Fed Moves First to Counter COVID-19 Market Fears
Tuesday morning, the Federal Reserve surprised markets with an emergency interest rate cut of 50 basis points (bps). The Fed’s move is likely the first in a series of synchronized actions by the G-7 aiming to support developed market economies as the coronavirus continues to spread outside of China. The Fed’s move comes one day after a G-7 meeting in which finance ministers and central bank governors discussed the global economic effects of the COVID-19 outbreak. Even if we see a coordinated global approach from both developed and emerging markets, if the economy remains vulnerable, the Fed may still take additional action in the near future.
The Fed’s shock-and-awe approach was clearly intended to arrest the equity market correction and to stabilize broader financial conditions. Rate cuts cannot stop the spread of the virus, nor are they particularly well-suited to deal with supply chain disruptions; however, they can contribute to an environment where easy financial conditions buffer the economic shock, as opposed to exacerbate it.
First and foremost, the Fed wants to avoid a crisis of confidence that disrupts public credit markets and leads to an abrupt pullback in bank lending. Without Fed actions to ameliorate market panic, credit could tighten at the same time that weaker businesses run into cash flow problems related to the global disruptions in manufacturing and trade or domestic disruptions in travel and services consumption. Travel and tourism make up roughly 3% of the U.S. economy, while the largest metropolitan statistical areas (MSAs) collectively account for over 30% of U.S. GDP (source: Bureau of Economic Analysis). A U.S. virus outbreak that sharply disrupts activity in these areas could severely depress growth. And as we highlighted in our recent Cyclical Outlook, large areas of the corporate private credit market are especially vulnerable to a general deterioration in economic growth. Private credit, leveraged lending, and high yield markets hold large concentrations of debt in sectors that are highly cyclical. In addition, energy, transportation, gaming, hospitality, and airline sectors all appear vulnerable to a larger U.S. domestic outbreak of the disease, which would limit travel and tourism.