Stock market volatility over the past week has been unlike any in memory, and has become a direct reflection of the anxieties in the public mood. On Sunday, the Federal Reserve Bank took emergency action for the second time in two weeks to quell market fears. Faced with the growing economic uncertainties in the face of the coronavirus, the Fed announced its second emergency rate cut. Two weeks after cutting the Fed Funds rate by fifty basis points to 1.00% it dropped the rate to zero.
Whether they view it as a force for good or for evil, people tend to take the Fed for granted. For some, it is the wizard, the force behind the curtain responsible for boosting the economy when the economy and employment are flagging — it was the singular institution that steered the world through the global financial collapse just a decade ago — or cooling things off when inflation looms on the horizon. For others, the Fed is a dark force that messes with private markets that should not be messed with. From these quarters come regular calls to return to the Gold Standard, audit the Fed, or abolish it outright.
In the futures market — the shadow stock market where investors can express their sentiment when U.S. markets are closed — the Fed action did not go over well. In a brief flurry of activity, the Dow futures fell 1,000 points, to its maximum allowed 5% (see the red bar on the the right in the graph) — foreshadowing an even larger fall in the Dow at the Monday open.
The coronavirus has pierced the soft underbelly of our global economic order. There are so many things that we have come to take for granted, first among them is the orderly flow of commerce, be it food delivery services or global trade that brings, in this case, medications and hospital supplies from across the world.
Decades ago, during the long manufacturing decline of the 1970s and 1980s, I worked with a man whose ball-bearing business was teetering on bankruptcy, and would soon close. How, he asked, could a nation survive without domestic ball-bearing plants. They are an essential component for all manner of critical devices. It was inconceivable to him that a nation would allow its future to be dependent on receiving critical materiel from foreign sources.
Yet so it is today. We live in a fully integrated world, where we rely on systems to work, trade to move smoothly, and everyone to do their job. This is a fundamental premise of our just-in-time economy, and our just-in-time lives.
On Saturday, in the wake of a week of unprecedented volatility in both the stock and bond markets, Mohamed El-Erian, one of the Wise Men of the financial world, described the difficulty of integrating the coronavirus outbreak and the requisite changes that we may have to integrate into our lives. “Think of what is happening as a huge paradigm shift for economies, institutions and social norms and practices that, critically, are not wired for such a phenomenon. It requires us to understand the dynamics, not only to navigate them well but also to avoid behaviors that make the situation a lot worse.
“The bottom line is that the economic disruptions immediately ahead will be more severe and widespread than the ones experienced by the bulk of the population in advanced countries.
“We live in a global economy wired for ever deepening interconnectivity; and we are living through a period in which the current phase of health policy — emphasizing social distancing, separation and isolation — runs counter to what drives economic growth, prosperity and financial stability. The effects of these two basic factors will be amplified by the economics of fear and uncertainty that tempt everyone not just to clear out supermarket shelves but sadly also reignite terrible conscious and unconscious biases.”
Against that backdrop, the fading of the Fed represents one more institution upon which we have come to rely that may not be there going forward as we have come to imagine. By dropping its key short term interest rate to zero, and indicating at the same time that it will resume its bond buying that has come to be known as Quantitative Easing to try to reduce long term interest rates toward zero as well, the Fed has now thrown everything it has at the economy.
While this may be a good thing given the economic uncertainties that we face, the financial world does not seem yet to understand that when a true recession actually comes — something economists view as increasingly likely later this year — the Federal Reserve Bank will have little or no ammunition with which to seek to restore economic activity. As illustrated above, over the past half-century, the Fed has dropped interest rates by 500 basis points — 5.00% — as recessions approached. This was why Fed Chair Jerome Powell was so intent on raising the Fed Funds Rate over the course of 2018; if the Fed did not raise rates when the going was good, it would have no policy tools left when things turned south. Now, when the next recession comes, with interest rates already at zero, there will be nowhere left to go.
The stock market volatility that we have seen mirrors the anxieties that we all feel in the current historical moment. Investors, like the rest of us, have lost their capacity for patience. After each market move, they want to know if we have reached the bottom, if it is over yet. Like the rest of us, they want to understand how the coronavirus movie ends.
That uncertainty will be with us for a while, and then comes the longer-term question about what we learn from this. For the country and the world, knowing that coronavirus could foreshadow future similar pandemics, we will have to consider questions about the ramifications for global trade and global public health infrastructure. And then there is the Fed. Few in the investor world have considered the longer-term ramifications of the Fed actions this weekend, and the implications of a return to zero interest rate policies for the future. The realization that the Fed may be just the latest institution to lose its salience in our lives will not rest easy on the markets.
Follow David Paul on Twitter @dpaul. He is working on a book, with a working title of “FedExit! To Save Our Democracy, It’s Time to Let Alabama Be Alabama and Set California Free.”
Artwork by Joe Dworetzky. Check out Joe’s political cartooning at www.jayduret.com. Follow him on Twitter @jayduret or Instagram at @joefaces.