
A3: More Coordinated Global Action Needed (Stephanie Segal and Matthew P. Goodman)
The pandemic itself makes clear the importance of coordinated policy actions, as a hotspot anywhere in the world poses a risk everywhere. Yesterday, the G7 announced its commitment “to coordinate measures and do whatever it takes, using all policy tools, to achieve strong growth in the G7 economies, and to safeguard against downside risks.” Finance ministers committed to coordinate on a “weekly basis” but were light on specific commitments to reduce uncertainty. Given substantial efforts by monetary authorities to deal with the crisis, including measures announced yesterday by the Federal Reserve to alleviate funding stress, markets are awaiting details on the magnitude and mechanisms for deploying a fiscal response, especially by the United States. While the bill passed by the U.S. House of Representatives over the weekend and pending in the Senate includes measures to provide direct support to workers, Treasury Secretary Mnuchin previewed over the weekend additional support to specific sectors which will also be part of the administration’s response.
While actions by G7 countries are critical, the grouping falls short of adequately covering the key players in the global economy, leaving out China, the world’s second largest economy; Russia and Saudi Arabia, two of the world’s three largest energy producers; and India, the world’s second most populous nation, among others. These countries are all members of the G20, which was elevated to the preeminent forum for international economic policy cooperation during the global financial crisis (GFC). Leadership by the current G20 president, Saudi Arabia, has been largely absent—indeed, their actions in the oil markets have only added to the economic distress—but the G20’s leadership role will have to evolve in order the meet the magnitude of the challenge.
A4: Do Not Blame the Bad Chinese News (Daniel H. Rosen)
U.S. financial market performance now reflects the credibility of the American system and its resilience in the face of COVID-19. The gyrations in markets have little or nothing to do, at this point, with exposure to China’s economic conditions. China’s January and February data released on March 16 told professional investors nothing they did not already know, other than how honest Beijing was prepared to be. Admitting starkly bad economic results in China frightened observers who have not been paying attention. That said, for analysts concerned about restoring trust and rationality to public policy, this bad news had a silver lining. All of us will have a dismal 2020; those who acknowledge the pathology—in finance, as in epidemiology—will have a better ability to remedy the damage because they are more likely to gain the confidence of investors, producers, and consumers.
Scott Kennedy is senior adviser and Trustee Chair in Chinese Business and Economics at the Center for Strategic and International Studies (CSIS). William Alan Reinsch is senior adviser and Scholl Chair in International Business at CSIS. Scott Miller is senior adviser with the Abshire-Inamori Leadership Academy at CSIS. Stephanie Segal is senior fellow with the Simon Chair in Political Economy at CSIS. Matthew P. Goodman is senior vice president, Simon Chair in Political Economy, and senior adviser for Asian economics at CSIS. Daniel H. Rosen is non-resident senior adviser with the Trustee Chair in Chinese Business and Economics and founding partner of the Rhodium Group.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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