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Nikolaj Schmidt, Chief International Economist
Investors fear central banks have reached the limit of their influence
– Nikolaj Schmidt, Chief International Economist
The Fed’s decision on Sunday, March 15, to slash its main policy rate by 100 basis points (bps) and announce at least USD 700 billion in asset purchases was followed on Monday by the Bank of Japan’s announcement that it aimed to double its purchases of exchange‑traded funds to JPY 12 trillion.
Despite these moves, which were without parallel since the global financial crisis, stock markets suffered heavy losses on Monday morning following a weekend of worsening news over the coronavirus. This implies that investors fear that central bank support is close to being exhausted and that a robust fiscal response to the demand shock remains elusive.
Elsewhere, the Bank of Japan temporarily doubled its annual target for equity purchases to JPY 12 trillion (USD 112 billion). The Reserve Bank of New Zealand cut its main policy rate by 75 bps
to 0.25%, and the Bank of Canada cut its benchmark lending rate 50 bps to 0.75%.
The steep declines in equity markets that followed the central bank moves over the weekend indicate that investors fear that central banks have almost reached the limit of what they can meaningfully do to support markets during this crisis. The Fed’s actions over the weekend were bold and may go far toward ensuring that money markets do not break down (which would be a calamity). The true impact of the Fed’s actions will become apparent in the coming days and weeks.
However, the bottom line is that, because this is a health crisis, there are limits to what monetary policy can do to alleviate it. Central bank actions to loosen financial conditions and address market dislocations are necessary, but not in themselves sufficient, to persuade investors to embrace risk assets at this point in time. Banks cannot keep economies afloat by themselves.
This means that it now ultimately falls to governments to provide a convincing fiscal response if market volatility is to be assuaged. Even fiscal policy may not be able to achieve much in the near term other than limiting the financial damage to corporations or households during this enforced period of economic hibernation. While this is obviously important, it may not calm markets immediately as fiscal measures tend to have low multiplier effects.
We believe that a negative fed funds rate is unlikely. The Fed continues to reiterate its aversion to negative rates, saying that they have not been successful in stimulating growth or inflation in the eurozone or Japan. Additionally, negative rates would likely inhibit the U.S. money markets, which are far more critical to the successful functioning of the U.S. economy than money markets and economies in other parts of the world.
However, U.S. Treasury yields could move below zero if demand for safe‑haven assets remains very strong.
– Ju Yen Tan Senior Portfolio Manager, Global Fixed Income
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