‘Shock and awe’ from the Fed — and the limits of easy money

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The U.S. Federal Reserve’s promise of unprecedented support for debt markets wasn’t enough to lift global stock markets on Monday, as a stimulus bill stalled in Congress and cases of the novel coronavirus continued to mount.

The S&P 500 fell 2.93 per cent, while in Toronto, the S&P/TSX dropped 5.26 per cent, as investors mulled the Fed’s “bazooka" of new initiatives.

Among other things, the U.S. central bank committed to unlimited buying of U.S. Treasuries and most mortgage-backed securities. It also revived a program to buy up debt securities backed by student loans, credit card loans and some small-business loans.

For the first time, the Fed said it will also buy corporate bonds, which it stopped short of doing even in the depths of the 2008 financial crisis. In addition, it will unveil a “Main Street business lending program” to lend directly to small businesses – something it has never done before.

The scale of the emergency measures sent observers scrambling for appropriate metaphors. Jim Paulsen, chief market strategist for Leuthold Group, called it “shock and awe from the Fed.” Michael Pearce, senior U.S. economist at Capital Economics, said it was turning “the easing up to 11.”

“It is difficult to find a superlative to describe what the Fed announced this morning,” Jim Bianco of Bianco Research wrote in a note. “At first blush, it looks like they are nationalizing financial markets, except for equities and high yield.”

No matter how you frame it, the Fed is going to heroic lengths to ensure credit markets remain open and money flows don’t seize up.

By agreeing to act as a buyer of last resort for a wide range of debt, the Fed is trying to prevent lenders from running for shelter because of the rising risk of defaults by cash-strapped businesses and consumers. If a large number of lenders were to pull back from making new loans or rolling over old ones, then borrowing costs on everything from home mortgages to business loans would skyrocket, dragging the current downturn into an even deeper spiral.

Unfortunately, the Fed can do only so much. Easy money, on its own, is not enough to revive a shuttered economy. If people aren’t working and businesses are closed, access to cheap loans may help cushion the blow, but it can’t spark a recovery.

For now, though, the Fed appears to be the only part of the Washington apparatus capable of decisive action. Congress is at loggerheads over a massive stimulus bill, while President Donald Trump is incinerating confidence with his erratic pronouncements on the crisis.

Fed policy makers, normally a buttoned-down group, are not mincing their words. Jim Bullard, president of the Federal Reserve Bank of St. Louis, told Bloomberg News on Sunday night that the U.S. unemployment rate may hit 30 per cent in the second quarter – higher than even in the Great Depression of the 1930s. He also said that gross domestic product may tumble by an unprecedented 50 per cent.

Private-sector forecasters are in the same ballpark. Goldman Sachs sees U.S. GDP shrinking at an annualized rate of 24 per cent in the second quarter, while Morgan Stanley predicts a 30-per-cent plunge. Whatever the exact figure, the quarter will nearly certainly be the worst on record. (By contrast, the worst period of the last financial crisis was the fourth quarter of 2008, when GDP slid at an 8.4-per-cent rate.)

If the virus is quickly brought under control, the worst of the downturn might last only a quarter or two. But by that time, many households and businesses could be insolvent. Restarting the economy would pose an enormous challenge.

Conventional monetary and fiscal policy are of only limited help against what is at root a medical emergency. As Citigroup global chief economist Catherine Mann has noted, the chain of events behind today’s troubles is the opposite of what transpired in the most recent crisis. In 2007, the problems began in the financial markets and moved into the real economy. This time, it’s a problem in the real economy that is infecting financial markets. So long as the virus continues to spread, financial markets are unlikely to find an equilibrium.

Stocks slid after the Fed’s announcement, suggesting it sees things in a similar light. The Fed measures “will neither stop the spread of the virus nor end the uncertainty around the extent of the economic fallout,” Jonas Goltermann of Capital Economics wrote in a note. “Our view remains that until there are clear signs that the efforts to contain the virus are working and the pandemic is being brought under control, equities and other risky assets will not rebound on a sustained basis.”

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