The COVID-19 outbreak has hit the world just as governments, central banks and financial markets in many industrialised nations were seeing hopes of a recovery in economic growth after a slow down in response to the effects of major geopolitical events last year – the US/China trade war, Brexit and escalating tensions in the Middle East.
Those hopes promised governments and central banks some latitude to ease fiscal policy (i.e. spend) and to hold steady on monetary policy (i.e. not to worry about having to further cut interest rates that are already at record lows, or in many cases negative). But, COVID-19 has dashed those hopes, for now.
Governments are having to loosen purse strings through unplanned public sector expenditure (e.g. at borders and hospitals) while witnessing a slow down (or, in some cases, a complete halt) in household spending and business production, which will translate into governments spending more and earning less.
Central banks are scrambling to identify the problems so that they can take action, just as they did when the GFC hit.
Financial markets are keenly waiting for central banks’ responses, confident that central banks can again come to the rescue of markets and economies. This time though, the problems are very different and so the required responses most likely will be very different, and central banks have less ammunition to call upon. The central banks’ interest rate quiver, at best, has one, maybe two, arrows left and the bow string is frayed. So, they must look at other targets and take other measures.
The dramatic falls in sharemarkets have rocked investor confidence with such force that bond and credit markets have also reacted forcefully. Cash exiting sharemarkets has gone into the safety of government bonds but there has been collateral damage by way of a sharp spike in market volatility, wider credit spreads and, more significantly, stymied primary and secondary market activity in the corporate bond markets. In the case of the US, the CBOE Volatility Index closed Friday at its highest since August 2015 and the US corporate bond market has all but ground to a halt.
Indications are that central banks are very worried about the impacts of this latest disruption on the liquidity and stability of banking systems, which carry higher priorities for central banks than managing inflation, unemployment and growth through monetary policy.
On Friday, the Chair of the Federal Reserve (Fed) Board, Jerome Powell, reassured markets that “the coronavirus poses evolving risks to economic activity” and that the Fed “is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”
Powell’s statement on Friday came a day after the Bank of Korea assured that “it will judge whether to adjust the degree of monetary policy accommodation, while thoroughly assessing the severity of the COVID-19 outbreak, its impact on the domestic economy, and changes in financial stability including household debt growth.” No mention of interest rates, rather a generic reference to “monetary policy accommodation” and a focus on “financial stability.”
Governments, central banks and (bank) economists are universally assuming that this will be a short to medium term event while planning for the worst over a longer period. Now is a time for governments and individuals to undertake reasoned and disciplined risk management planning, not to panic.